Money: Some of Everything for '84

It's a strange world we live in—a world in which, for instance, it has become cause for rejoicing in many quarters that our incipient economic recovery is slowing down. When the real rate of growth in the gross national product (GNP) slowed from 9.7 percent in the second quarter of 1983 to 7.7 percent in the third, many economists and government officials breathed an uncharacteristic sigh of relief. In November, sharp drops in housing starts occasioned more of this curious celebration. "Whew," economists said. "Thank goodness the economy isn't growing so fast."

After one of the longest and deepest recessions since World War II, you might think that everyone would be happy to just let her rip. But no. Indeed, the Federal Reserve avowedly set out to slow the recovery. And evidently it succeeded. Most forecasts for economic growth for 1984 are in the 4–5 percent range.

The reason for this perverse economic attitude, of course, is fear of inflation. And the fear is justified. The kind of monetary expansion permitted by the Federal Reserve from August 1982 through May 1983 to get the economy growing was, and to some extent remains, a very real inflationary time bomb.

Slowly, however, the tide of opinion seems to be shifting back toward concern about setting off another recession. The Reagan administration has loudly voiced its opinion that the Federal Reserve has become too tight. The danger is that, in responding to election-year political pressure, the Fed will overreact and return to excessive money creation.

As it is, monetary policy has probably been just about right—for once. The Fed's monetary aggregates were, in the final quarter of 1983, within a none-too-restrictive 5–9 percent target growth range. Looking at it from a longer-term perspective, both M1 (currency in circulation plus checking deposits) and the monetary base (cash plus bank reserves) had grown nearly 10 percent over the one-year period ending in mid-November. M2, a broader measure including savings and time deposits, had grown even more.

In the latter part of that year, the money supply was growing at 5 percent or less. If the Fed sustains that rate, there is some hope of maintaining the low (3–4 percent) inflation rate without damaging the economy too badly.

Unfortunately, there is a high likelihood that the Fed will veer from this moderate course because of (you guessed it) the budget deficit, which is expected to remain at least $185 billion next year even with the recovery-induced increases in revenues. The deficit will probably continue to absorb at least 75 percent of net national savings. Treasury financing will increasingly clash with private credit demands as the recovery matures. Long-term capital projects in particular will suffer, as indeed they have been neglected for some time.

Lawrence Kudlow, the former associate director of the Office of Management and Budget for Economic Policy, who now heads up an economic consulting firm, says that the budget deficit presents the Fed with a monetary policy choice "between bad and worse." Either "low money growth to fight inflation will clash with heavy borrowing, keeping real interest rates high and real growth low," says Kudlow, "or loose money to accommodate the deficits and produce faster growth will reignite inflation, with a flight from dollar assets and a financial-market crisis."

The Fed's choice, most likely, will be to risk inflation in an attempt to forestall another recession. And traditionally, the Fed does inflate during election years.

What does this mean for investors? It probably will mean that those good yields on money-market accounts and Treasury bills will diminish even if interest rates rise somewhat. The real interest-rate premium cannot remain as high as it is.

That means that the dollar, which will also be increasingly buffeted by soaring trade deficits, will (finally) fall dramatically. It also means good news for precious metals. The November fall of gold and silver to under $380 and $8.50 per ounce, respectively, was probably the last bit sell-off and probably the last time we will ever see those metals so low—before the bull trend takes hold. Some analysts see precious metals at twice those prices within a year's time.

Ironically, a recurrence of inflation may not unduly damage the stock market. So long as the recovery continues, the bull market on Wall Street could continue.

Louis Rukeyser, host of the Public Television System's Wall Street Week, sees inflation coming back with certainty. Nevertheless, he forecasts a strong economy and a strong stock market for the remainder of the decade.

"The rich people of 1993 are buying stocks in 1983," Rukeyser told me in a recent interview. Despite the huge runup in stock prices that has already taken place over the past year, he thinks "we're still in the early stages of an historic bull market."

"To succeed in investing you don't have to get in at the bottom and get out at the top," he told me. "You just have to determine whether we're closer to the basement or to the roof." His conclusion is that "we're no longer in the subbasement, but we're still on the ground floor."

Although it doesn't seem plausible that stocks and metals should rise together, there is precedent for it. At any rate, it's wise to carry a balanced portfolio and be prepared for either to move.

Steve Beckner is a financial reporter and columnist for the Washington Times and the author of The Hard Money Book.