Saturday April 1 1:04 PM ET
Will Greenspan Raise Rates Sharply?
By Pierre Belec
NEW YORK (Reuters) - It's the fallout from the exploding new economy. Federal Reserve Chairman Alan Greenspan is
operating under the guise that he's not a destroyer of stock market wealth but rather a preserver of economic health.
The critics disagree. They say the Fed chief has gained the dangerous reputation of being a player in the market rather than just a
referee.
And the fear is that there's nothing to stop Greenspan, who is obsessed over high stock prices, from converting his irrational
exuberance speech of 1996 into action.
Greenspan believes the antidote for dealing with a runaway market is to raise interest rates, which
implies that the central banker has lots of experience in managing unruly markets.
Interest rates have so far been raised five times since last June, each by a modest quarter
percentage point. But the monetary tightening has not caught Wall Street's attention.
Stocks are still in overdrive and the economy is buzzing along. And investors are looking at those rate increases in their rear-view
mirrors as just annoying bumps in the road.
The Street hasn't gotten the message from the series of rate hikes totaling 1.25 percentage points because the tiny moves did not
carry any shock value. The increases were all telegraphed well ahead of time and the news was treated as a foregone conclusion
by the market.
Experts say that in order for Greenspan to get it right, he will have to raise interest rates by at least a stiff half percentage point at
the next Fed policy meeting on May 16 -- and simultaneously boost margin requirements, the down payments investors make to
borrow money to buy stocks.
The central bank also will have to convince commercial bankers to tighten their lending practices and avoid speculative loans.
Buying stocks on credit has surged recently, with the margin debt on the New York Stock Exchange soaring 75 percent in the
past 12 months to a record $265 billion. Margin buying has exploded in popularity because the 50 percent down payment is
simply a deal that is too good to pass up.
Proof that the economy is snubbing Greenspan is that the nation's economic growth -- the gross domestic product -- grew at a
blistering 7.3 percent annual pace in the final quarter of 1999, the strongest in nearly 16 years.
And consumer credit soared $17 billion in January, the biggest leap since 1989. Existing home sales rose in February despite
mortgage rates that were 1.5 percentage points higher than a year ago. And the labor market is still the tightest in 30 years.
Instead of taking air out of an overblown stock market, Greenspan's policy has incited mutual fund managers -- who view as a sin
any investment strategy that favors holding cash -- to run to already overpriced technology stocks.
The technology-laced Nasdaq Composite Index has raced up more than 80 percent since Greenspan started raising interest rates
last June, valuing that market index at about 74 percent of the nation's gross domestic product. Yet, the Nasdaq-listed companies
produce only 21 percent of American goods and services.
``Many view Fed chief Greenspan as omnipotent,' says Kent Engelke, capital market strategist for Anderson & Strudwick Inc.
``There is a real possibility that he may view the continual ascent of stock prices as a direct assault upon his credibility.'
Greenspan has been negative on stocks since December 1996, when he rocked global markets with his comments about
investors' ``irrational exuberance.' Back then, the Dow Jones industrial average was just 6,000. The blue-chip index has nearly
doubled since then, which doesn't say much about Greenspan's credentials as a stock market analyst.
``Will Greenspan shock the market with an inter-meeting increase, or change his traditional 25-basis-point (quarter percentage
point) increase to 50-basis-point (half a point)?' Engelke asked. ``There is a historical precedent for such action and the February
FOMC minutes suggested such a scenario.'
The next meeting of the Federal Open Market Committee in May could be a nail-biter. After all, Wall Street was made aware
recently that some Fed members had argued for a half-point jump in interest rates at the February policy-setting meeting. Instead,
the Fed bankers opted for an increase of only a quarter point.
Experts say no one knows what it will take to cool this market down and for that reason, they worry that Greenspan may go too
far with his money policy.
Louis Rukeyser, publisher of Louis Rukeyser's Wall Street newsletter and host of the financial television program ``Wall Street
Week,' said the Fed chairman has been more honored than right.
``His crystal ball on the stock market is notoriously flawed, as was embarrassingly evident when he started mumbling about
irrational enthusiasm several years -- and many thousands of (Dow) points -- ago.'
What's the shape of the economy?
Hit the rewind button. Productivity is rising and American companies are the most competitive in history. Corporate earnings are
rising and the stock market is strong. Inflation is dormant.
``The benefits of capitalism are blessing more American homes every year, clearing the ideological way to an unprecedented
century of human freedom,' Rukeyser said. ``What a miserable time to be alive. And if anyone starts to enjoy things too much,
we can always call in Alan Greenspan to straighten us out.'
Rukeyser does not buy into Greenspan's theory that markets left to their own devices will create ``imbalances' or 'excesses.'
``It's ironic that one of the Fed's excuses for continuing an essentially misguided policy is that it hasn't been working,' he said.
``Therefore, Greenspan apparently concludes, it's necessary to administer larger doses of poison.'
Higher interest rates are generally bearish for stocks because they bump up the cost of doing business for companies, thereby
cutting into their earnings .
While another cluster of interest-rate increases may not torpedo stocks or the economy, the fact is that it will not be helpful.
``It may touch off new, unjustified fears that this really is just a 'bubble' because a bunch of folks who never saw it coming figure
that that must be the only possible explanation for their myopia.'
James Dines, publisher of the Belvedere, Calif.-based Dines Letter, and a critic of Greenspan's policies, said higher interest rates
do not always automatically stop a bull market.
``For example, interest rates in the bond market hit their lows in September 1998, and they've been rising since then,' he said.
``On Sept. 1, 1998, the Dow was at 7,827, and today it's at 11,000.'
Wall Street has sensationalized Greenspan.
``People get too excited over Greenspan and they put too much emphasis on what he does,' Dines said. ``It's part of the media
hype and even a 50-basis-point increase would not stop this market from going higher.'
Can Greenspan be dead wrong?
``This whole business about Greenspan stopping inflation with higher interest rates is just wrong. It has nothing to do with reality.
Inflation is defined as an increase in the nation's money supply and Greenspan is running the printing presses, which he controls,
boosting the money supply at a rate of 10 percent a year,' Dines said.
Indeed, the economic numbers have been saying that Greenspan is barking up the wrong tree.
While the GDP soared in last year's fourth quarter, the measure of inflation -- the implicit deflator -- was not a source of concern
at 1.5 percent, up a tad from an inflation rate of 1.2 percent in 1998.
``Prosperity is good,' Dines said. ``It's a fraud for Greenspan to walk around saying prosperity is dangerous for the economy.
Prosperity does not cause inflation and it's moronic to believe that the wealth effect from the stock market will create shortages of
goods and products.'
Dines said that any ``imbalances' will eventually be corrected when prices go up. Simply put: People will stop buying stuff or
switch to substitutes after prices rise too much.
``It's the rational mechanism of prices in an economy,' he said.
For the week, the Dow Jones industrial average was down 191.00 points at 10,921.92. The Nasdaq composite index slumped
390.15 to 4,572.88 and the Standard & Poor's 500 index was off 28.88 at 1,498.58. |
