**OT** Is It the Fed's Job to "Pop Stock Market Bubbles"?
By John P. Dessauer
Editor, Investor's World
February 18, 2000
Is there a dangerous stock market bubble in the United States? Some say yes, while others say no. Maybe we are asking the wrong question. The debate assumes that stock market bubbles are dangerous, and need to be "popped" by outside forces. Few are challenging this assumption. Last month, Bruce Bartlett, a fellow with the National Center for Policy Analysis and a syndicated columnist for the Washington Times, attacked this assumption. Here is his conclusion:
"Mr. Greenspan should stop worrying about the stock market. If the Fed should continue to tighten monetary policy out of misguided fears of a stock market bubble, it could very easily repeat the mistakes of 1928 and 1929. If there is a bubble, the Fed should just let it play out. So long as economic fundamentals remain solid, any downturn in the stock market will mainly impact those foolish enough to buy stocks they know are overpriced."
I fully agree with Bruce Bartlett. If Mr. Greenspan needs any encouragement to follow this advice, all he needs to do is remember Japan. In 1989, the Japanese central bank set out to puncture a bubble of speculation in stocks and real estate. The result was an economic disaster. More than 10 years later, the Japanese economy is still stuck in a recession.
What would have happened if the Japanese instead had focused on prosperity and economic stability back in 1989? What if they let the speculative bubble expire on its own? We will never know the answer, but economist Lester V. Chandler in his book, "Benjamin Strong: Central Banker," raises this question about the same situation in our own country, in the Great Depression:
"Even with the benefit of hindsight, one cannot state dogmatically that the level of stock prices attained by mid-1928 could not have been sustained if prosperity had been maintained and the economy had continued to grow as in preceding years."
His words are terrifying. Chandler is telling us that the Fed most likely caused the Great Depression by "attacking stock market speculation" rather than focusing on the economy. Done once in our past, it is logical to fear that it might happen again. We hear now from Mr. Greenspan about the dangers of the "wealth effect," the theory that individuals use stock market gains to support wild spending on lavish lifestyles and thereby drive up the rate of inflation.
It sounds sensible when expounded by bright economists, but most people are not extravagant with their stock market profits, and, even if it true, does it make sense to try to make the wealthy poor? Think back to New York in 1929, and Tokyo in 1989, and the chilling decades that followed. In other words, the "wealth effect" theory totally ignores what happened in history. When exposed like this, it makes you wonder how any economist in 2000 could even say the words, "wealth effect," never mind use the theory to propose puncturing a bubble that is assumed to exist.
To his credit, Alan Greenspan has stopped talking about "irrational exuberance" in the stock market, but he has moved on to raising short-term interest rates to stem "wealth effect" inflation. Maybe he ought to revisit the basic issue, engage in a discussion with more sensible economists like Bruce Bartlett and Lawrence Kudlow. Lets' tackle the core issue of speculative bubbles themselves. The last thing any of us want to see is a misguided Fed causing unnecessary economic damage. |
