Arigato, Alan-San
Wesbury, Brian S.
Arigato, Alan-San Brian S. Wesbury is chief economist at Griffin, Kubik, Stephens & Thompson, a Chicago-based investment bank. JUNE/JULY 2003 • THE AMERICAN SPECTATOR 15 makers from making...
...As late as November 2000, with industrial production already down for five consecutive months, the Fed still fretted about inflation...
...By the end of the year, Mexico had devalued, and Greenspan called in a $40 billion bailout—getting credit for stopping a problem his own Fed had caused...
...The Fed, going all the way back to the mid-1960s, has been almost always wrong...
...The result was one of the worst years in bond-market history...
...And then barely six weeks later, just days into the new year, the Fed was meeting in emergency session and slashing the federal funds rate by fifty basis points...
...Students of psychology will see the problem: the Fed is narcissistic...
...But once it became clear that the Fed's next move would be to tighten monetary policy, those trades were unwound with a vengeance...
...Its favorite OutputGap-Phillips-Curve models—which focus on GDP growth rather than price stability—put it automatically behind the curve...
...Indeed, as a practical matter, it is impossible to tell whether the monetary aggregates that the Fed and everyone else relies on—M1, MZM, etc.—are driven by the supply of money or by demand for it...
...The problems facing the U.S...
...I, 16 THE AMERICAN SPECTATOR • JUNE/JULY 2003...
...The arbitrage desks were hard at work and long-term rates fell...
...Some analysts see lack of money as the root and point to slow growth in monetary aggregates as proof...
...Like Japan, Alan-san is ignoring the real problem and thereby preventing its solution...
...And as interest rates shot up, the Fed's volatile tightening spread around the world...
...The economy itself is another matter...
...If all that weren't enough, the likelihood of a tax rate cut by midyear gives businessmen and investors one more reason to hold off on economic activity...
...Senator Connie Mack tried to get the Fed to move that way in the mid-1990s, but Greenspan stymied him at every turn...
...It's chicken and egg...
...But at the first sign of stronger growth—or a change of heart at the Fed—yields will once again rise sharply...
...No one, not even all the economists at the Fed, can divine the perfect level for unemployment or real GDP growth...
...Once the Fed said that short-term rates would not soon be heading higher, hedge funds and bond desks around the world started selling short and buying long—the so-called "carry trade:' This yield-curve arbitrage sets off waves of refinancing that can push long-term rates well below equilibrium value...
...Only the adoption of a price rule and inflation targeting can permanently fix these problems...
...They never did...
...Nonetheless, after the Fed made its worries about deflation clear, long-term interest rates fell...
...In 1994 the federal funds rate doubled to 6 percent, and 10-year Treasuries hit 8 percent...
...And the fact that everyone is worried about deflation now suggests that this argument has always been wrong...
...If the economy is growing rapidly and the stock market is strong, this must reflect easy money...
...What is most interesting is that normally rational people are now siding with the Fed in this argument...
...More importantly, volatility in monetary policy would increase, and the inevitable rise in interest rates would be larger than is necessary, creating turmoil in financial markets...
...Take a bow, everyone...
...The yield curve for fixed-income securities is historically steep...
...But because so few in Congress or the press understand monetary policy, Alan Greenspan can play them like the proverbial fiddle...
...And because inflation reacts with a lag of two years or more, the Fed's tight money of 1999 and 2000 may still be a factor today—albeit, increasingly a waning one...
...In the late 1990s, when the economy was booming, the Fed convinced itself that we were growing too fast, unemployment was too low, and inflation was just around the next corner...
...A similar cycle set in during 1993 and 1994...
...Today the biggest complaint about the "Maestro" is that he waited too long to tighten monetary policy in the late 1990s—he, too, was mesmerized by "the bubble:' This argument, however, falls short...
...Like today, the bond market had convinced itself that the Fed would never tighten...
...But that is exactly what they try to do...
...Growth indicators are weak and employment is falling...
...This led to the calamitous series of interest rate hikes in 1999 and 2000, despite weak gold, falling commodity prices, a soaring dollar, and an inverted yield curve...
...Risks continue to be weighted mainly toward conditions that may generate heightened inflation in the foreseeable future," the FOMC intoned...
...Gold prices are up 28 percent in the past two years and now stand above $350 an ounce...
...On the other hand, when times are tough, it must be because of a lack of liquidity—open the valves...
...Reappointing him to another term—as President Bush recently announced he would do—will put this necessary change off again...
...The boom of the late 1990s was caused not by easy—or any other—Fed policy, but by transformational technologies that are still remaking our economy...
...In fact, just as in 1983, once the tax cut finally becomes law, the economy should take off...
...Evidently, the "foreseeable future" is not very far...
...When it looks at the economy, it sees its own reflection...
...That's where we find ourselves today...
...Some take this as de facto evidence of tight money—in fact it's just a reflection of current Fed policy...
...JUNE/JULY 2003 • THE AMERICAN SPECTATOR 15 makers from making decisions...
...economy have nothing to do with monetary policy...
...Earnings have already started to turn around, even though growth has been slow, so any increase in top-line nominal growth will feed directly to the bottom line...
...Eleven more cuts have followed, pushing rates to forty-year lows...
...most Believes the Fed...
...American corporations have boosted productivity by using technology to cut costs and become more profitable...
...Economic growth remains slow, but inflation never showed up...
...If the Fed were now to inject more liquidity into the system, this would only further weaken the dollar and fuel reflationary fires that are already burning...
...But the fact is that monetary aggregates have been lousy predictors of growth, going back at least twenty years...
...THE LESSON T he Fed's past mistakes are so obvious that it is hard to understand why anyone puts credence in their forward-looking utterances...
...The Fed ignored these signals of deflation and remained in denial, even though the economy was clearly showing signs of monetary fatigue...
...If the Fed had indeed allowed too much liquidity into the economy, inflationary pressures would have shown themselves...
...The Fed's mistake was to give itself too much credit (the other sort) for the boom and then start tightening to slow the economy down...
...As a result, we need to fall back on more accurate measures of dollar liquidity, and fortunately we have them—prices—for which virtually all the important indicators today point strongly to reflation...
...The dollar has lost more than 15 percent against the euro in the past six months...
Vol. 36 • June 2003 • No. 3
