Today the stock market was acknowledging
Alan Greenspan as its savior. The
Federal Reserve chairman pretty much said that the
Federal Open Market Committee would be switching its economic outlook to neutral at its Dec. 19 meeting and that it could even be cutting rates over the next few months.
The Fed head's speech spurred stocks higher, as well it might. An easier interest rate environment not only means an easier business environment, it also makes for lower bond yields. Those make stocks relatively more attractive.
Basking in the glow of the rally -- the
Dow Jones Industrial Average added 3.3% to 10,899, the
S&P 500 rose 3.7% to 1377, and the
Nasdaq Composite jumped 10% to 2890 -- Wall Streeters are to be forgiven if they happened to forget that it was exactly four years ago today, in a
speech before the
American Enterprise Institute
, that the phrase "irrational exuberance" first sprung from Greenspan's lips.
Quoth the chairman: "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?"
The 1996 speech had an immediate, though not very long-lasting, effect on markets. The Dow fell as much as 162 points the next day before recovering to close down 55.16 at 6381.94. The Nasdaq fell as much as 35 points (which was substantial in those days) before rebounding to close down 12.44 to 1287.68. Take a look at those Dow and Nasdaq levels and compare them to today. Even after an incredibly tough year, it seems like Greenspan's comments were, um, early.
"I think he regretted those words," says
deputy chief economist Diane Swonk. "He was behind the curve on what was happening, and I think he came out and admitted that."
What was happening, says Swonk, was that the U.S. was in the midst of a massive productivity boom. While the Fed believed that recent gains in productivity were only temporary -- productivity is cyclical like that -- it turned out that the productivity trend of the country was moving higher. That meant that the noninflationary run rate of the economy was a lot higher than it had been previously and that higher stock market valuations made sense.
"He was not making a market call," counters
Morgan Stanley Dean Witter
chief economist Steve Roach. "That's where Wall Street is wrong in its criticism. He was stressing the potentially lethal interaction between the stock market and the economy. I think the framework that he laid out four years ago was spot on. He took a lot of flak for that, but I give him credit for saying what needed to be said."
Ignoring for the moment the criticism that the Fed, through its responses to the Russian debt crisis in 1998 and Y2K worries in late 1999, created the environment that led to the exuberance that Greenspan worried about, Roach's point seems worthwhile. The chairman worried that at some point the market could run away with itself, and that this could have an effect on the real economy. It's hard to argue that the incredible wealth created late last year and early this year had no effect on the economy, and it may be that the removal of that wealth is also having a measurable effect. Greenspan argued as much today:
With equity prices weakening in response to reduced earnings from higher costs and a more moderate pace of sales, the "wealth effect" that spurred consumer spending is being significantly attenuated. Moreover, high and rising equity prices had facilitated a good deal of financing for newer companies, both in the equity and bond markets. Widened spreads in the high-yield markets reflect, in part, a reduced potential for new equity issuance to support debt servicing. Higher costs of capital for these companies likely is exerting some restraint on overall business capital spending.
Perhaps the most lasting effect of Greenspan's Dec. 5, 1996, speech was that "irrational exuberance" entered the vernacular. A
search on the term returns 9,998 stories, while one on the misspelling "irrational exuberence" returns an additional 28. Meanwhile, "rational exuberance" returns 368 stories. Greenspan's might not have quite been the phrase that launched a thousand quips, but it's close enough for government work.