Econ 101: Betting on the Media or the Market?

     The stock market is reflecting the strength of the American economy. The Dow broke 13,000 on April 25 for good reason.

     Corporate earnings are strong, the economy is growing, tax revenues are up and the federal budget deficit is shrinking. Yet the media continue to try to find bad news or to pretend that somehow market participants are misguided.

     Should we bet on the market or the media?

     The day after the Dow reached 13,000, the Media Research Center pointed out how CBS and ABC both reacted to the Dow reaching its historic high with stories that implied the economy is weaker than anyone believes. CBS and ABC emphasized a housing slump and rising gas prices.

     So let’s take the housing slump first. Indeed there is a problem in the subprime lending market, something not unrelated to the willingness of Fannie Mae to purchase subprime mortgages and federal government programs to encourage people to purchase homes rather than rent.

     However, the problems lie in a small portion of the total housing stock. Even if every subprime loan defaulted, the houses would not disappear. They would remain as assets. All we are facing is a short-term cash flow issue that will temporarily dampen demand for housing, slowing the growth of housing values. This does not indicate a fundamental problem with the U.S. economy or indicate a recession is in the offing.

     Meanwhile, gasoline prices are rising because of increased demand along with government restrictions on refining gasoline. Increased demand for oil and gasoline is a sign of increased economic activity, not falling economic activity.

     The run up in gasoline prices has been affected on the supply side by government regulation. Government forces gasoline companies to alter blends in the summer months and limits companies’ ability to open oil refineries. These also are not indications that the private economy is retreating; rather, the government is overreaching.

     How are our fundamentals doing? Gross domestic product, the most-used measure of the amount of production in the economy, is rising. It rose at an annual rate of 2.5 percent in the fourth quarter of 2006 and by 1.3 percent in the first quarter of 2007 to reach a record level of $13.6 trillion.

     Current dollar personal income rose by 4.7 percent in the fourth quarter of 2006 and by 9.2 percent in the first quarter of 2007. These are not indicators of an economy in danger of a recession.

     Unemployment numbers certainly don’t indicate a faltering economy. Non-farm payrolls rose in March by 180,000 to drive unemployment down to 4.4 percent. The monthly jobless figure has been between 4.4 percent and 4.6 percent since September 2006.

     Some much-needed perspective: the most recent unemployment rate in Britain is 5.5 percent; in Canada 6.1 percent; France 8.2 percent; Spain 8.6 percent; Germany 9.2 percent; and Poland 14.4 percent.

     The economy remains strong because the underlying fundamentals for growth are in place. The government reduced tax rates on savings and investment in 2003, and this remains a major factor in our economic growth. Technology is advancing at an increasing rate, reducing production costs and increasing the type and number of goods and services available.

     The primary threat to the American economy is poor public policy. If the Bush tax cuts are left to expire by the Congress, and if Congress becomes enamored with an activist regulatory agenda, then the incentives to innovate and produce and the cost of producing will be upended – and the economy and the stock market will tumble.

     Recent revenue figures should reduce the pressure for a tax increase. Federal tax revenues have been surging since the 2003 tax cuts. Tax revenues were $2.479 trillion for the 12 months ending January 2007, up $255 billion from the previous 12 months.

     The estimate for the federal deficit has declined to $117 billion for FY 2007, and the number is likely to come in significantly below that. Without a major increase in federal spending, the budget should be balanced by FY 2009. This will lessen pressures on interest rates as well as reduce political pressure for a tax hike that would push the economy in a negative direction.

     The media continue to search for a reason to doubt the wisdom of traders who put their own money at risk in judging the strength of the economy. The Dow is up as I write this more than 136 points since it reached the 13,000 mark. As long as Congress provides a climate of low taxes and reasonable regulation, we can expect another year of 3- to 4-percent growth in the economy, and a rise in the Dow of double digits. My money is on the market.

Dr. Gary L. Wolfram is the George Munson Professor of political economy at Hillsdale College in Hillsdale, Mich. He also serves as an adviser to the Business & Media Institute.