nytimes.com
April 20, 2001
A Foreseeable End to the Fed's Magic
By JAMES GRANT
he essential American financial dilemma is implied in a throwaway line in the statement released by the Federal Reserve to explain this week's surprise interest- rate action. The current risks, said the Fed, "are weighted mainly toward conditions that may generate economic weakness in the foreseeable future."
The telltale word, "foreseeable," is one favored by sloppy writers, psychics, mentalists and economic planners. "A cliché and a fuzzy one," adjured Strunk and White in "The Elements of Style." "How much of the future is foreseeable? Ten minutes? Ten years? Any of it? By whom is it foreseeable? Seers? Experts? Everybody?"
Not by everybody, experience teaches, and certainly not by seers, experts and federal bureaucrats. Cisco Systems, the archetypal "new economy" company, was recently forced to admit that it could hardly see past the end of its computer- enhanced nose. Is the Fed so much better equipped to predict coming events?
Remarkably, Wall Street is prepared to believe that it is. While the smashing of the icons of the boom years proceeds apace, the Fed chairman, Alan Greenspan, still lives high up on the pedestal of the long prosperity.
How does he do what he does? Nobody knows. It is a mystery. He collects data and ponders them. He conceives a course of action. This action takes the form of a double manipulation, first of an interest rate and second of the mind of the market. What is the purpose of these actions? To impart value to the dollar (a slip of paper of no intrinsic value), to promote economic growth, to guard against price inflation and to protect and defend the financial system.
This is a mighty tall order. In fact, it is reminiscent of the task that the economic planning agencies of the former Soviet Union were famously unable to carry out. For them, the "foreseeable" portion of the future turned out to be surprisingly short.
Does capitalist America have a clearer view? The Fed's myriad fans don't like to admit that what Mr. Greenspan actually does is to fix a price. Not just any price, either, but the federal funds rate: the fulcrum interest rate for the American dollar and a good portion of the global economy. What is an interest rate? It is a price that balances saving with investment. Set the rate too low, and there is likely to be too much investment. Too high, and too little.
On the evidence of the late boom, the Fed for many years set the rate too low. Thus, a comprehensive measure of investment — including residential construction — has been soaring. Last year, it amounted to more than 18 percent of gross domestic product, the highest percentage since the late 1970's.
Investment, as we all know, is a good thing, but like all good things it can be carried to excess. On the evidence of the collapse in the high- tech economy (an event not foreseen by the Fed), outlays on computer- related equipment now appear to be excessive. Low interest rates are a balm to a recession-bound economy. However, to the extent that they redirect new capital into old, redundant places, notably information-technology hardware, they do harm.
The value placed on invested capital is measured by the stock market. Even after a year of horrific losses, valuations are still historically high. As a rule, the higher the valuations, the greater the risks borne by investors. By intervening in the money market aggressively and cunningly — thereby inducing new speculative flows into equities — the Fed has given its seal of approval to a stock market that many investment professionals refuse to touch even with other people's money.
The private market in interest rates is a human institution, and therefore imperfect. However, as Chairman Greenspan knows, markets usually outshine governments in the work of setting, or discovering, prices. Yet, oddly enough, Mr. Greenspan has become a living symbol of the efficacy of price fixing. But it's likely that sometime before his career is over, he will become a symbol of the futility of that black art.
James Grant is the editor of Grant's Interest Rate Observer.
Copyright 2001 The New York Times Company | Privacy Information |
