Correction, Please!

The Perversity of Wall Street

Mark Skousen is editor of Forecasts & Strategies, one of the nation’s largest financial news letters, and an economist at Rollins College, Winter Park, Florida 32789. His book, Dissent on Keynes, is available from Laissez Faire Books, (800) $26-0996.

“Strong employment gains tend to be negative for both stocks and bonds.”

—Marty Zweig, The Zweig Forecast

July 29, 1994

GDP rises 5 percent? The market dives! Unemployment jumps to 7 percent? Hurray, bonds rally!

Why is it that good news on Main Street is bad news on Wall Street? And vice versa? Financial analysts and institutional investors are convinced that strong economic performance is bad for the financial markets. High economic growth or good jobs reports can only mean higher inflation down the road, they assume, which in turn will force the Federal Reserve to tighten money and raise interest rates. Presto, stocks and bonds decline on good economic news.

The real culprits, says The New York Times (“Why America Won’t Boom,” June 12, 1994), are the bondholders of America. “The American economy is governed by the bond market,” Louis Uchitelle writes in The Times, and “the confederation [of bondholders] has ruled in recent months that the economy should lose strength, not gain it.” Another recession may not be good for the country, but it’s great for bondholders as interest rates decline and bond prices skyrocket.

No wonder Wall Street suffers from a tarnished public relations image.

Surprisingly Good News

Fortunately, there is good news for both Wall Street and Main Street. Believe it or not, the United States can enjoy a booming economy without interest rates rising. In fact, interest rates can decline under the right circumstances, even as the demand of business expansion increases.

Latin America and many other emerging market economies have proven that economic growth and lower interest rates can go hand in hand. In Mexico, Chile, India, and many other rapidly developing nations, interest rates have declined in the face of strong economic expansion and a rising standard of living. How? While pursuing anti-inflation policies, their governments have cut tax rates, privatized government services, reduced tariffs, welcomed foreign capital, and deregulated business. In addition, some countries (such as Mexico and Argentina) have eliminated capital gains taxes altogether, thus encouraging saving and investing.

The Trouble with Easy Money

Unfortunately, the United States and other industrial countries are not following these sound principles of free-market capitalism. Instead, they are relying primarily on “easy money” policies to stimulate economic growth. If a strong economic recovery is spurred by easy-money/low-interest rate policies, the fear of inflation is very real when the economy heats up. Hence, interest rates tend to rise once an inflationary boom gets started.

That is precisely what has happened in the United States during the early 1990s. To get the economy moving again, the Fed pushed short-term rates down to 3 percent, encouraging millions of savers to switch out of bank deposits and CDs and into stocks, bonds, and mutual funds. Obviously, this artificially low interest rate strategy could not last forever. As the Austrian economists point out, an inflationary policy will eventually raise interest rates and cut short the recovery. A boom must lead to a bust. In the first half of 1993, interest rates started increasing in the face of rising inflationary expectations.

Prosperity by Other Means

The key is to spur genuine economic growth by means other than easy money and artificially low interest rates. How then? By encouraging higher rates of saving and capital formation. This could be accomplished very easily by reducing or eliminating taxes on businesses, savers, and investors. A sharp reduction in the capital gains tax rate and the corporate income tax rate would do wonders for economic growth without raising interest rates. So would exemptions on interest and dividends, or expanding tax-deferred retirement programs.

As a result, the supply of saving and investment capital would expand, putting downward pressure on interest rates. Again, as the Austrian economists demonstrate, a longer-term time preference, as reflected in higher rates of saving, tends to drive interest rates lower.

Then, we could put an end once and for all to this myth on Wall Street that a booming economy necessitates higher interest rates.

Someday, when the United States gets its act together, we can look forward to this headline: “GDP jumps 10%. Dow skyrockets to 30,000, surpasses Nikkei.”

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