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Long-Term Crisis with a Short-Term Remedy

What an astounding difference 20 years can make! Twenty ago, I was a short-term pessimist and a long-term optimist. Today, the reverse is true. Why the about-face? In the waning days of the Carter administration, the U.S. economy was in shambles and unraveling at the seams. It was easy to be a short-term economic pessimist. After all, inflation was at double-digit rates and rising. Oil prices were predicted by some so-called experts to be headed toward $50 to $200 per barrel. Mortgage rates were at 18%. But economists understand that short-term interest rates like the prime rate cannot coexist very long at 22.5% with long-term bond rates like 30-year Treasuries at 12%. Rate inversions, especially of this magnitude, reflect significant distortions that carry the seeds of their own undoing. Similarly, in those dreary days, the Consumer Price Index had accelerated to 13.5% with real GDP advancing at 1%, another disequilibrium condition with no long-term future. Finally, the OPEC oil cartel--helped along by earlier wrongheaded U.S. policies of wage and price controls--had succeeded in driving up gasoline prices to record levels. But again, economists know that rising oil prices create strong incentives for cartel members to cheat on production quotas, there-by bringing prices crashing down again. And indeed, the misery of the late 1970s and early 1980s gave way to glorious growth in the 1980s and record expansion in the 1990s. In contrast, the short-term outlook today is excellent. The U.S. economy has lust about everything going for it: freer trade and an unparalleled network of global distribution that can take goods made on the other side of the earth and put them on a U.S. Wal-Mart shelf in less than 30 hours (and have 63% of the items sold before the invoice is even due!). The U.S. is at the top of its game in technology and is the beneficiary of immense in-migrations of capital and top-flight human resources. The U.S. is fortunate to have finally landed a Federal Reserve Board of Governors that treats as first priority a stable price level. Moreover, we have also been fortunate to have gridlocked the administrative and legislative branches of government for long enough to contain federal spending at a 3% pace over the past six years, compared with nearly 3.6% real GDP growth. Finally, U.S. demographics over the next 8-10 years unequivocally favor solid growth in income, employment, saving, and investment. …