Alan Greenspan demonstrated his awesome
powers once again on Tuesday, sending the stock
markets skyward by simply admitting that the
economy was slowing. The Federal Reserve
Chairman's speech was widely interpreted as an
indication that the Fed could lower interest rates next
year. The recently battered Nasdaq jumped more than
10 percent, an all-time record increase.
The signs of an economic slowdown are
everywhere: third quarter GDP growth dropped to
2.4%, from 5% in the previous quarter. Auto sales,
housing starts, and retail sales are also lagging. Vice
Presidential candidate Dick Cheney declared this
week that "we may be on the front edge of a
Cheney's comment was an unusual break with
protocol-- presidents and their spokespersons don't
normally talk up the possibility of a recession,
because the talk itself is not healthy for the economy.
He was trying to link the downturn, if it happens, with
the Clinton-Gore administration, while it is still early
enough to do so.
But the person who really ought to take the
lion's share of the blame for a "hard landing" is Alan
Greenspan, and yet he retains his image of
infallibility. Fearing "tight labor markets"--
something that most people celebrate because it
means more job opportunities and a chance at a pay
increase-- the Fed has raised interest rates 6 times in
the last year and a half.
These rate increases, which brought the short-
term Federal Funds rate to its highest level in nine
years, have just started to have their intended effect:
slowing consumer and business spending. In the
coming months this will probably be seen as a
mistake, and one that will not be so easy to correct.
The other major source of the slowdown has
been the decline in the stock market, which also
causes both businesses and wealthier consumers to
cut spending. The Nasdaq dropped 48 percent and the
Dow about 10 percent from their peaks this year, and
the Greenspan-led rally isn't going to make up for
While the Fed did not create the stock market
bubble, the way Mr. Greenspan has handled it has
exposed our economy to great risk. He was acutely
aware that stocks were overpriced four years ago,
when he made his famous speech about "irrational
exuberance." The Dow, already overvalued at 6300,
responded with a 2 percent drop. Although the market
quickly recovered and began its ascent to the
stratosphere, Greenspan reassessed his strategy. This
bubble may be crazy, he thought, but I'm not going to
take the blame for letting the air out of it.
Over the next few years, the Dow would grow
by 80 percent and the Nasdaq nearly quadruple. But
Greenspan would no longer raise the idea that it was
overvalued, and he actually retreated from his
previous remarks. This was a serious mistake. The
Fed could have continued to talk the market down,
and even used its control over margin requirements--
for borrowing in order to buy stock-- to dampen the
Instead, the Fed began a series of interest rate
hikes in June of 1999. In other words, rather than
target the stock market, where the problem resided,
the Fed trained its weapons on the whole economy.
This is certainly unfair-- it punishes everyone from
home buyers to workers (when unemployment rises,
as it almost certainly will); and the vast majority of
Americans have gotten little or nothing out of the bull
market in stocks. It also had the effect of setting up a
one-two punch-- the shrinking stock bubble and
interest rate effects hitting the economy at the same
time-- that could very well end in a knock-out for the
Had the Fed used its power and influence --
the kind that we witnessed on Tuesday-- to squeeze
the stock market rather than the economy, we would
not be facing such a high risk of recession.
Unfortunately, stocks are still-- on average--
enormously overvalued relative to any conceivable
earnings that the underlying companies might
produce. The country is also carrying a record trade
deficit and an overvalued dollar that could plummet at
any time. A falling dollar would increase inflation by
increasing the price of imports. The Fed, which
elevates the fight against inflation above all other
concerns, would be loathe to lower interest rates in
the face of a falling dollar-- even if that's what were
sorely needed to jump-start the economy.
The Fed actually brought on the last (1990-91)
recession by raising interest rates to 10 percent in
1989. Although Mr. Greenspan began lowering them
as the economy slowed, it turned out to be too little
and too late.
How quickly we forget.
Mark Weisbrot is co-director of the Center for
Economic and Policy Research in Washington, DC.
He is co-author, with Dean Baker, of Social Security:
the Phony Crisis (2000, University of Chicago Press)