What Greenspan Is Worried About
- All trading in
global financial markets was reactive to the testimony of Fed Chairman
Greenspan - Currency markets
rallied versus the dollar as the Treasury’s policy of “benign neglect”
was echoed by the Fed chieftain - Bond markets and
stocks surged on Greenspan’s words but I have to wonder if the
Chairman’s words were misconstrued.
This week in the markets has felt as if
Salvador Dali had hijacked our clocks and time became surreal. The G-7
communiqué brought severe, early gyrations as investors struggled to
deal with the enigmatic statements of the world’s financial
potentates. Stocks, bonds and foreign currencies were virtually
unchanged on the week, after early week volatility, and awaited Sir
Alan’s economic proclamations. I thought that he would deliver a tepid
statement to Congress but that the committee’s questions would be
provocative, this being on election year. Greesnpan’s words were not
at all bland, but rather very pointed in dealing with several hot
financial topics. Two minutes into his delivery, the text of his
speech was released on the Internet, and the markets roared to
life. The Dollar was sold hard as the bonds and stocks started a rally
that set the European markets galloping forward, too. Such is the
power of words that emanate from the Chairman’s mouth. The bond
markets did not hear the dreaded words of an overly robust recovery
but were calmed by the sound of, “…however, progress in creating jobs
has been limited.” No rate increases on the horizon and it is
full speed ahead, captain.
“To be sure, the FOMC’s
current judgment is that its accommodative posture is appropriate to
foster sustainable expansion of economic activity. But the evidence
indicates clearly that such a policy stance will not be compatible
indefinitely with price stability and sustainable growth;Â the real
federal funds rate will eventually need to rise toward a more
neutral level.”          Â
This has been the crux of the Dollar
sell-off over the last 18 months. The real rate of return on money has
been negative and this has dragged the Dollar down. This and his
maestro’s comments about the benign effect of the falling currency let
loose a large rally in the Euro. As long as the Fed continues to push
this “benign neglect” story, along with Treasury, the Euro will
rally. After Greenspan speaks to the Senate committee tomorrow, we can
anticipate “jawboning” from the Europeans. The gauntlet has been
thrown down and it will be interesting to see the response now that
the Euro is approaching its previous highs. In what way will the
European Central Bank act -Â to lower rates or intervene in the
currency markets?
As was discussed previously, the bond
and stock markets rallied with the anticipation of a continued patient
Federal Reserve. However, I think the markets are missing a
critical piece of Greenspan’s testimony. I would argue that Greenspan
actually called for tax increase and that when this gets reconsidered,
the markets (stocks and bonds), may react negatively. In the third to
last paragraph of his testimony, the Chairman states:
“Nonetheless, given the already
substantial accumulation of dollar-denominated debt, foreign
investors, both private and official, may become less willing to
absorb ever-growing claims of U.S. residents. Taking steps to increase
our national saving through fiscal action to lower Federal budget
deficits would help diminish risks that a further reduction in the
rate of purchase of dollar assets by foreign investors could
severely crimp the business investment that is crucial for out
long-term growth.” (emphasis added)
Here you have it. Sir Alan is worried
that the current fiscal and budget profligacy cannot continue forever,
for the foreigners we depend on won’t keep sustaining our spending
habit. Fiscal action to stem our wanton ways will be needed –
otherwise the party will end and it will look like Monday at
Woodstock. Greenspan has handed the Democratic Party the domestic
issue it needs and it couldn’t have come at a more opportune time. The
testimony is filled with other points about budgetary restraint and
this I believe will be a negative that weighs on the entire U.S. asset
class. This is only my opinion, of course, but I warn that when the
markets awake from their hangover, the remedy will be painful. It is
not a question of if, but rather when.
More testimony tomorrow so stay focused
and nimble.
Yra Harris
yra53@aol