Market to Fed: GFY
quote.bloomberg.com
05/14 12:46
Mr. Market Sits Mr. Greenspan Down for a Chat: Caroline Baum
By Caroline Baum
New York, May 14 (Bloomberg) -- Dear Alan Greenspan: My name is Mr. Market and I'm writing to tell you you've done enough.
Say, what? How do I know it's enough when you and your band of 16 policy makers, your legions of staff economists and your reams of data see recession risk around every corner, from falling employment, profits and capital spending to flagging business and consumer confidence?
I'll be happy to share my proprietary indicators with you, Mr. Greenspan, but it's gonna cost you, let's say two of your arcane manufacturing ratios for every one of my gems. (Trust me: you're getting the better deal. The reason I'm being generous is because I'm dying to see the ideas you float in your tub.)
You may have noticed that bonds are getting hammered, even though traders and investors expect at least another 50 basis- point cut in the funds rate. Many Wall Street economists, sniffing out a reputation-salvaging forecasting coup with their recession calls, are pushing the idea of a 3 percent to 3.5 percent funds rate.
You don't need a PhD in economics to know that the rise in long rates, over which the Fed has no control, is a forecast of higher short-term rates in the future. In other words, I'm telling you this malaise isn't going to last.
Tip from TIPS
Another sign is the improvement in investment-grade and high- yield bonds relative to risk-free Treasuries. The narrowing in spreads in both high-grade and junk bonds suggests the 200 basis points of easing this year -- a record during your tenure at the Fed -- are allaying credit fears. The stock market, too, is telegraphing the same message.
You know those inflation-indexed bonds you were so hot to introduce into the auction line-up so you could have a ``24/7'' handle on inflation expectations? TIPS had their best quarter ever in the first quarter of the year -- meaning interest in inflation protection was going up just as the economy was going down.
How would you account for that, Mr. Greenspan, when the economy is so weak, growing about 1.5 percent on average in the last three quarters? Inflation expectations, represented by the yield differential between nominal bonds and TIPS, rose a cumulative 20 basis points on Thursday and Friday. The widening in the spread coincided with the decision by the European Central Bank, the last holdout in a grand-slam reflation effort, to lower interest rates, even as they said their daily novenas on why they couldn't/wouldn't target the real economy.
`Well-Contained'
What I'm telling you is that inflation isn't as dead or contained as you say it is. In fact, inflation past is looking pretty perky, with all measures -- with and without food and energy -- still heading higher 11 months after the economy shifted into low gear. While inflation is a lagging indicator, it doesn't seem to be rolling over on cue this time.
Maybe that's because of all the monetary fuel you're creating. It may seem ridiculous to be worrying about inflation when capacity utilization is at a 10-year low. Instead of too much money chasing too few goods and services, the definition of inflation, all the evidence suggests there's too much stuff for the limited demand!
That's today's story. My indicators, on the other hand, are focused on tomorrow. The surge in money supply growth will stimulate demand in the months ahead, not to mention higher prices. That's what the steepening yield curve is saying.
Growth/Inflation Tradeoff
Things may look terrible now, Mr. Greenspan, with all the risks slanted in the direction of further economic weakness. It can't feel good to rely entirely on a fickle consumer, without whom the economy would be toast.
Besides, there's no constituency out there except yours truly to chide you for additional largesse. In general, you're applauded for acting aggressively in an attempt to contain the damage from the bursting of the Nasdaq bubble.
Still, some analysts maintain there's nothing the Fed can do to correct the over-investment; only the passage of time and the absorption or depreciation of capital stock will do that. In the meantime, for a given nominal stock of money, the economy will generate less real output and more inflation, the opposite combination as the one that persisted in the late 1990s.
It may be fashionable to blame energy producers for, among other things, higher inflation. But the bottom line, Mr. Greenspan, is when it comes to inflation, it's the central bank that bears sole responsibility. In digging the economy out of the mess created when the Nasdaq bubble burst, you may be digging us into an even bigger one.
With warmest regards, I remain
Yours very truly,
Mr. Market |
