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To: Oblomov who wrote (246995)	6/24/2003 3:17:57 PM
From: MythMan	Respond to of 436258

2:15 tomorrow.

To: Oblomov who wrote (246995)	6/24/2003 3:23:29 PM
From: Haim R. Branisteanu	Respond to of 436258

More probably, this month’s rate cut will have nothing to do with economics. It will be a simple case of market manipulation. The Fed needs to keep cutting rates — and to tease the market with the prospect of even more reductions — because it must keep blowing up the bubble in the bond market. With every week that passes the situation in the US bond market at present looks more and more reminiscent of the bubble in technology stocks which built up in the late 1990s and collapsed in March 2000. Investment bubbles always move through the three phases of scepticism, confidence and absolute certainty, illustrated in the chart. In the case of the Nasdaq bubble each of these were punctuated by comments from the Fed. Just as the event which marked the climax of the Nasdaq bubble was Greenspan’s statement in February 2000 that “something fundamental has changed in the US economic cycle” as a result of new technology, so in the present bond bubble, the climactic phase has been marked by the official pronouncement from the last FOMC meeting. This stated that the risk to the US economy from falling prices was now more serious than the risk of accelerating inflation. Thus the Fed’s primary objective, which had traditionally been to control inflation, would now be to push prices up. Did this mean that a Japanese-style deflation was actually imminent in the US? While some investors jumped to this conclusion, on the assumption that the Fed “must know something we don’t know”, most were content to buy bonds in deference to a simpler slogan: “Never fight the Fed”. The Fed’s May 6 statement effectively guaranteed to continue reducing interest rates to support the bond market, even if there were no further signs of economic weakness. It was also hinting strongly that it would enter the bond market directly, if this seemed necessary to keep long-term interest rates down. With the Fed promising to manipulate the markets in favour of bond investors, there seemed to be no risk in chasing long-term interest rates ever-lower, regardless of the true state of the economy. The question is why the Fed has decided to offer investors what looks like a free option, commonly known in the markets as the “Greenspan Put”. (In technical parlance, a “put option” is a an insurance-type contract which compensates the investor in the event of a market decline). The risk of deflation is objectively smaller today than it was a year ago, so we have to look for a more plausible explanation. The US economic recovery has suffered two false starts since it started to pull out of recession in the summer of 2001. The first recovery was snuffed out by September 11 and the subsequent panic in financial markets, the second by the even bigger stockmarket collapse last summer, following the Enron and WorldCom scandals. After this experience, the Fed is determined to make sure that nothing pushes the US economy and Wall Street off the rails yet again. The likeliest agent of such economic sabotage in the months ahead would have been a sharp rise in bond yields. In a normal business cycle, bond investors would start getting nervous around this time as the revival of economic growth inevitably reminds them of the risk of higher inflation in the future. How convenient, therefore, that Greenspan should start to think aloud precisely at this point about the perils of deflation, instead of inflation. And how reassuring that he should back up his theoretical conjectures with an explicit promise to print dollars without limit to prevent any possible rise in interest rates. Greenspan’s efforts have been well rewarded. Long-term interest rates have fallen instead of rising in the three months since the Iraq War, despite the improvement in economic prospects and the rebound on Wall Street. As a result, the US economic recovery will almost surely be sustained. But just to make doubly sure, the US authorities added another potent ingredient to the cocktail of economic stimulants — and this extra ingredient made it even more critical for the Fed to keep pumping up the bubble in bonds. The “Greenspan Put”, as well as acting as a safety net for US domestic bond investors, has also helped to neutralise the biggest risk of the Treasury’s new policy on the dollar. Whether the new dollar policy is described as benign neglect or outright devaluation there can be no doubt about two points. First, that it is a very powerful stimulant for the US industrial economy. Secondly, that this policy carries one big short-term risk: a free fall of the dollar could trigger a panic in the bond market, if foreign investors liquidated their US holdings. Such a bond market panic, which would force up long-term interest rates, could undo all the good work done by the weak dollar in stimulating US economic growth. The beauty of the “Greenspan Put” is that by continuing to pump up the bond bubble, the Fed has managed to neutralise this risk, at least for the time being. timesonline.co.uk