(CORRECTED )Steve,Re: Fed may be too tight already. Barron's May 29:
interactive.wsj.com
MAY 29, 2000
Forget Overheating; the Fed Could Be Too Tight
By H. Erich Heinemann
In every economic expansion, business people make mistakes.
Ultimately, they hire more workers than they can employ
profitably, and they invest in more capacity to deliver
goods and services than their markets can absorb -- at
least temporarily.At the top of each cycle, managers
recognize these facts. They stop hiring, which abruptly
halts growth in jobs. At the same time, they cut capital
spending. Together, these actions push the economy into a
self-reinforcing contraction -- in a word, recession. Based
on 40 years of observation as journalist and economist, I
think the U.S. is close to just such a critical turning
point.Of course, mistakes by government policy makers
are also part of the witches' brew. Fiscal and monetary
policy, as always, is at the top of the current list of
potential trouble spots. The operating surplus in the
federal budget (revenues minus expense, other than net
interest) was $450 billion in the first quarter, not only a
huge amount in dollars but also 4.6% of the economy,
the highest figure since 1951. A spike in the federal operating
surplus has preceded every U.S. recession since World War II.
Meanwhile, machinations by Alan Greenspan and his band
of mischief makers at the Federal Reserve are playing their
typical role in setting the stage for the next downturn.
As the chart on this page shows, transaction money --
narrowly defined to include domestic currency and plain-
vanilla checking accounts that don't pay interest -- has
hardly changed since 1997.Such a sustained slowdown in the
growth of spending money qualifies at minimum as monetary
restraint, if not actual tight money.
Four main factors support this view:
interactive.wsj.com
ú Over time, the main impact of Fed policy is on
aggregate money demand for goods and services (translated
from the jargon, gross domestic product in current
dollars). During the past three years, current-dollar
spending has risen at a trend rate of only 5.6%. That is
both unusually slow for a long expansion and well below the
trend growth rate of 7.4% in nominal spending since World
War II.
ú Judging by the performance of the Treasury's
inflation-adjusted bonds, expectations of price change
remain modest, even though many purported inflation
indicators (wages and oil prices are among the most
popular) seem to have stirred recently.
These "indicators" are popular on Wall Street, but they are
misleading because they ignore money growththe underlying
cause of sustained changes in the rate of change of
prices.
To restate an old clich‚, inflation happens
when the Fed prints too much money, not when too
many people go to work.
ú The overseas value of the dollar has surged far
above the trading range that evolved in the late
1980s and continued until 1997.Participants in the
foreign exchanges plainly believe that the Fed's
disciplined monetary policy will prevent any sustained
acceleration of inflation. Even though oil prices are
up, tight money will keep inflation from spreading through
the economy. This is what happened in 1990; investors
should look for a replay in 2000. The downside is that
Greenspan's overvalued dollar appears to be at least partly
responsible for the record deficit in U.S. foreign trade.
ú As prospects for lower inflation in the U.S. have
improved, the dollar price of gold has gone down.
The slide started years ago. At present, I can see no signs
of reversal in that trend. However, at the first hint that
political support for reasonably stable prices in this
country was weakening, the gnomes of Zurich (and their
sisters and their cousins and their aunts) would bid up the
metal. Like a moth circling a candle flame, Wall Street is
mesmerized by the Federal Reserve's target for overnight
interest ratesor to be more specific, by changes in that
target. Traders appear to assume that increases in the
target will restrain the economy and that cuts will
stimulate it. These assumptions often aren't true.
In general, nominal short-term rates are a weak
indicator (lousy would be a better word) of the Fed's
monetary policy stance. Nominal rates minus current
inflation (so-called real rates) are more useful, but Wall
Street "economists" rarely take the trouble even for this
simple calculation.
Fed officials have raised their funds rate target five
times during their current cycle of rate
increases -- starting last June with a hike from
4.75% to 5%. The first four moves appear to have had
little or no impact on real rates. The Fed actions
simply kept pace with the pickup in reported price changes
that was already embedded in the economy.However, the
fifth increase, a halfpoint jump to 6.5% earlier this
month, could tell a different story. Nominal rates are
up, while transitory pressures in wholesaleand consumer
prices have started to ease. (The CPI was unchanged in
April following substantial increases during the winter;
producer prices were down.)In this setting, the Fed may
have to pull reserves out of the banking system to prevent
rates from dropping below its 6.5% target. In turn, that
could lead to an outright decline in the supply of
domestic spending money, and thus turn monetary restraint
into tight money.Investors should keep in mind that the
primary job of a Wall Street economist is to keep clients
confused, on the theory that confused clients are more
likely to trade than those who know what they're doing.
(I should know; I used to be part of this gang.)When
economists talk about the economy, they usually refer
to "real" activity -- total spending adjusted for price
changes. The difference can be huge. As one example,
nominal output of computers rose 19.5% in the year ended in
the first quarter of 2000; real output was up 45%.Where
economists (Wall Street or otherwise) generally talk about
the real economy, business people must make decisions about
hiring, firing and capital spending in the nominal,
current-dollar world. Imagine the confusion economists
create when real activity is unreal, and nominal
transactions, "unreal" to economists, are in fact
day-to-day reality.Newspaper headlines may blare about
record expansion and exploding growth. Yet cash registers
convey a more moderate story of sluggish increases in sales
and rising expenses. Since February 1992, when
the job market hit bottom in the last recession, private
employers have added almost 21 million new jobs to their
payrolls. Almost 90% of this enormous gain is in industries
that the Labor Department classifies as
"service-producing."These industries include
transportation, utilities, communication, finance insurance
and real estate. Within this overarching classification,
retail trade and "services" (everything from hospitals to
haircuts to hotels) are by far the biggest gainers with
almost three-quarters of the total increase. Through 1998,
at least, all of these job gains were at business
establishments with fewer than 1,000 employees.
Government data suggest that several million people who
hadn't previously participated in the labor market are
working today. Most are women, who account for roughly 55%
of the net gain in employment in the 'Nineties. The ratio
of employment to population for women over age 16 has long
since soared into record territory, while the comparable
ratio for men is in a long-term downtrend and has yet to
surpass its cyclical high in 1990.
Conventional wisdom among financial gurus
is that the nation is on the cusp of a new era of
continuous prosperity, owing mostly to accelerated rates of
gain in productivity or output per hour. I am profoundly
skeptical of such claims -- not least because of the
ridiculous spike in consumer spending (too hot not to cool
down) and the virtual disappearance of personal saving
(too cold not to warm up).On a more basic level, investors
must remember that productivity gains are largely
concentrated in manufacturing, where the number of
production workers hasn't changed significantly since the
1940s, while the job gains have been in service sectors
where productivity improvements have been few and far
between.In May 1990, most of my fellow pranksters in the
economics game were convinced that steady, if moderate,
growth could continue indefinitely. They were wrong then,
and I believe they are wrong now.
H. ERICH HEINEMANN, retired chief economist of Ladenburg
Thalmann & Co., is a former economic
correspondent of The New York Times.
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Message #1891 from Steve Fancy at Jun 1, 2000 11:48 AM ET
Zbyslaw, any speculation on employment report tomorrow and PPI/CPI next week. Seems we should see signs of the slowdown everyone seems to want? Kinda ironic, the world is waiting to see US economy slow to bid stocks up.
I've been thinking of unloading some of my June 40 calls today, but if it closes over 55.5 and tomorrow is stable to up, ALA could be oughta here as momentum players take notice. If this situation were to materialize, I'm thinking ALA could see 60-65 in short order before settling down, whereas it seems low fifties, or maybe 48 if the bottom were to fall out again. Any other opinions?
I suppose MSFT may be a large factor over the next couple days also, as well as any Fed govenor comments.
sf
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