Larry Kudlow is Wrong!

Online, December 28, 2009 (Newswire.com) - Larry Kudlow is predicting a strong V shaped economic recovery in 2010. His reasons for this prediction are a steep positive yield curve and the rising stock market. While Mr. Kudlow is a top notch economist and I appreciate his optimism, here is why I believe he is wrong.

Yield Curve
A steep positive yield curve is not necessarily a good predictor of the strength of the economy. As seen in the chart below, the yield curve was positive and above the 80 year average throughout the 1930s and this did not portend strong economic growth.

For the chart see
(Source: http://seekingalpha.com/article/23870-an-80-year-yield-curve-history-and-its-implications (12/24/09), An 80-Year Yield Curve and its Implications, Shaw, Richard, "Seeking Alpha." or http://hallingblog.com/2009/12/29/larry-kudlow-is-wrong/

In the 1970s, the yield curve was positive and above the 80 year average for much of the decade and this did not portend strong economic growth. The 60s saw the yield curve below the 80 year average and negative twice, which did not signal weak economic growth.

A steep positive yield curve in a free market would indicate that banks and investors are bullish on the economic prospects for the future. This would result in banks being willing to invest in businesses. However, in the present case the weakness of the bank's balance sheets will make them reluctant to loan money to small businesses. In addition, I do not believe that the steep yield curve is indicative of investors' willingness to put money into start-up companies, but the product of the Federal Reserves manipulation of the money supply.

Stock Market
The recent run up in the stock market is highly correlated with the falling dollar. For most foreign investors there has been no increase in value of U.S. equities denominated in their currencies. The rise in the stock market is not a vote of confidence in the economy of the U.S., but a product of the weak dollar.

Uncertainty
The passage of the heath care bill, the potential passage of the cap and trade bill, and never ending series of tax, spending, and regulatory proposals by the Obama administration are creating uncertainty. This uncertainty is significantly hampering investment in the U.S. A historical parallel is the 1930s under FDR, which had a steep positive yield curve and uncertainty produced by a president who tried to micromanage every aspect of the economy.

Invention & Investment
Since 2000 we have significantly weaken our patent laws and there are proposals in front of Congress and cases in front of the Supreme Court that may further weaken them. This has significantly reduced the investment in technology start-up companies in the U.S. Technology innovation is the only way to increase real per capita income. In addition, Sarbanes Oxley continues to make it almost impossible for a technology start-up company to go public in the U.S. This significantly reduces the potential returns for investing in these types of companies. Without policies that promote entrepreneurial innovation, the U.S. will see anemic economic growth at best.

Conclusion
While the U.S. may see a bump in economic growth due to inventory rebuilding, it is unlikely to see a vigorous V shaped recover in 2010. In order for the U.S. to have strong sustained economic growth, we will need to strengthen the value of investing in technology start-up companies.

Dale B. Halling is the author of The Decline and Fall of the American Entrepreneur: How Little Known Laws and Regulations are Killing Innovation. The book, now available on Amazon, discusses how technological innovation is the key to increasing real per capita incomes and how we have crippled this engine of economic growth with little known laws since 2000.

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