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The Alan Greenspan Economy With the Alan Greenspan Economy, As Federal Reserve Chief Alan Greenspan approaches the end of his run as Fed chief, he's attempting to paint himself as a New Era Paul Volcker, vigilant against inflation to the end. But the fact is – with the Alan Greenspan economy, the Federal Reserve Chief is fighting a demon of his own making - risk. And it’s an economic demon that the new Fed Chief will inherit… and investors will bear the brunt of. Before the most recent FOMC meeting Alan Greenspan had to raise rates in anticipation of the inflationary effect of Hurricane Katrina relief money. The argument is basic supply and demand, with a little stimulus thrown in for good measure. The addition of $200 billion to the economy in the wake of Katrina will enhance demand and raise prices of building materials such as lumber and cement. That goes for energy as well. Since the Federal Reserve can't argue against a relief package for the victims of the hurricane, all they could do is hit demand via a rate hike. That the increase in demand is dictated by a natural disaster, and a rate hike won't have any effect, is irrelevant. The point is that with the Alan Greenspan views on the economy, the Federal Reserve Chief can respond to data that he knows will look inflationary (at least temporarily) with one of his standard "we'll continue to fight inflationary forces" (real or imagined) lines. Fighting an Economic Demon of the Alan Greenspan Economy Well, we got some of that inflationary data yesterday and today. Manufacturing activity (as measured by the ISM index and factory orders) as well as construction spending jumped in September. Predictably, so did prices for raw materials. This shouldn't have come as a surprise to the market, though it sure looked like the bond crowd was thrown for a loop yesterday. 10-year yields got within 100 bps of 52-week highs. As Greenspan approaches the end of his run as Fed chief, he's attempting to paint himself as a New Era Paul Volcker, vigilant against inflation to the end. But the fact is, Greenspan's mythos is more akin to Don Quixote or Robin Williams' character Parry from the wonderful 1991 movie The Fisher King. Greenspan is fighting a demon of his own making - risk. Greenspan attempted to redefine the Fed as a risk-manager, charged with shielding the US economy from extreme financial risk. But as any trader, athlete or CEO will tell you, you have to play to win. If you play not to lose, you're usually stuck with the very outcome you sought to avoid. Greenspan’s Economic Cause and Effect In 1996, when the Russian default threatened the global economy, Greenspan's response was to slash rates in an effort to lessen the effect of bad investments like the error of LTCM, the mega-hedge fund Long Term Capital Management, at a time when the US economy was expanding. The result: a stock market bubble. In 2002 and 2003, the fear of deflation led Greenspan to drop rates to all-time lows. The result: massive real-estate appreciation. Now, in the face of a slowing economy and high-energy prices, rates are going up. Greenspan seems intent on choking economic growth to fight inflation. Battling the Economic Windmills Here's the simple fact: you can't remove risk from an economy. In fact, capitalism openly embraces risk. Successful people are the ones who aren't afraid to risk it all. Timid people avoid risk. But what do we call those who, like Don Quixote, treat risk avoidance as a mythical struggle between good and evil? Jack Guyn, President of the Federal Reserve Bank of Atlanta, said the Fed has a way to go before it is done hiking rates. His concern is that high-energy costs will get passed on to the consumer. Umm... costs are already getting passed on to the consumer. Probably $120 a month for my family, just in gas prices. And once winter gets here, I'll be throwing an additional $200 a month on the bonfire. Does the Fed really think that monetary policy can somehow prevent price rises due to energy costs? I hope not. That's the economic equivalent of fighting windmills. More likely, the Fed is aware that the economy will slow as energy costs get passed through. And the only way the Fed will be able to ride to the rescue (again) is to have rates higher than they are right now A Future of Potential Trouble for the New Fed Chief Of course, it won't be Greenspan riding to the rescue. His term ends in January 2006. The new Fed Chief will inherit a healthy dose of imbalances as well as some interest-rate ammunition. If history is any guide, he or she will be busy from the get-go. The last few Fed changes have been difficult. Arthur Burns became Fed Chairman in 1970 right before the oil crisis. Paul Volcker got the job in 1979 in the midst of runaway inflation. And Greenspan took over two months before the October 1987 crash. The next Fed Chairman will likely inherit a US economy hampered by high-energy prices, slowing consumer spending and stagnant or falling real-estate prices. And I wouldn't be surprised if there's a little instability from China thrown into the mix. And with so much focus on energy, there are some very interesting – and potentially profitable – developments right now. |
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