The Price of Greenspan's Success

Even if he's not widely credited for it, Alan Greenspan has been successful recently in sustaining strength in housing, boosting stock and Treasury market prices, and weakening the dollar.

But acknowledging that Greenspan is getting what he wants is not the same as condoning his actions. Many observers worry Greenspan's short-term successes are going to cause major long-term headaches. Although the chairman is hoping rapid money-supply growth -- M2 has risen at an annualized rate of 13.4% in the last eight weeks -- will continue to fuel higher asset prices, critics contend this overly accommodative monetary policy threatens to unleash dangerous speculation in equities, reminiscent of the late 1990s, as well as grossly inflated Treasury and housing markets.

Broadly speaking, Greenspan is betting strength in the housing market -- and more recently stocks -- will spur consumer spending to keep the economy afloat until business expenditures revive. Despite a 42-year-low in the fed funds rate, corporate executives remain reluctant to spend because the 1990s spending boom generated poor returns and created overcapacity that remains onerous today. (Yes, many executives also are distracted by new accounting regulations and other oversight issues.)

"Do you really need more [capital spending] when capacity utilization rates are so low?" wondered John Lonski, senior economist at Moody's Investors Service. "You have to be patient and work your way out of this sluggish state."

Ahh, but we live in impatient times. In this world of instant gratification (yes, Dad, you were right), investors, policymakers and certainly politicians are loathe to contemplate slogging through years of sluggish growth. Trouble is, many economists believe Greenspan is prescribing the wrong medicine for what ails the economy.

A Lender and a Borrower Be

By keeping the fed funds rate at 1.25% since November 2002, and threatening to ease more, Greenspan has pushed Treasury yields to levels unseen since the 1950s and spurred record mortgage and refinancing activity. Concurrently, the Fed has encouraged rabid lending activity by giving banks a veritable license to print money via the so-called carry trade, whereby institutions borrow at the rock-bottom fed funds rate and lend at higher rates along the yield curve.