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Is Greenspan Fighting Phantom Recession?
Is Greenspan Fighting Phantom Recession?
By Pierre Belec
NEW YORK (Reuters) - Nearly two years ago, Alan Greenspan began raising interest rates to head off ``inflation'' and now he's chopping away at rates to head off ``recession.'' As it turned out, he was fighting phantom inflation and people are wondering if he is now combating a phantom recession.
One expert says the Federal Reserve chairman has gotten it wrong before and he may be missing the bull's-eye, again.
``First, the Fed was raising rates to fight inflation, which did not exist and now it is lowering rates to fight a recession, which we feel does not exist,'' says Penny Russell, economist at H. C. Wainwright & Co., Economics Inc.
While the Fed was raising interest rates to a 10-year high between 1999 and 2000, the Consumer Price Index, which tracks inflation at the retail level, edged up less than 1.5 percentage points and the core rate that excludes volatile food and energy prices went up even less.
Greenspan's tight money policy succeeded too well as the economy's growth has nearly stalled. In January this year, the central bank launched a bold move: preemptive rate cuts for fear that the six interest-rate hikes had put the economy at risk of recession.
Smart move? No, says Russell, dismissing the Fed's assurance that it can figure out to the nth degree when the economy is facing a killer problem, like a recession.
``What's happening is that we have been through an economic period when things were so extraordinary and when they go back to just ordinary, people seem to be more concerned than they should,'' Russell says.
DID GREENSPAN's RATE HIKES CHOKE ECONOMY?
``So it would appear,'' says Russell. ``But the truth is that no one at the Fed -- not even its illustrious chairman -- is capable of managing a large and complex economy like the U.S. or of knowing just when to raise and when to lower interest rates to keep growth within a predesignated range.''
Greenspan, who worried that the stock market was too high-priced in 1999, went on a rate-raising spree instead of allowing Wall Street to correct its excess in its own sweet time. The result of this hands-on money policy: the rapid destruction of $3 trillion in stock market wealth and disillusioned households that caused consumer confidence to plunge.
Falling stock prices made a lot of Americans feel poor because many of them looked at the market during the great boom years between 1995 and 1999 as a savings account with tremendously good yields.
The market's monster reversal, which sent the Nasdaq down an eye-popping 55 percent from its high during a 12-month period, shook consumer confidence in a New York minute. The reason that the apprehension spread so fast was because more than 50 percent of U.S. households have a stake in the stock market through retirement accounts.
Russell favors benign neglect and monetary neutrality rather than the Fed's jockeying, which she says destabilizes both the economy and stock market.
``Now, if the Fed could be persuaded to leave rates alone and let all the ripples die out, there is no reason that the economy could not get back on the fast track,'' she says. ``Noninterference would be even more stimulative than a tax cut.''
Greenspan and his fellow bankers have been known to fumble the ball. They misread the handwriting on the wall in 1990-91 when a recession was slamming the economy and fell asleep at the wheel.
So the Fed, which is now racing to keep the economy from tipping into recession, is faced with a dilemma on whether to cut interest rates for a third time this year. It has made two cuts each of 50 basis points in January after boosting rates by 175 basis points from June 1999 to May 2000.
Russell says that if interest rates had been left alone in 1999-2000, the economy would have slowed down by itself, ``gently not abruptly and we would have been enjoying higher growth than we are now.''
The betting is that the Fed again will lower by 50 basis points at its March 20 policy-setting meeting.
RECESSION ISN'T IN THE CARDS
Even the numbers crunchers say that an old reliable measuring stick -- the nation's money supply, also known as M2 -- is not emitting signals of a recession. M2 has jumped at an annual rate of more than 10 percent over the last three months, which means the Fed is printing more money to pump up the softening economy.
``Since the M2 series began in 1959, the U.S. economy has never entered a recession with the real M2 growth this high,'' says Paul Kasriel, head of economic research at Northern Trust Co. ``The additional 50 basis points of cuts we are forecasting to occur by March 20 would be expected to boost nominal M2 growth still more.''
Russell says the Fed appears to be focusing too much on momentary changes in the economy.
``The central bank is overreacting to what is happening in the economy,'' she says. ``It was astounding how precipitous the Fed was in lowering interest rates in January,'' she says. ``It was completely out of character for the central bankers to lower interest rates twice in the same month.''
Russell says that the Fed chairman raised interest rates in 1999 and 2000 because he saw inflation ghosts, then he cut rates in January simply out of ``fear of fear itself.''
``The current economic situation does not justify January's rate cuts,'' she says. ``Just a year or two ago, monetary policy appeared to be focused on fighting phantom inflation, now it appears to be focused on fighting a phantom recession.''
Even some Fed officials don't see a recession on the horizon. This week, Federal Reserve Bank of Dallas President Robert McTeer struck an upbeat note on the U.S. slowdown, saying he expected the country to avoid a recession and was encouraged by the latest economic conditions.
Also, Richmond Fed President Alfred Broaddus said recently that chances were ``pretty high'' that the United States was not facing a broad economic drop, but rather a slowdown centered in manufacturing companies.
NOT THE STUFF RECESSIONS ARE MADE OF
The nation's jobless rate held steady at 4.2 percent and payrolls outside the farm sector jumped by 135,000 in February after gaining 224,000 in January.
New cars are still rolling off the nation's dealership lots. Americans bought vehicles at an annual rate of 17.5 million in February, despite an economic slowdown and a plunge in consumer confidence. In January, consumers snapped up automobiles at the fastest pace in four months.
The Bank of Tokyo-Mitsubishi and UBS Warburg's Weekly Chain Store Sales Snapshot estimated that retail sales in February grew by 2.5 percent vs. a year ago.
Housing starts were the highest in nine months in January as mortgage rates tracked the downward slide in the Fed's interest rates and sales of previously owned homes rose 3.8 percent in January.
Additionally, the service sector that generates a whopping 80 percent of the nation's jobs held steady in February, even though manufacturing, which creates only 20 percent of the jobs, was in recession. For the manufacturers, it was a self-inflicted wound because they ignored signs last summer that the economy was slowing and kept producing goods until they gagged on their bloated inventories.
Another positive indicator is the stock market. The Dow Jones industrial average is within flirting distance of the 11,000-point level, which would seem to contradict the view that the economy is going to hell in a handbasket. The Nasdaq market, which sent technology stocks through the roof during the Great Bull Run, may be down a bone-jarring 55 percent, but that market does not truly reflect the economy.
``These are hardly a recession signal,'' says Russell. ''Further, when the stock market and short-term interest rates are in agreement on a forecast for the economy -- as they are now -- they are rarely wrong.''
Bill Valentine, president of Valentine Ventures LLC, says the stock market traditionally leads the economy by six to nine months.
``That means the market falls before the economy does and recovers in advance as well,'' he says. ``If this is a recession, we won't get official confirmation of such until April of 2001 and by then, it will be seven months old -- and too late to do anything about it.''
Over the last 30 years, in every recession except in 1973-75, the market had bottomed out or would start to rally within three months of the time people got a whiff that there was a recession.
Valentine's bet: even if a recession occurs, stocks will hold up because Wall Street has already assumed that it is an accomplished fact.
``If we do get a recession, it will be very slight and short, by historical standards -- two or three quarters, max,'' he says. ''The arsenal of interest rates and (President George W. Bush's) tax cuts will stave off an economic catastrophe.''
For the week, the Dow Jones industrial average was up 178.31 points at 10,644.62. The Nasdaq Composite Index was off 64.85 at 2,052.78 and the Standard & Poor's 500 index slipped 0.76 of a point to 1,233.42.
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