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Technology Stocks : How high will Microsoft fly? -- Ignore unavailable to you. Want to Upgrade?

To: Jon Stept who wrote (38509)	2/24/2000 9:09:00 PM
From: Captain Jack	Read Replies (2) \| Respond to of 74651

NEW YORK--Stock market investors love Federal Reserve Chairman Alan Greenspan. During his three terms in office, he's presided over an unprecedented run of the bull market as well as unparalleled economic prosperity. One after the other, he faced off a succession of crises: the 1987 stock market collapse, the mid-1990s inflationary uptick, the Asian flu and the Russian financial meltdown. Investors are convinced that with Greenspan at the helm nothing bad can happen, either to the economy or to the stock market. Unfortunately, this confidence makes Greenspan's current task much more difficult to accomplish and could eventually lead to a financial disaster. As Greenspan pointed out in his semi-annual congressional testimony, the main concern of the Federal Reserve at the moment is the extraordinary shopping spree by American consumers. Consumption has been the engine of economic growth in recent years, but during last year's holiday season Americans hit the stops as though the world really was going to end with the new millennium. Consumers are now buying much more than the economy can produce, widening the trade gap by 63 percent last year. Households are also spending more than they earn. The savings rate has plunged into negative territory to levels not seen since the Depression. The cause of this amazing spending boom is the stock market. Over 45 percent of Americans own stocks, either directly or through their pension and mutual funds. A sustained stock market rally in recent years has created a fairy-tale world in which nearly everyone can become rich without making a big effort. There's no need to put aside anything for old age: your pension fund holdings have skyrocketed, and projected federal budget surpluses will create a huge pool of money with which to fix Social Security. You can spend more than you earn since your existing savings are already multiplying rapidly in the stock market, at least on paper. As long as the stock market continues to generate easy money, consumers will continue to throw it away with gay abandon. The trade deficit will continue to widen, the dollar will plunge and inflation will eventually return. It's Greenspan's responsibility to keep this scenario from unfolding- which means stopping the bull market. The question is how? Greenspan is universally considered one of the most powerful men in the world, but the only tool he has at his disposal is control of interest rates. The Fed has already tightened four times since mid-1999, increasing rates by a full percentage point. Greenspan has told Congress that rates will be rising as long as the economy continues to grow at an unsustainable pace. The stock market is very sensitive to Greenspan's words and deeds. Stocks tumbled last summer when the Fed started raising rates. This year, the Dow Jones industrial average is down by over 1,000 points, or 10 percent of its value, which technically constitutes a market correction. But investors trust Greenspan. They think he can fix any problem. By raising interest rates he surely will nip trouble in the bud. So every period of jitters in recent months has been followed by renewed efflorescence of optimism, with stocks scaling new heights every time. Moreover, shares on the NASDAQ Composite have stopped reacting to higher interest rates altogether. The apologists of the new economy have convinced investors that high-tech startups use only equity capital to finance themselves, not bonds or bank loans, and therefore won't suffer any damage from higher interest rates. Back in the 1970s, central banks learned that in order to defeat inflation they must first overcome inflationary psychology. Consumer snapped up goods because they believed they would be more expensive tomorrow, workers demanded larger wage increases and businesses raised their prices to keep up with inflation. As a result, inflation became a self-fulfilling prophecy. A similar inflationary psychology now grips stock investors. They buy stocks because they believe stock prices will keep going up, creating a novel investment technique called momentum investing--thoughtlessly buying any stock already on an upward trend. The only skill you need is not to sell no matter how absurd the valuations become. Momentum stocks such as Yahoo, Amazon.com and America Online are sure to keep rising. Stock investors now see every dip in the market as a buying opportunity, rushing in to buy before the stocks renew their momentum. Whenever the Fed breaks the upward market trend, investors rush in and start on another ring of the spiral. To break the inflationary psychology of the 1970s, Federal Reserve Chairman Paul Volcker was forced to jack up interest rates to punitive levels, and keep them up until people were convinced consumer prices had stopped increasing. The current Fed chairman may be forced to do the same. For Greenspan to maintain investor respect, he may have to raise rates higher and keep them up longer in order to convince investors he wants to put an end to the bull market. Greenspan's task is like that of a bullfighter. So far, interest rate increases have served to get the stock market bull going. To stop the stock market bubble, Greenspan may be forced to deliver a mortal blow. ALEXEI BAYER, an economist, is president of Kafan FX Information Services, a New York-based consulting firm. His views are not necessarily those of Bridge News, whose ventures include the Internet site www.bridge.com.