|
PureBytes Links
Trading Reference Links
|
Too much confidence in the supposedly omnipotent AG?
JW
---------
http://www.businessweek.com/@@YGnANWYQQG8RvgAA/premium/00_14/b3675107.ht
m
NEWS: ANALYSIS & COMMENTARY
Greenspan's Dilemma
The more confident investors are in him, the harder his job becomes
Since taking office as the nation's top banker 13 years ago, Federal
Reserve Chairman Alan Greenspan has managed to foster ever-stronger
confidence. Through stock market crashes, global financial crises, and
the emergence of a New Economy in which the old rules about growth and
productivity have gone out the window, he has fine-tuned Fed policy with
nary a miss.
But now the Fed chief may be suffering from a rare malady: too much
credibility. Investors have so much faith in Greenspan's ability to keep
the economy growing rapidly without inflation that they're ignoring all
his bearish warnings about the need to slow growth. Shrugging off the
Fed's rate hikes, they're snapping up stocks and bonds as if today's
white-hot growth and extremely low inflation are a permanent condition.
Call it exuberant irrationality: On Mar. 21, the day of the Fed's latest
quarter-percentage-point increase in the target federal funds rate, the
Dow Jones industrial average soared 227 points. Bond prices rallied
across the board, pushing the 30-year Treasury bond's yield decisively
below 6% to its lowest level in seven months. Behind the rally: relief
that the Fed didn't raise short-term rates by a half point--and
confidence that the good times will keep rolling. ''The central bank's
credibility is very high right now,'' says Chris Conkey of Evergreen
Investment Management in Boston. ''There's a strong sense the Fed is on
top of things.''
But the more confident investors are in Greenspan, the harder his job
becomes. Soaring stock prices and falling long-term interest rates are
fueling the supercharged economy and frustrating the Fed's efforts to
slow growth down to more manageable levels. And Greenspan deserves some
of the blame, because his own overly complicated explications of
monetary policy have left many investors stumped. Indeed, some argue
that if Greenspan really wants to cool the economy, he's going to have
to make a bigger or unexpected increase in rates. ''The Fed needs to
tighten much more aggressively,'' says Greg Jensen of consultant
Bridgewater Associates.
ON MESSAGE. Greenspan's not about to do that. Somehow, though, he needs
to persuade investors there really is something to worry about even
though there is no sign of actual inflation outside of skyrocketing oil
prices. In speeches and congressional testimony, he has advanced a
number of rationales for raising rates. But far from clarifying matters,
he has sown confusion about the Fed's intentions.
Perhaps the Fed chairman could learn something from politicians about
staying ''on message.'' He says productivity growth is shielding us from
inflation, and techies cheer. Then he muses that this same productivity
may be goosing the stock market and thus overstimulating the economy,
and the catcalls begin. Greenspan vows to raise short-term interest
rates until the economy slows. But in the same breath he argues that
it's private investors, not the Fed, who really set market interest
rates. He talks about the desirability of the stock market taking a
breather, yet insists that he's not targeting stock prices.
With apologies to the scriptwriters of the film Cool Hand Luke, what we
have here is a failure to communicate. It's not that Greenspan has blown
the job--to date, he has delivered brilliantly on the Fed's mission of
keeping inflation low and growth strong. The risk, experts say, is that
the muddle over his message could make it harder for the Fed to justify
further rate hikes to prevent the economy from overheating. While
Greenspan isn't elected, he is sensitive to the popular will--especially
in a Presidential election year. If he can't convince the public that
slower growth is needed, ''he could end up erring on the side of doing
too little rather than doing too much,'' says William Dudley, chief
economist at Goldman, Sachs & Co.
But communications problems aside, associates say that Greenspan remains
convinced that the Fed's drip-drip-drip approach to raising rates will
succeed in keeping things in balance. And while he is optimistic that he
has a handle on the New Economy, there's no doubt that he is trying to
set policy in extremely confusing times. After nine boom years, and
despite five rate hikes, growth continues to race ahead at an astounding
pace. First-quarter growth now looks to be 5% or more. And that's on top
of what could be an upwardly revised, mindboggling rate of close to 8%
in the final quarter of last year.
At the same time, the huge productivity gains wrought by technology have
made it far harder to suss out the right policy response to that growth.
With productivity up by more than 6.5%, unit labor costs actually fell
in the fourth quarter of 1999 despite record-low unemployment. Prices,
too, seem under control. Consumer prices, excluding food and energy,
rose at an annual rate of just 2.1% through February. Greenspan also
sees no signs of an inflation-fueling pickup in wage demands.
BASIC TRUTHS. Those conflicting signals make it all the more imperative
for Greenspan to get his message across more clearly. Many investors are
persuaded that Greenspan has turned sour on productivity and is directly
targeting the stock market. Yet Fed insiders insist that neither is the
case. In truth, Greenspan is perhaps the biggest believer inside the Fed
that productivity growth is continuing to accelerate, raising the
economy's noninflationary speed limit and bringing benefits to employers
and employees alike. He's also among the most skeptical of the Fed's
ability to second-guess the stock market, although he does note that the
central bank must take Wall Street's impact on Main Street into account
when setting rates.
Cut through Greenspan's elaborate explanations and you end up with
Economics 101: supply and demand. Demand for capital is booming as
companies rush to invest in productivity-enhancing equipment. But the
supply of personal savings is contracting as confident consumers spend
more of what they earn. With demand for capital outstripping supply,
Greenspan figures the cost of money--interest rates--needs to go up.
Greenspan sees the same pressures on the output side of the economy.
Demand for goods and services is outpacing supply. So the unemployment
rate is falling: U.S. companies are having to dig deeper into the labor
pool to produce more goods and services. And since U.S. companies can't
satisfy all the domestic demand, imports and the trade deficit are
rising. Again, higher rates are the way to slow demand.
In keeping an eye out for signs of trouble, Greenspan is focusing on
profit margins as well as prices, Fed insiders say. If margins start to
feel the pinch from rising raw material or labor costs, that could lead
to some rough sailing for the economy. Pressures on margins are a
harbinger of either higher inflation or lower profits, both of which
could jeopardize the expansion.
IN THE VISE. So how is the battle to balance supply and demand going? If
you look at the demand side of the economy, there seems to be reason to
worry. The stock market is still rising, making consumers feel wealthier
and thus stimulating their spending. The Wilshire 5000 Total Market
Index--the broad measure of stocks that Greenspan follows--is up 23% in
the past year, and up 15% since the Fed began raising rates last June.
Interest rates are a problem for Greenspan, too. Long-term rates, after
rising for much of the past year, have recently begun to turn down
(sidebar). That threatens the Fed's efforts to engineer a slowdown by
keeping borrowing strong and the economy hot.
The picture is brighter on the supply side. Productivity growth is
strong, raising the ability of companies to produce what consumers are
demanding. And the federal budget surplus is booming, raising the supply
of savings.
Greenspan hopes the New Economy will increase its output of goods and
services rapidly enough to accommodate strong demand. But if it doesn't
and inflation starts to gather force, the Fed will really have to
tighten the screws--even at the risk of causing a serious slowdown in
the economy. Then the fruits of exuberant irrationality will be all too
evident.
By Rich Miller, with Laura Cohn, in Washington, and Peter Coy in New
York
|