June 18, 2004,
Thereís a lot of angst these days over the threat of rising inflation. Sensitive market prices are saying donít worry about it, but economists are worrying nonetheless. Should you worry, too? No. Markets are smarter than economists.
Key leading indicators are showing 5 percent to 6 percent real growth of gross domestic product this year with roughly 2.5 percent inflation. This is quite a good scenario. Itís a pro-stock market scenario. Itís a pro-growth scenario. Itís an anti-budget-deficit scenario. And itís a George W. Bush-for-president scenario.
Liquidity and inflation indicators do not suggest that virulent inflation is headed our way. The mere hint of a slightly less-accommodative policy from the Federal Reserve has driven down the prices of gold and other metals by roughly 10 percent this spring. (Commodities, remember in particular gold are leading indicators of changes in general price levels.) And even with rising energy prices, the Commodity Research Bureauís broad-based futures index has declined about 6 percent.
True enough, consumer prices have moved up to 3 percent and producer prices have jumped to 5 percent. However, buried inside the latest producer price report, crude materials (less food and energy) have registered a 19 percent annual decline rate over the past three months, picking up the recent commodity weakness. The 10-year Treasury another inflation-sensitive indicator is hovering around a historically low yield of 4.7 percent.
All of this suggests that the current inflation rise will prove to be moderate in scope and relatively short-lived in its duration.
The Fedís emergency liquidity injections of 2003 and early 2004 have fed through to higher inflation faster than the central bank expected. So the Fedís open-market committee intends to remove this liquidity in the months ahead. Good. In all likelihood we can expect one-quarter-point increases in the fed funds base policy rate at each meeting over the next year and a half. Thatís a measured removal of excess liquidity.
But letís not forget some important counter-inflationary factors that are alive in the economy. At lower tax-rates, the economy will supply more investment and output. Therefore, if inflation is caused by too much money chasing too few goods, we can expect stepped-up production of goods and services to reduce inflation from the supply-side.
Strong productivity-growth trends similarly increase the economyís potential to grow. This factor also reduces the economyís cost structure, as do the Bush tax cuts. Hence, more goods will absorb excess liquidity.
The combination of a mild dose of monetary restraint along with faster economic growth should act to moderate inflation pressures. Itís a good policy mix, and one that will produce GDP growth of 4 percent or more over the next few years with inflation just above 2 percent.
Politically, however, itís the near-term economy that counts. The sense has been that the fledgling Bush boom has not yet registered with the public at large. But not so fast.
Scott Rasmussenís latest nightly tracking polls show that 49 percent of most-likely voters trust Bush more on the economy, while only 41 percent trust Kerry. On national defense, 54 percent prefer Bush while only 38 percent are for Kerry.
In the latest Investorís Business Daily/TIPP poll, 57 percent of respondents see Bush as a strong leader versus 42 percent for Kerry; 83 percent believe Bush stands firm on his beliefs, while only 48 percent see Kerry that way; and intensity among Bush voters is 70 percent, while Kerry gets a lukewarm 44 percent.
A strong stock market will also help tilt the scales toward Bush this November. And there are three reasons to be bullish on the stock market. First, the economy is growing rapidly. Second, corporate profits are rising rapidly. And third, George W. Bush is the pro-growth candidate standing firm with pro-investor tax cuts. The stock market will want him back for another four years and will rally to this end.
The most accurate gauge of recent election results going back to 1988 is the Iowa Electronic Presidential Winner-Take-All Market. This pay-to-play market has a better track record than the polls. Why? According James Surowieckiís new book, The Wisdom of Crowds, the collective wisdom of ordinary people is smarter than the tabulations of the elite polling experts. Surowiecki specifically points to the Iowa market trading system as a superior election forecaster to the polls.
So, whatís the Iowa market telling us now? The Bush ďcontractĒ is currently trading at 54 cents on the dollar, while the Kerry contract is exchanging hands at 47 cents. Since trading began on June 1, Bush has steadily held this lead. There you have it. The market speaks.
Larry Kudlow, NRO's Economics Editor, is CEO of Kudlow & Co. and host with Jim Cramer of CNBC's Kudlow & Cramer.