Bursting Greenspan's Bubble
Philadelphia Inquirer, Dec. 10, 2000
Knight-Ridder/Tribune Media Services, December 6, 2000
Baltimore Sun, December 13, 2000
Milwaukee Journal Sentinel, December 10, 2000
Sacramento Bee, December 7, 2000
Times Union (NY), December 10, 2000
Alan Greenspan demonstrated his awesome powers once again on Tuesday, sending the stock markets skyward by simply admitting that the economy was slowing. The Federal Reserve Chairman's speech was widely interpreted as an indication that the Fed could lower interest rates next year. The recently battered Nasdaq jumped more than 10 percent, an all-time record increase.
Cheney's comment was an unusual break with protocol-- presidents and their spokespersons don't normally talk up the possibility of a recession, because the talk itself is not healthy for the economy. He was trying to link the downturn, if it happens, with the Clinton-Gore administration, while it is still early enough to do so.
These rate increases, which brought the short-term Federal Funds rate to its highest level in nine years, have just started to have their intended effect: slowing consumer and business spending. In the coming months this will probably be seen as a mistake, and one that will not be so easy to correct. The other major source of the slowdown has been the decline in the stock market, which also causes both businesses and wealthier consumers to cut spending. The Nasdaq dropped 48 percent and the Dow about 10 percent from their peaks this year, and the Greenspan-led rally isn't going to make up for that.
While the Fed did not create the stock market bubble, the way Mr. Greenspan has handled it has exposed our economy to great risk. He was acutely aware that stocks were overpriced four years ago, when he made his famous speech about "irrational exuberance." The Dow, already overvalued at 6300, responded with a 2 percent drop. Although the market quickly recovered and began its ascent to the stratosphere, Greenspan reassessed his strategy. This bubble may be crazy, he thought, but I'm not going to take the blame for letting the air out of it.
Unfortunately, stocks are still-- on average-- enormously overvalued relative to any conceivable earnings that the underlying companies might produce. The country is also carrying a record trade deficit and an overvalued dollar that could plummet at any time. A falling dollar would increase inflation by increasing the price of imports. The Fed, which elevates the fight against inflation above all other concerns, would be loathe to lower interest rates in the face of a falling dollar-- even if that's what were sorely needed to jump-start the economy.
The Fed actually brought on the last (1990-91) recession by raising interest rates to 10 percent in 1989. Although Mr. Greenspan began lowering them as the economy slowed, it turned out to be too little and too late.
How quickly we forget.