You're a Good Man, Alan Greenspan...
SAN FRANCISCO -- After falling off the proverbial cliff in December, the U.S. economy managed to cling to a branch in January, according to
"The exceptional weakness so evident in a number of economic indicators toward the end of last year -- perhaps in part the consequence of adverse weather -- apparently did not continue in January," Greenspan said in
testimony before the
Senate Committee on Banking, Housing and Urban Affairs
In the future, economists may refer to this as the "
Beetle Bailey syndrome."
But as fans of the classic
comic strip know, even if Beetle is able to extricate himself from a jam, he still risks being pulverized by Sgt. Orville Snorkel. While I realize the sergeant is usually the one hanging from the branch (let's not quibble over details), Greenspan's testimony indicated he is aware the economy faces a similar danger:
"Still, as the
Federal Open Market Committee
noted in its
last announcement, for the period ahead, downside risks predominate," he said.
That comment suggests more rate cuts are likely. But Greenspan also repeatedly acknowledged the economy's long-term strength and his faith in continued productivity benefits, suggesting Fed easing may be less aggressive going forward.
The disappointment of that realization was reflected in the performance of financial markets today. The
Dow Jones Industrial Average
fell 0.4% to 10,903.32 after trading as high as 11,012.90, the latest in a string of failed attempts by the index to sustain a move above 11,000. The
slid 0.9% to 1318.80 after trading as high as 1336.62, and the
lost 2.5% to 2477.73 vs. its intraday best of 2554.65.
Treasury bonds -- further weakened by a stronger-than-expected January retail sales report -- also finished lower.
"The Fed signaled its intention
that it will move from a sense of urgency and aggressive easing to a traditional gradualist approach," said Mickey Levy, chief economist at
Banc of America Securities
, who believes such an approach is now appropriate. "That would imply no move before next meeting and 25 basis points at the next meeting" on March 20.
Fed funds futures are still pricing in an 87% likelihood of a 50 basis-point ease in March, but that's vs. a near certainty of such an occurrence previously.
Perversely, the best way for the stock market to get what it wants from the Fed is to continue to demonstrate its disappointment.
"A deep drop in equity prices will not be tolerated," said John Lonski, senior economist at
Moody's Investors Service
. "The Fed will most definitely cut interest rates between meetings" if stocks continue to falter.
Lonski referred to Greenspan's repeated references to stocks'
direct effect on the economy, most prominently:
Even consumer spending decisions have become increasingly responsive to changes in the perceived profitability of firms through their effects on the value of households' holdings of equities. Stock market wealth has risen substantially relative to income in recent years -- itself a reflection of the extraordinary surge of innovation. As a consequence, changes in stock market wealth have become a more important determinant of shifts in consumer spending relative to changes in current household income than was the case just five to seven years ago.
...But Just a Man
Some observers cheered the Fed chairman's acknowledgment of stocks' influence, judging it appropriate and evidence of the so-called Greenspan put. But critics continue to fret that it's dangerous for central bankers to target stock prices because it encourages investors to take excessive risks. The old
moral hazard argument.
Greenspan is telling investors 'buy the stocks and we'll do what we can do to limit downside risk,' " Lonski said. "Unfortunately, if
the Fed sticks to this policy, they'll eventually pay the price in terms of higher inflation."
The economist agreed inflation risks have been glossed over by the nation's
recession obsession, noting core
inflation rose an annualized 2.6% in 2000.
Additionally, wage gains remained strong -- the
employment cost index
rose 0.8% in the fourth quarter despite all of the layoff announcements -- and could accelerate "if it turns out the latest slackening
in jobs growth comes to a quick end," he said.
The economist also noted the "relatively rapid rate of growth for M2
money supply," and that private sector borrowing grew 7.4% for the three months ended in November, "despite talk of a credit crunch."
Finally, "it's odd to have a supposed recession when the housing sector still tends to do quite well," Lonski said, noting refinancing applications rose 480% in January vs. year-ago levels while applications for new mortgages climbed 11.5%.
"Those are pretty good numbers, and they are telling us the latest decline in borrowing costs ought to provide a lift" to the economy, he said. "We might just be surprised at the speed with which the U.S. economy stabilizes and regains a brisk pace of expansion."
Without predicting this particular scenario, Lonski cautioned the Fed could find itself in a position later this year of being unable to lower rates further to combat an economic slowdown because of inflation that its recent policies helped create. "The resulting slowdown becomes worse and the U.S. ends up in a severe downturn made worse by a steep drop in equity values," he said.
Translation: Greenspan's "virtuous cycle" becomes a potentially vicious one.
In today's testimony, Greenspan revealed the Fed forecasts inflation -- as measured by the
GDP price deflator -- is likely to be 1.75% to 2.25% this year.
Notably, in the same testimony a
year ago, delivered Feb. 17, 2000, Greenspan projected inflation would be 1.75% to 2% in 2000 "or a bit below the rate in 1999." Inflation came in at 2.5% in 2000, he reported today.
Last year, the chairman forecast GDP would "slow somewhat" in 2000 from 1999's 4.2% growth and come in around 3.5% to 3.75%. GDP rose 5% in 2000, according to preliminary figures.
There's no sin in failing to exactly predict what the economy will do over a given point of time -- indeed, the Fed had adjusted its predictions for year 2000 when Greenspan returned to the Hill in
July. Today, he acknowledged the Fed is struggling with the "faster adjustments" of business cycles in the information age and -- referring to consumer confidence -- said "our economic models have never been particularly successful in capturing a process driven in large part by nonrational behavior."
While I applaud Greenspan for admitting his fallibility, I have to wonder why so many investors still see him as an all-knowing deity. I also wonder how much longer that perception can last.
Aaron L. Task writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
Aaron L. Task.