-------- Original Message --------
Subject: A story of the Fed in Wonderland as Greenspan puts emphasis on gr owth - Economic View by Anatole Kaletsky
Date: Tue, 24 Jun 2003 13:20:18 +0100
From: "Mitchinson, David" <[EMAIL PROTECTED]>
To: "'[EMAIL PROTECTED]'" <[EMAIL PROTECTED]>
I'm subscribed on my home address (mitchinson.org) my friend (and subscriber) Laeeth (i think [EMAIL PROTECTED]) would like to post this article from Kaletsky but as he's in Chicago can't. Could you post it please?
His message is below.
> From: Isharc, Laeeth [SMTP:[EMAIL PROTECTED]
> To: Mitchinson, David
> Subject: FW: A story of the Fed in Wonderland as Greenspan puts
> emphasis on gr owth - Economic View by Anatole Kaletsky
> hope u ok. can u send this to armchair and austrian lists. be
> interested to know response.
> Sent: Tuesday, June 24, 2003 8:12 AM
> Subject: A story of the Fed in Wonderland as Greenspan puts emphasis on
> gr owth - Economic View by Anatole Kaletsky
> From this morning's Times
> > June 24, 2003
> > Economic View
> > A story of the Fed in Wonderland as Greenspan puts emphasis on growth
> > Economic View by Anatole Kaletsky
> > DOES an economy that is growing by 2 per cent, with 2.2 per cent
> > inflation, negative real interest rates, a rapidly devaluing currency,
> > booming property and stock markets and a massive stimulus from falling
> > taxes, need a further large cut in interest rates?
> > If you immediately answered "yes" to this questions, you are the lucky
> > winner of a seat on the Federal Reserve Board. If you answered "no",
> > or even if you hesitated for a moment, you have failed your entrance
> > exam for the Fed.
> > Benjamin Franklin said that life in America had only two certainties:
> > death and taxes. Today we can add a third: the next cut in interest
> > rates. The next meeting of the Federal Open Market Committee (FOMC) is
> > tomorrow and the only question is whether the Fed cuts interest rates
> > from 1.25 per cent to 1 per cent or 0.75 per cent. I have no view
> > about which option the committee will go for, but I do have a view
> > about the economic arguments behind this rate cut: they will come
> > straight out of Alice in Wonderland.
> > Alan Greenspan, Chairman of the Federal Reserve, has said that he
> > wants to buy "insurance" against deflation - a persistent and
> > generalised decline in prices which deters investment, discourages
> > consumers from spending and sends the economy into depression.
> > But how can an economy where consumers are enjoying 3 per cent wage
> > growth and are about to benefit from one of the biggest tax cuts in
> > living memory, and where real interest rates are already minus 1 per
> > cent suddenly collapse into deflation? Maybe Greenspan imagines that a
> > White Rabbit will appear out of nowhere and lead America, Alice-like,
> > down a black hole. 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
> > if foreign investors liquidated their US holdings. Such a bond market
> > panic, which would force up long-term interest rates, could undo all
> > good work done by the weak dollar in stimulating US economic growth.
> > beauty of the "Greenspan Put" is that by continuing to pump up the
> > bubble, the Fed has managed to neutralise this risk, at least for the
> > being.
> > Of course this kind of market manipulation cannot work forever. At
> > some point, when it becomes impossible to deny any longer the
> > expansionary implications of the cheap dollar, the Bush tax cuts and
> > the Fed's ultra-stimulative policies, the "Greenspan Put" will
> > presumably be removed (just as the Fed's support for Nasdaq was
> > removed after May 2000). By that time, however, the US economy should
> > be growing very strongly and the dollar may be so cheap (at least
> > against the euro) that foreigners will again be happy to buy US assets
> > without special inducements or guarantees from the Fed.
> > In the meantime, Greenspan will just have to pump ever harder to keep
> > the bond bubble inflated, which is why a rate cut is an absolute
> > certainty tomorrow afternoon.
> > Will he be right to manipulate the markets in this shameless manner?
> > In my view, he will. After three years of sub-par economic growth,
> > rising unemployment and falling asset prices, the Fed's only concerns
> > today are to revive US growth, restore full employment and boost the
> > stockmarket - and quite rightly in my view. The inflationary risks
> > that still obsess the European Central Bank and preoccupy even the
> > Bank of England are quite rightly ignored in Washington.
> > This is not because America faces more risk of deflation than Europe
> > or Britain. It is because Washington quite rightly puts first things
> > first.
> > When the economy is weak, at the low point of the cycle, Americans
> > understand that the central bank's job is to stimulate growth and to
> > forget about inflation. The time to worry about inflation is when
> > unemployment starts dropping and growth accelerates above trend. At
> > that point, the Fed will surely tighten policy quite severely,
> > interest rates will rise sharply and bond prices will collapse.
> > The question is when bond investors will start to anticipate this
> > disaster. The Fed's game of blowing bubbles is not like the Caucus
> > Race in Alice, where the rule was "winners and losers, all must have
> > prizes".
> > When US economic recovery becomes self-sustaining, Greenspan will
> > suddenly blow the whistle - and the losers will be the Bigger Fools
> > still holding long bonds.
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