Very Nice Series of Postings John....!
Thank You for Sharing your thoughts.
Here's another commentary...!
Chip
quote.bloomberg.com
Caroline Baum
Commentary. Caroline Baum is a columnist for Bloomberg News. The opinions expressed are her own.
08/20 15:49
Crisis Management No Proxy for Monetary Policy: Caroline Baum
By Caroline Baum
New York, Aug. 20 (Bloomberg) -- Financial markets may be optimistic that the Federal Reserve will lower interest rates again tomorrow. They aren't optimistic about the result.
The Fed is widely expected to lower the overnight federal funds rate by 25 basis points to 3.5 percent tomorrow, a level last seen in early 1994 when the central bank was engaged -- probably for the last time -- in a preemptive policy move.
Since that time, the Fed has pretty much been tweaking growth or reacting to events, which more often than not amounted to crisis management.
In February 1994, the Fed started to raise the federal funds rate from 3 percent, where it had been for 16 months. When the banking system was on the ropes, an overnight bank lending rate equal to the inflation rate was feasible. When the economy started to take off, as it did in the latter part of 1993, Fed chairman Alan Greenspan knew that zero percent real rates would have to go.
In a very deliberate and measured fashion, the Fed lifted the funds rate from 3 percent in February 1994 to 6 percent in February 1995.
Since that time, it's been either fine-tuning (1995) or reacting to contemporaneous data and events. In 1998, the Fed cut rates three times in response to what Mr. Greenspan called the ``seizing up'' of financial markets, something he had not witnessed in 50 years of daily observation of the economy.
That period was characterized by an explosion of money and credit growth because the seizures hadn't affected the banking system.
Field Marshals
Unlike the period after the 1987 stock market crash, when the Fed eased but reversed gears quickly, the Fed stayed the course through June 1999, when it started raising rates. If there is a proximate cause for the bubble in technology stocks, it would have to be the Fed's acquiescence, providing the money to stoke it. Speculative sentiment is one thing; having the means to speculate is quite another.
The Fed raised rates by 175 basis points between June 30, 1999 and May 16, 2000. On Nov. 15, the Fed was still fretting over rising energy prices and inflation.
By Dec. 5, Greenspan received some intelligence from his correspondents in the field: Corporate CEOs told him their orders fell off a cliff in the fourth quarter. The Fed chief expressed his new concerns in a speech that day, the five-year anniversary of his ``irrational exuberance'' comments.
On Dec. 19, the Fed decided that inflation was no longer the threat; greater economic weakness was. Higher energy prices were still a concern but had switched teams and were now deflationary compared with inflationary one month earlier.
Lagged Effects
Once again, the Fed found itself playing catch-up ball, cutting rates in the first half of this year at the most aggressive pace since 1982. The first five moves -- two of which came between meetings, a rarity since the Fed started announcing policy changes in 1994 -- were all 50 basis points. On June 27, the Fed halved the increment to 25 basis points.
One day later, when the minutes of the May 15 policy deliberations were released, it was surprising to learn that three policy makers were in favor of a 25 basis-point rate cut or none at all; and that ``members anticipated that a neutral balance of risks statement could be appropriate before long.''
The implied yield on some eurodollar futures contracts, which react to changing expectations for the Fed, rose 15 basis points on the news.
Extended Slump
But other news on the economy quickly supplanted the Fed's views on the economy, which makes you wonder why traders hang on Greenspan's every word. Second-quarter earnings were lousy, with profits to date for the Standard & Poor's 500 companies down 18.3 percent from a year earlier, the worst performance in a decade. Along with their earnings, many companies, especially those in the technology area, revised their outlook for a return to profitability to the middle of next year.
The Nasdaq Composite dropped 4.6 percent last week and the S&P 500 was down 2.4 percent.
``The fear now emerging is not that we will have to deal with a technical recession in the second and third quarters of this year, though this is a possibility,'' says Chris Low, chief economist at First Tennessee Capital Markets. ``Rather it's that the trouble might drag well into next year. In a world of falling revenues, cost control is the only route to profits.''
Whenever things right themselves -- the good news is that the average life for technology equipment is much shorter than that for heavy machinery -- the Fed will find itself in the same situation it was in in early 1994. The real funds rate could be negative soon, if those economists calling for another 100 basis points of easing are correct. What that means is when things start to take off, the Fed will have to readjust the funds rate so as not to foment another credit binge.
Leading Index
How will policy makers know when that time has come so they don't end up chasing the real economy once again, running a kind of boom/bust monetary policy?
The Index of Leading Economic Indicators, which is designed to anticipate economic developments some six months into the future, rose 0.3 percent in July, its fourth consecutive monthly increase.
Last year, the LEI was signaling trouble ahead in the second quarter. Very few economists took the trouble to notice.
While the Index is far from perfect, it does do a pretty good job of forecasting. It would be standard operating procedure for the negativity to crescendo just when the economy is starting to improve.
A long time ago, Nobel Laureate Milton Friedman recommended replacing the Fed with a computer, which would provide the economy with a steady rate of monetary growth via an automatic drip. In the long run, the only thing the Fed can influence is the rate of inflation. That's why some central banks -- notably the European Central Bank -- have a sole mandate of price stability and leave growth to the fiscal authority. It's the government's policies on taxes, spending and regulation that affect the economy's potential for growth.
Given the boom and bust of the late 1990s and early 2000s, Friedman's suggestion might not be such a bad idea. |
