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Very interesting story from Reuters.
JW
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Sunday December 12 1:28 AM ET
Y2K Paranoia or Greenspan's Irrational Exuberance?
By Pierre Belec
NEW YORK (Reuters) - The stock market just keeps on climbing and Federal
Reserve Chairman Alan Greenspan has been making a massive amount money
available in the financial system.
Is it irrational exuberance or Y2K paranoia? Or Both?
Greenspan has permitted the biggest expansion of money supply in the Fed's
history in the weeks leading up to the end of the year, when the so-called
Y2K computer bug could disrupt financial systems.
The Fed's move has been explosive on Wall Street because a free flowing
money faucet at the Fed boosts confidence in the financial system, and the
economy at large, and is the stuff that makes bull markets get bigger.
M3, the Fed's broad definition of money, which includes currency, travelers'
checks, bank deposits and money market mutual funds, has climbed $194
billion over the past 13 weeks -- the biggest increase ever. The money
supply increased at an annualized rate of 15 percent, which is well above
the Fed's target growth rate of only 5 percent.
Just a week ago, M3 went up a huge $36 billion, which would seem to indicate
that the central bank is buying insurance against some possible disruptions
as the calendar changes from 1999 to 2000, analysts said.
``The money supply has gone through the roof and the increase, adjusted for
inflation, is the biggest in the nation's history,'' said Don Hays,
president of The Hays Market Focus Advisory Group, an investment consulting
firm.
``The Fed may be flooding the nation with cash because of jitters among
central bankers that the Y2K computer bug could do more damage to the
financial system than most people expect,'' he said.
``I just don't have another excuse other than Y2K to imagine why the Fed
would flood the system, unless there is something that's happening behind
the scenes that we don't know about,'' Hays said.
``This huge liquidity is the reason for the big rally in stocks since
October,'' Hays said. ``It's a replay of the market's run-up exactly one
year ago, when the Fed rushed to flood the system after the panic from the
Russian loan default and the Long Term Capital Management hedge fund
disaster.''
The Fed came to the rescue of the LTC fund, which teetered last year on the
brink of bankruptcy due to the global market turmoil. The fund's losses
threatened to slam the financial system, which in turn could have hurt the
economy.
But the increase in money supply and financial system liquidity may also
``reflect Greenspan's thinking that the stock market is on a very unstable
foundation because of valuations and Y2K might be the trigger that could
keep it from coming down softly,'' Hays said.
One of Greenspan's goal's over the last four years of extraordinary gains in
stocks has been to ``talk'' the market down, or to set the mood for the
market to come down from its lofty levels in a gradual way and to avoid a
panic on the Street, which would demoralize business confidence. But the
market has not yet suffered a serious reversal.
And the Fed may fear that Y2K could be the thing that could yet punch a big
hole in the market bubble, analysts said.
Three years ago, in December 1996, Greenspan sent global stock market
reeling with a comment about investors' ''irrational exuberance,'' and Wall
Streeters now say the Fed head is not practicing what he preaches.
There are few signs of panic in the run-up to the new year, when computers
may confuse the year 2000 with 1900, messing up date-sensitive functions.
Corporate America says it is confident that it has fixed the Y2K problem,
but the Fed is apparently not taking any chances.
The concern is that disruption on a large scale could stun corporate
earnings, slam the stock market and drive the economy into recession,
analysts said.
``We don't have the slightest idea how Y2K is going to play out,'' Hays
said. ``From listening to all the 'informed' sources, I have to come to the
conclusion that no one else does either.''
Paul Kasriel, chief U.S. economist for Northern Trust Co. in Chicago, said
there is no doubt that the cash from the Fed has been the elixir for the
market's rally.
``People are not borrowing just to stuff the money in their mattresses,'' he
said. ``They borrow to spend and it ain't a coincidence that the stock
market has picked up as the money supply has exploded.''
The Fed can boost confidence in the financial system and make the economy
grow faster by making more money available to banks, which eventually leads
to cheaper loans.
It can also discourage lending when the economy grows at a fast clip, and
threatens to fuel inflation, by withdrawing money from the banking system,
or by raising short-term interest rates.
Kasriel said the money supply growth was revved up in October, which is
about the time that stocks began their recovery from a selloff that threw
the Dow Jones industrial average for a loss of 1,300 points -- a classic
correction of 10 percent -- between September and mid-October.
The other major market gauges were also battered, with the Standard & Poor's
500 index slumping 12 percent and the Nasdaq Composite index skidding more
than 6 percent.
Since then, the Nasdaq has been rewriting the record books, making highs on
an almost daily basis. In addition, the S&P last week hit a new high while
the Dow Jones industrial average came within less than 50 points of beating
its Aug. 25 record of 11,326.04.
``Without the money supply growth, I am convinced that the market would be
in much weaker shape at this time,'' Hays said.
Kasriel said that things could get interesting for the market next year as a
result of the Fed's action.
``The Fed may choose to ignore the rapid growth in credit and money that it
has a hand in creating,'' he said. ``But investors ignore it at their own
peril.''
Kasriel said that, unless the Fed can rope in credit demand, it will have to
raise interest rates more than the half percentage point that he has been
expecting in the year 2000. The Fed this year has already boosted interest
rates by three quarters of a point.
``It is beyond me how the stock market could continue to be immune to
further increases in both short-term and long-term interest rates,'' he
said.
So the big question is: Will the 73-year old Greenspan leave his job the
same way he came in, in 1987, with a stock market crisis?
For the week, the Dow Jones industrial average was down 61.48 points at
11,224.70. The Standard & Poor's 500 index was off 16.26 points at 1,417.04
and the Nasdaq Composite index was up 99.65 points at 3,620.25.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com).
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