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Digging a deeper hole? I think so. Lower interets rates aren't the
solution to all problems (consider Japan). What will happen when we
find that lower rates don't fix the problems?
JW
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http://www.thestreet.com/p/comment/detox/1396002.html
Another Panic Cut Sets Stage for Rate Hikes Next Year
By Peter Eavis
Senior Columnist
4/18/01 3:06 PM ET
Go ahead, fight the Fed. Wednesday's half-point cut in the federal
funds target rate makes Alan Greenspan an even easier opponent.
A cold, hard look at Greenspan's conduct of monetary policy shows
that the chairman of the Board of Governors of the Federal Reserve is
far from infallible. In fact, since he took over as Fed chief in
August 1987, Greenspan has spent much of his time cleaning up messes
that he himself is responsible for.
The next mess is in the making, and it'll be even bigger after
Monday's rate reduction. If recent history is any guide, inflation,
already close to its five-year high, will rise to unstomachable
levels within the next 12 months as a result of the Fed's current
cheap-money policies. Detox's prediction: Greenspan will be hiking
rates in 2002, if not before. The market, when it gets wind that
tighter money is on the way, will tumble. And investors who chose not
to see Easy Al as a God will be rewarded -- richly.
Deep Breaths
Evidence of the next leg up in price inflation can be seen
everywhere. Money supply figures are soaring, which, by definition,
means banks are churning out new loans. The mortgage market is on
fire. Consumer debt is growing at a rip-roaring pace, even though
people's debt burdens are at record levels. Hundreds of stocks still
trade at absurd bubble-type valuations, underlining how much hot
money still exists.
For some unfathomable reason, most market mavens think inflation
automatically ceases to become an issue when the economy slows, as it
has in the U.S. The real lesson is that unwise attempts to boost
flagging economies or collapsing financial markets -- something the
Fed is guilty of now -- have been a chief cause of inflation through
the ages.
Now, the Fed is redoubling efforts to reflate the bubble sectors.
Take the capital goods industries, particularly the tech sector,
which have been whacked over the past six months. In the release that
accompanied Wednesday's cut, the Fed showed its deep concern for
capital investment, saying that it "has continued to soften," adding
that the "persistent erosion in current and expected profitability,
in combination with rising uncertainty about the business outlook,
seems poised to dampen capital spending going forward."
And the stock market, even though it has been rising recently, also
has the Fed worried. In the release, the central bank frets about the
effect that "reductions in equity wealth" will have on consumption.
Looking at that, it's hard not to conclude that the Fed's Wednesday
cut is also meant to help the market go back up.
Hans Tietmeyer, the ex-head of Germany's Bundesbank, the only major
central bank with a record to be proud of in the postwar period, was
quoted as saying recently: "The U.S. central bank is dangerously
close to becoming a prisoner of the financial markets." After
Wednesday's Fed move, he'll surely be removing the words "dangerously
close to."
Like all superaccommodative central banks, the Fed hates to see the
economy adjust to get rid of unhealthy areas. The fact is, the
capital goods industry, like the Nasdaq, was in a state of gross
excess. In 2000, private sector investment accounted for 19% of the
economy, the highest level in the series, which started in 1929. It
only got to that level through a massive boom in IT sales. Capital
investment, dominated by tech buying, accounted for 25% of U.S.
growth in the second part of the '90s, according to Dick Berner,
economist with Morgan Stanley. Now, there's a huge glut in tech gear,
something dramatically underlined by Cisco's (CSCO:Nasdaq - news -
boards) inventory writedown this week. Clearly, John Chambers' recent
squeals to the Fed to cut rates to help his business didn't fall on
deaf ears.
Past as Prologue
So, what next? Greenspan is repeating past dysfunctional behavior. In
1987, he slashed rates to bail out an overheated stock market, only
to raise them aggressively the following two years as inflation got
out of control. In 1994, he ratcheted up the cost of money,
contributing to Mexico's currency collapse. The Treasury bailed out
Mexico -- a move the Fed aided with lower rates -- and the emerging
markets bubble continued to balloon until the Asian crises of 1997-
1998.
In 1998, Greenspan brought down rates rapidly to ensure that
liquidity was pumped back into the financial markets after the near
collapse of Long Term Capital Management. Money supply soared.
Greenspan primed the pump some more ahead of the Y2K changeover, and,
almost like clockwork, inflation was moving up quickly by early 2000.
That led to the rate hikes of last year. And it was these that caused
the collapse in the Nasdaq and capital spending. A bold pattern
emerges: panic-cut-hike-panic-cut-hike-panic-cut-hike. Whatever
medical term one might use to label this type of behavior, it's
clearly no way to run a central bank.
Where are the excesses now? Well, the stock market is back in
fashion. A no-hoper like Yahoo! (YHOO:Nasdaq - news - boards) is
trading at a cool 500 times expected 2001 earnings, for example.
Heating Up
But look at what's happening in the consumer and housing debt
markets -- it belies belief. Consumer debt is growing at over 10%.
This is happening at a time when delinquency data show that consumers
should be cutting back on their debt. In the fourth quarter of 2000,
consumer debt payments as a percentage of disposable income grew to
14.3% from 14.1% in the previous quarter -- levels that haven't been
seen since 1986. Meanwhile, Moody's figures show that an increasing
number of credit card loans are going bad. In February, the write-off
rate for credit card loans was 5.8%, while delinquencies were 5.26%.
Both numbers are well above year-earlier periods.
The OFHEO House Price Index was up 8.13% in the last quarter of 2000,
the highest increase since 1987. Government-sponsored entities that
buy mortgages like Fannie Mae (FNM:NYSE - news - boards) and Freddie
Mac (FRE:NYSE - news - boards) are stuffing their balance sheets with
new loans. Fannie Mae's mortgage portfolio totaled $641 billion in
March, up 19% from March 2000. Fannie's portfolio grew at a 23% rate
in the first three months of the year, up from the 16% rate for all
of 2000. Despite the growth, mortgage delinquencies totaled 4.54% of
loans in the fourth quarter of 2000, the highest level in eight
years, according to the Mortgage Bankers Association. More loans
going bad even as loan totals soar -- this is a classic sign that the
credit bubble is entering very dangerous territory.
With all these loans being advanced, is it any wonder that prices are
still buoyant? Inflation, as measured by the Cleveland Fed's index,
designed to strip out the "noise" in price data, measured 4.2% in
February and 4% in March. The last time it was at these levels was in
January 1996. Price indexes could go even higher when recent jumps in
gasoline prices are added in. The Fed may know this and might've
wanted to get a rate cut in before the next inflation releases
undercut the case for one.
However, given the strength of the above indicators -- and the fact
that other recent economic numbers have shown surprising strength,
like Tuesday's industrial production rise of 0.4% -- some independent-
minded commentators are deducing that the reason for the inter-
meeting cut was not to address softness in the economy at all. Sean
Corrigan, analyst at Capital Insight, of Rochester, England, wonders
whether the reduction could be to address a systemic problem we don't
know about yet. Could a bank or a large hedge fund be in trouble as a
result of a bad bet or extensive exposure to a large bankruptcy, he
asks? Perhaps Argentina is about to come off its dollar peg and
devalue and the Fed is softening up the market for that.
But don't cry for Argentina. Shed your tears for Easy Al, and all
those lemmings who believe in him.
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