Beware of Dr. Green And Mr. Span
Saturday July 7, 3:04 PM EDT
By Pierre Belec
NEW YORK (Reuters) - Some pretty smart people are warning about the danger of playing with interest rates, comparing the nation's central bankers to Dr. Jekyll and Mr. Hyde. Call these critics the Alan Greenspan bashers.
They deserve attention simply because they stand out among the sea of Greenspan worshipers in the financial media who think that the chairman of the Federal Reserve is the greatest thing since sliced bread.
"Of late, Dr. Green the gradualist has been superseded by Mr. Span, the activist inflation/recession fighter," says David Ranson, the head of research at H.C. Wainwright & Co., Economics Inc.
He says the central banker's tinkering with interest rates -- six increases totaling 175 basis points between 1999 and 2000 followed by six reductions amounting to 275 basis points this year -- are destabilizing the $10 trillion American economy and messing up the business cycle.
"It's an unnatural process at best," he says. "The economy has a natural balance of its own and big changes in money policies cause the economy to lose its balance. It's much like sitting on a bicycle and someone slams the wheel to one side and you struggle to regain your balance."
Ranson believes the fast-paced economic changes, boom to bust and back again, will complicate the life of the average Wall Street investor who is trying to squeeze a dollar from an already unpredictable stock market.
Need some convincing? In the wake of the 1999-2000 rate-raising spree, the market took a head-spinning fall and investors are still unsure where stocks are going.
WAITING FOR THE RATE BOOMERANG TO COME BACK
"There is a delay process of up to 1-1/2 years for the economy to respond to money policy shifts," Ranson says. "So what Greenspan is now doing is adding stimulus at a time when the economy doesn't need it after adding restraint two years ago when it again was uncalled for. The net result is that these changes have disrupted the important business cycles."
Business cycles are defined as changes in the economy ranging from expansion, recovery, contraction to recession. As a result, the swings in cycles have a big impact on corporate earnings, inflation and stock market profits.
"In the late 1990s when the Fed was inactive, the business cycle almost completely disappeared but it has now returned because the central bank has been super-active," says Ranson who has long argued that just about every cycle has been caused by shifts in monetary policies.
"The Fed is creating the circumstances for its continued intervention in the economy," he says. "Each loosening a year or two later has forced the Fed to tighten again and each tightening has brought on a renewed loosening."
Although the jury is still out as to whether the economy is in recession, the Fed chief may be playing it safe. The reason: recessions -- two quarters of declines in growth -- are tricky because they can only be identified with hindsight.
Ranson believes the central bank is currently rushing to keep the economy from stalling, building up a lot of unwanted stimulus for next year when the economy will be back on its own feet and booming again.
With the current rate reductions taking a long time to filter through the economy, Americans are waiting for the impact to be felt, which is putting Greenspan in a political maelstrom.
The economy is expected to grow by 2.7 percent in this year's fourth quarter after an uninspiring 0.5 percent rise in the second quarter and 1.2 percent increase in the first quarter. This compares with a brisk gain of more than 4 percent last year as the economy extended its unbroken string of growth to a record 10th year.
The Fed's rapid-fire rate slashing since early January has helped to slow the stock market's wealth destruction and kept consumer confidence from crashing.
The economy and capital spending are still sliding, while manufacturing, which has been in recession for the past year, is now starting see faint signs of a recovery. In June, manufacturing had its best showing so far this year.
The cruelty of the Fed's rate-boosting two years ago, which has slammed corporate earnings, is forcing Corporate America to fire thousands of workers. Only a couple of years ago, the same companies had a tough time attracting skilled workers as the future looked bright.
"The Fed is enormously exaggerating its power and ability to see exactly when and how its actions will affect the economy," Ranson says.
He says that the monetary tightening has curbed the economy too much.
"The side effects of the Fed's action have been so great that the central bank can't live with the results, which explains why the Fed is reversing itself with large rate cuts," Ranson says.
MAJOR CHANGES IN GREENSPAN'S THINKING
"During the early years of Greenspan's chairmanship, the central bank had been very gradualist but as Greenspan's confidence in himself increased, the Fed became more and more pro-active, more interventionist and, to use their words, 'preemptive,"' Ranson says.
But by cutting rates now, the Fed is de facto admitting it was wrong in raising in the first place. "But I don't think they are keen to come out and say so," Ranson says.
The last time the Fed reversed itself was in 1998 when it took back interest-rate cuts of 75 basis points, explaining that it had over-reacted to the threat of a global economic crisis after Russia's debt default and the collapse of the big hedge fund, Long Term Capital Management.
"The interesting thing is that less than a year later in 1999, the Fed was repudiating its rate cuts," Ranson says.
He believes that this preemptive business is the real problem.
"No matter how early they try to preempt the perceived problem, the Fed will end up creating instability," Ranson says. "Also, the bankers are never early enough because they see life in the rear-view mirror."
Richard Salsman, chief investment strategist for InterMarket Forecasting Inc., is another Fed critic.
"Unlike financial markets, which look ahead, the Fed looks behind," he says. "While markets forecast, Fed officials backcast."
CHALLENGING TIMES FOR FED
"The Fed's job has become tougher since the introduction of new technology in the economy," says Allen Sinai, chief global economist for Primark Decision Economics Inc.
"Technology has gotten a far more important role, even more than housing," he says. "And, because it is so new, the central bank doesn't have much history to go by in terms of how it impacts the economy and its behavior in upturns and downturns."
For example, the nature of capital spending by businesses has changed dramatically because they are now able to correct their inventory problems more quickly, thanks to this information technology stuff.
"The companies' ability to start and stop production with a lot of speed is changing the dynamics of business cycles," Sinai says. "What's also happening is that it is creating the perception at the Fed that the economy's ups and downs will be shorter and thus, business cycles will be smaller.
But since this is all too new, the Fed will need to study a lot more business cycles before it can clearly understand what is going on in this 'New Economy.' |
