Why $3 gas won't slow the US economy

As all the pollsters are telling us, there's an inverse relationship between rising gasoline prices and President Bush's falling approval ratings - most especially his approval rating on the economy. Of course, these polls describe a certain national angst over energy that harkens back to the dreadful 1970s. But there's a better reality out there: Namely, the upturn in gas prices simply is not stopping the economy the way it did three decades ago.

Today's economy may be the greatest story never told. It's an American boom, spurred by lower tax rates, huge profits, big productivity, plentiful jobs, and an ongoing free-market capitalist resiliency. It's also a global boom, marked by a spread of free- market capitalism like we've never seen before.

The political resolution to the disconnect between fear (high energy prices) and reality (a great economy) remains to be seen. But as the data keep rolling in, the economy continues to surpass not only the pessimism of its critics, but even the optimism of its supporters.

Recent data on production, retail sales, and employment are stronger than expected. The latest durable-goods report shows huge gains in orders for big-ticket items such as airplanes, transportation, metals, machinery, and computers - even cars and parts. These orders suggest that the economic boom will continue as far as the eye can see. And there's more: The backlog of unfilled orders, the best leading indicator of business activity, gained 12 percent at an annual rate in the first quarter. With this kind of real-world corporate activity in the pipeline, highly profitable businesses will be doing a lot of hiring in the months ahead in order to expand plant and equipment capacity.

As for the energy angst, President Bush recently outlined a sensible pro-market mid-course policy correction. He is suspending the ethanol tax mandate that forced gasoline distributors to switch to the corn-based fuel from the MTBE oxygenate. This ethanol regulation was one of the great energy-policy bungles of all time. Neither refiners nor transporters were anywhere near ready to implement this misguided mandate, which drove up pump prices by 50 cents in just a few weeks.

But with Mr. Bush's recent action, futures prices for unleaded gasoline are already retreating, and it wouldn't surprise me if the whole ethanol price hike effect was reversed. Crude oil is also declining in the aftermath of the Bush announcements, which included the decision to stop the crude-oil fill rate for the Strategic Petroleum Reserve. At the margin, government deregulation is giving markets more latitude - always a good thing.

The big point here is that free markets work. Rising prices from the global boom will lead to more conservation, less consumption, and more production, but only so long as government stays out of the way. Instead of blaming ExxonMobil for high gas prices, irate motorists and voters should blame Congress for mandating, regulating, and taxing against energy.

Indeed, bashing big oil won't create a drop of new energy. Actually, over the past 15 years, ExxonMobil's total investment has exceeded the company's earnings, according to Washington analyst James K. Glassman. Meanwhile, all the evidence from time immemorial shows that gas prices are set by market forces, not manipulation at the production level. So-called price gouging is nothing but a political red herring. Windfall profits taxes and special tax subsidies will only diminish energy investment, not increase it.

Energy is best left in the hands of the free market. With this in mind, Congress should allow environmentally friendly drilling in the Arctic National Wildlife Refuge and the Outer Continental Shelf, the building of more LNG terminals, and the creation of nuclear power facilities. Deregulation works: Just look at the boom in Canadian oil sands.

Bush can also build on his new energy policy with more pro-growth measures that will extend the economic boom: Get rid of the ethanol tax for good. Repeal the tariff on imported ethanol from Brazil and elsewhere. Repeal the multiple taxation of dividends and cap gains. And abolish the death tax while you're at it.

Exercise the budget veto pen to stop bridges and railroads to nowhere. Go back to the Reagan economic model of a strong dollar to hold down inflation and lower-tax-rate incentives to promote economic growth. That model will work as well today as it did 25 years ago, when it launched the long prosperity boom we continue to enjoy.

Most of all, let free markets work. This is the new worldwide message of freedom, prosperity, and optimism.

• Lawrence Kudlow is CEO of Kudlow & Co., an economic and investment research firm. ©2006 Creators Syndicate Inc.