An Independence Day Stroll Down the Mall

Key Washington institutions -- the Fed, the Capitol and OMB -- aren't so far apart that officials can't talk to each other now and then.
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WASHINGTON -- It's quite a hike from the

Federal Reserve

to the

Capitol

-- all the way from one end of The Mall to the other -- so it's understandable if denizens of these two critical influences on the nation's economic health don't often get a chance for curbside conversations at the coffee truck. But do they talk at all? Ever?

Last week, the Fed responded to what it perceives to be an excessive pace of economic activity by hiking its funds rate target by a minimal 25 basis points, after having laid the groundwork for it through

Alan Greenspan's

exegesis before the

Joint Economic Committee

two weeks

earlier. Recall: "That propensity to spend, in turn, has been spurred by the rise in equity and home prices, which our analysis suggests can account for at least one percentage point of GDP growth over the past three years." That's the 1% that he seemed to feel was too much. Equity and home prices were portrayed as the villains in the plot.

So the

FOMC

couples its 25-basis-point tut-tut with a

removal of its tightening bias, despite what surely must have been a realization that markets would see this as softening the impact of the move itself and therefore might produce a rally in equities. Which it did -- all of the broad US equity indexes reached new highs in the wake of the Fed's move. The members must have known that traders would see the lack of a bias as equivalent to a free pass to the next FOMC meeting: The overnight money rate is quite reliably fixed until Aug. 24. So with uncertainty about the cost of short liabilities minimized, let's see what can be done with that money on the asset side: Let's play the duration trombone.

Why would the FOMC remove its tightening bias but then add verbiage that refers only to one risk exposure, i.e. inflation? Nick Perna of

Fleet Bank

suggested to me that it might be because of the recent change in communication policy. Before the change took place two months ago, any asymmetry -- or bias -- to the Committee's inter-meeting policy stance was solely an internal matter; the rest of the world wouldn't know about it until after the fact. So maybe they haven't quite got the feel yet for living in fishbowl.

That's a better guess than mine was. I thought that any committee that refers to itself with a capital C, like any grown man who calls himself The Kid, is not entirely to be trusted.

Schlepping eastward along The Mall, we pass within snickering range of the

Office of Management and Budget

. This is the institution that used to forecast staggering federal deficits for as far as the eye can see. Rather near-sighted, as it turns out. Now it projects gigantic surpluses deep into the o-zone. It now foresees a cumulative surplus on the unified federal budget (i.e. including operating budget and Social Security) of $2.93 trillion over the next 10 years. That's trillion. Dollars. "We have cut up Washington's credit card," said President Clinton. "Now we can pay off the debt".

If we do, that will destroy a time-tested method for estimating size: bigger than a breadbox, smaller than the national debt. The national debt has been the biggest thing in the solar system, a googolplex of claims hanging over future generations. But paying it off will create quite a problem for investors who prefer belt-and-suspenders safety of principal: One nation's debt is another man's money market mutual fund. That man too is likely to be forced to play the duration trombone.

And the Federal Reserve will have to learn new tricks. What is the open market in Federal Open Market Committee, after all, but the market for US government securities? The Fed will have to find new instruments to use in implementing monetary policy. Maybe it will buy up your mortgage when it wants to ease. Maybe it will call it when it wants to tighten.

Moving farther east to where the exotic creatures live (no, not the zoo; that's about five miles north of here), we come to the Capitol. The Congressional Budget Office last week updated its own projection of the federal surplus and it came within a few dozen billion dollars of OMB's number. Maybe they do hit the coffee truck together.

But paying off the national debt doesn't seem like such a terrific idea at the east end of the Mall. Some of the denizens of the Capitol prefer to spend the excess loot on new programs and entitlements, while others prefer to rebate it to the citizenry in the form of tax cuts. Spending programs? Tax cuts? The Congress, collectively, prefers both.

But do they confer, ever, with the folks back at the west end of the Mall? The Fed has tightened once and seems to suggest that that's all it wants to do. And Congress is constitutionally inclined to inject $2.93 trillion of what the textbooks call "fiscal stimulus" into an economy that is already becoming distorted by the g-forces of its own acceleration.

Paying off the national debt. It is difficult to conjure with the implications. Which may be why the markets seemed to pay no mind to these estimates last week. When you think that it was only a matter of mere months ago that Washington's best-laid plans were terrifying us boomers with the thought that we can't afford to retire, that we'll have to keep nose to grindstone far into our decrepitude, or even into our sixties.

When you stand on Capitol Hill and look back down the Mall, all you can think is, "is this a great country, or what?"

Happy Fourth! God bless America! (I think the guy on the coffee truck is running it.)

Jim Griffin is the chief strategist at Aeltus Investment Management in Hartford, Conn. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Aeltus manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at

GriffinJ@aeltus.com.