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Today's Commentary: 04.27.04
Being Greenspan: When and How, Not Whether
So much is being written and spoken about the not-so-far-in-the-future rate hike, which will be lovingly engineered to perfect effect by the Federal Reserve Chairman Alan Greenspan, that one might let the reasons why he only talks about them without having yet acted slip past unnoticed.
Let's talk first about where Greenspan stands on the state of the economy. He likes what he sees. We have growth. We have money in abundance and policies in effect to keep that money available at a cheap cost to the borrower. We have a deficit which is something he at once disdains but also recognizes as another catalyst for the current expansion. And we have low inflation or as he prefers, the absence of deflation.
He also is beginning to believe that we may be fully employed. He is disturbed by the fact that employment benefits which ran out for 85,000 people each week during the month of March was not the desired direction but dropping those poor souls from the government dole actually improved the employment number. He is also comfortable with that data as well.
We don't, however really have growth or low inflation or manageable deficits in a historic sense, and this is something Mr. Greenspan also knows. And he's not alone.
The International Monetary Fund, the group that bails out debtor countries, has been worried recently that the current interest rate in the United States is too low. American businesses and the American people have begun to believe that this low rate environment will be here forever and are borrowing and spending on that belief.
Alan knows that most of us are not looking too far into the past to find historic averages for all these rates that we now take for granted. The average 20 year rate for mortgages is 8.5%. Are we so foolish as to think that these rates won't return in the near future? Many of us apparently are that foolish and we have been so at the chairman's urging. In the same breathless monotone that uttered the words "irrational exuberance" lo' those many years ago, he recently extolled the wealth creating effects of adjustable rate mortgages. Should the interest rates begin to inch up and the chairman is left with little in the way of choices at this point, these real estate bettors will become real estate debtors very quickly. Removing the wealth effect of this group and those who have refinanced to do more than just lower their monthly payment, will force the wrath of historic rates upon these hapless borrowers. Much like the converse way bond prices and yields move, mortgage rates on the rise tend to drive the price of homes down.
Growth in earnings had been fun to watch this season as companies find investors nonplussed by the sharp upturns in revenues and earnings per share - compared to a dismal quarter last year. You remember the winter of last year, don't you? Businesses literally stopped as they watch the Bush war machine roll first over international law and then into Iraq. They were afraid that the actions by the American president would damage world markets.
The 'ever ready to spend' consumers had become realistic about terror and went about business as usual after the war began. With a tentative peripheral view of the world, caution became the new watch word in business. Growth just happened incidentally as business refused to expand. Instead they moved forward by contracting labor forces and increasing productivity and aided by some pricing increases they ended up doing little in the way of actual growing their marketshare.
The national deficit, the likes of what we have experienced over the last year is not a historical norm either. The portion of governmental debt in relation to GDP over the last twenty years runs around 2%. Flirting with 4% as it currently is actually is an invitation for interest rate hikes.
Greenspan has cleared the air about deflation and now has left us with the unavoidable effects that inflation will have on the economy. Once again, the last twenty years will be mined for historic inflation rates. That average of 3% would make the chairman comfortable but he is beginning to see the data reflect an otherwise higher number. Once inflation takes a toehold, it will continue to grow for the next decade and if you add this healthy ability of businesses to price their goods for what the market will pay into the core index for the first three months of 2004, expect inflation to hit 5%. That will be the new core excluding the volatile gas and food prices.
But he warns that inflation may still not be a factor of "the protracted period of monetary accommodation". A recovering economy doesn't need low interest rates however. All that's left is the timeliness of the increases in interest rates. They are coming and it will probably be very painful indeed - at least from a historic perspective.
