Comstock Partners, Inc.
Greenpan's Continuing Dilemma
November 13, 2002
In his congressional testimony today Chairman Greenspan attempted to explain why the FOMC reduced rates by a surprising 50 basis points despite finding the risks to the economy to be neutral. He had trouble pulling it off. In answer to a question he stated that while they were confident the economy was not headed for deflation, they could be wrong, and that the rate reduction was an insurance policy they could well afford since the threat of inflation was so low. Does that sound neutral to you? It seems to us that Greenspan for once was speaking very clearly. He stated quite simply that deflation was a greater threat than inflation. In our dictionary, that is definitely not the definition of “neutral”.
In other repects the Chairman’s take on the economy sounded as if they were reading our negative comments of the last few months. Here are some quotes: “…several forces have continued to weigh upon the economy: the lengthy adjustment of capital spending, the fallout from revelations of corporate malfeasance, the further decline in equity values, and heightened political risks. Over the last few months…evidence has accumulated that the economy has hit a soft patch. Households have become more cautious in their purchases, while business spending has yet to show any vigor…Uncertainty about the economic outlook and heightened geopolitical risks have made companies reluctant to expand their operations, hire workers, or buy new equipment. Executives consistently report that in today’s intensely competitive global marketplace it is no longer feasible to raise prices to improve profitability…In such a setting, firms must focus on the cost side of their operations, if they are to generate greater returns for their shareholders…most important, businesses have revamped their operations to achieve substantial reductions in costs.” Left unsaid is the fact that all of these cost reductions come out of another companiy’s revenues, and that these companiies have to reduce costs in what becomes a negative feedback loop.
Since a central banker’s comments would not be complete without some balance, Greenspan also enumerated the positive side, which was largely an explanation of how low mortgage rates provided the “powerful stabilizing force” through “turnover of the housing stock, home equity loans, and cash-outs associated with the refinancing of existing mortgages.” This is true, of course, but the Chairman did not explain how this was accomplished through a massive, but unsustainable, buildup of debt that is one of the main factors threatening to throw the economy into a deflationary spiral.
Overall, today’s market generally ignored the Chairman’s testimony and spent most of the session bouncing around on the latest developments regarding Iraq and the new revelations in the Citibank scandal. In our view the volatility is typical of a market that is topping out after yet another bear market rally. Reality will soon return with a slew of further earnings downgrades for the next couple of quarters, and the market is likely to embark upon a new downleg that takes out the previous lows.
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