Economic indicators do not point
to a market drop this year
Gerard Jackson
Readers frequently ask me for market tips. If I knew half as much about the share market as they seem to think, I would be richer than Bill Gates. Unfortunately, economics is not a discipline that tells one how to get rich or which stocks to buy. But that doesn’t mean it has no predictive power, even though that power is of a qualitive kind that is confined to predicting patterns or trends.
What concerns many observers of current market conditions is the state of the American dollar. They consider the dollar overvalued and ready for a severe correction that will have a damaging affect on share prices.
Economic history has taught me many things, one of which is that powerful economies can maintain overvalued currencies for a remarkable length of time. As for devaluation, this need not occur directly. If other countries start inflating at a faster rate than the US the dollar might actually rise in comparison.
The reality, of course, is that all the currencies are falling in value. This phenomenon would conceal from most people the fact that the dollar was still falling. In other words, currencies are falling at different rates, despite apparent favourable movements in exchange rates.
It goes without saying that a number of factors could influence the dollar rate. There is the economic situation in Europe. With Spain electing a socialist government and France and Germany stagnating the demand for US dollars could rise.
Rising commodity prices is another factor at work. Analysts are arguing that strong global demand is pushing up prices, particularly oil. Prices are not being pushed up but pulled up by loose monetary policies. Austrian analysis stresses that loose monetary policies tend to influence commodity prices before making themselves felt in manufacturing and then through the rest of the production structure.
(Austrians, as some critics charge, do not ignore the fact that ‘cheap money’ policies can influence consumption before they stimulate the higher stages of production. On the contrary, they point out that stimulating consumption will retard economic recovery).
The rise in commodity prices strongly suggests to me that the Fed’s ‘cheap money’ policy is igniting another boom. The Fed has pushed short-term interest rates down to a 45-year low, leaving the federal funds rate at 1 per cent. This has lowered the commercial banks’ prime rate for many short-term consumer and business loans to 4 percent, the lowest rate since the early sixties.
Therefore I would have expected these low rates to encourage mines to increase their output and factory production to expand. Last Monday’s Fed report seems to indicate that this is happening.
The Bush tax cuts complemented the effects of the Fed’s monetary policy. Cutting the tax rate on dividends to 15 per cent boosted investors’ savings. Now these cuts provided a clear demonstration that changes in taxes change behaviour; businesses that hoarded cash are now paying it out to their shareholders, some of them for the first time.
High corporate tax rates combined with the destructive effects of the double taxation of dividends distorted investment decisions by encouraging firms to hold on to their returns. Freeing up this cash will provide additional saving for new ventures and so add to the economy’s flexibility.
Current stock yields are a conundrum for some commentators. Although yields are particularly low historically, analysts emphasise that the rise in share prices during the boom the artificially lowered the yield. This is true, as far as it goes. However, though overall yields are pretty low Dow stock yields appear comparatively high.
Business Week recently observed that "earnings from continuing operations at S&P 500 companies . . . leaped 28 percent, compared with the year-earlier period." That firms are paying out dividends indicates that they are increasingly confident that profits will continue to rise.
This brings me to last week’s BrookesNews where I dealt with the so-called problem of the productivity-unemployment riddle in which I once again stated that the upsurge in productivity must translate into an increased demand for labour.
I pointed out that part of the demand lag for labour could be due to a lack of confidence by companies in the future of profits. As that no longer appears to be the case, I expect the demand for labour to start rising. The recent result of a survey by Manpower Inc. seems to support this view.
What this comes down to is that share prices could continue to rise right into 2005 as excess capacity falls, investment rises and output and productivity continue to increase. Barring unforeseen events, such as a savage increase in energy prices, I think current indicators suggest that a severe drop in share prices later this year is highly unlikely.
The downside is that loose monetary policies eventually result in a bust. One only has to think of the consequences of the Johnson administration’s monetary policy to get a good idea of where the US economy is heading.
On a final note: some supply-siders argue that even though cutting taxes stimulates economic growth the economy still needs an accommodative money supply to create enough liquidity to fund new projects and generate investment incentives.
This is dangerous economic nonsense: the same nonsense that brought on the Great Depression and gave us the Clinton boom and bust. This fallacy that the classical economists disposed off so long ago is now paving the way for another recession.
22 March 2004
BrookesNews.Com
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