Knight-Ridder/Tribune Media Services, March 16, 2000
Alan Greenspan has been messing with the stock market, and that has got some people upset. If he's not careful he could find himself demoted in the eyes of the media from "the Great and Powerful Oz" to something lower down the food chain.
The Fed Chairman thinks the stock market is overvalued, and he's right about that. And he has legitimate reasons to worry about the bubble continuing to grow, and then bursting on his watch. After all, the Fed will be responsible for cleaning up the mess if this happens, and for trying to prevent the economy from tanking along with the market.
But it's the way he's decided to contain the market that makes his judgement look questionable. The majority of Americans have no money at all in the stock market, not even in retirement funds. Why punish them? That is what he is doing by raising interest rates, as he has already done four times in the last eight months. If he continues along this path-- as he appears committed to do-- he will slow the economy enough to throw a lot of people out of work. He may also put an end to the modest wage gains that most employees have finally seen over the last few years, after decades of wage and salary stagnation for the majority of the labor force.
Is this really what he wants to do? Sometimes it seems that way. In a recent speech at Boston College, Greenspan fretted aloud about the possibility that low unemployment might cause wages to rise faster than productivity. Could we please worry about this when it actually begins to happen?
And why is he so concerned about wage growth, anyway? There is little threat of it causing a burst of inflation. In the same speech Greenspan also expressed anxiety that rising wages might "squeeze profit margins." But is this really his concern? Over the last decade there has been a significant redistribution of income from wages and salaries to profits. If not for this re-division of the pie, the typical worker would be making $1200 per year more today.
With a quarter of all employees hauling down less than $8.00 an hour, is it really Greenspan's job to make sure that they don't get any of this income back?
Interestingly, Greenspan's commitment to keep raising interest rates until the economy slows enough to soothe his anxieties seems to have backfired, at least initially. His announcement accelerated the divergence, which began about a year and a half ago, between the Dow and the Nasdaq indexes-- the "old economy" vs. the "new economy" stocks. That's because the "old economy" stocks are more sensitive to interest rates-- so the Dow fizzled while some of the technology stocks that make up the Nasdaq took off. Although this trend could reverse itself, Greenspan's move could end up the making stocks more overvalued than ever, since most of the bubble is in the Nasdaq.
This illustrates another problem with the Fed's strategy. Greenspan didn't want to say what he knew-- that the stock market was overvalued. So he came up with a strange new theory of inflation. In this theory, the rapid productivity increases of recent years have caused investors to forecast huge increases in future profits. They therefore bid up stock prices.
The increase in the value of stocks causes their owners to spend more. In the mind of a man who sees an inflationary bomb about to go off every time he opens the business section of the newspaper, this can only lead to prices spinning out of control-- at least somewhere up the road. The Fed's conclusion: raise interest rates until the economy slows.
But there are no productivity increases and no forecasts of future profits that can, as a matter of arithmetic, justify current stock market prices. The problem is not productivity or consumer spending but a classic speculative bubble: investors are buying stocks because they believe stock prices will continue to rise. This is an easy self-fulfilling prophesy for as long as the belief lasts; but it can't last indefinitely.
If Greenspan really wants to keep the stock market bubble from growing, or even let some air out, there are less blunt instruments he can use. He could raise the margin requirements for borrowing to buy stocks, to discourage speculation. He could say what he knows about overvalued stock prices, and warn investors to reduce their exposure to the market.
All of which would be much more fair and reasonable than targeting the labor market and the economy on which mostly everyone-- stockholder or not-- depends.