The headlines in Saturday's Financial Times shouted "Dow Plunges on Inflation Fears." In fact, stock prices really fell in anticipation of irrational despondency by Federal Reserve Chairman Alan Greenspan. The market, which Adam Smith called the "invisible hand" of lots of independent actors making separate decisions, has been reduced to a herd of lemmings second-guessing the moves of one unelected official with a passion for Ayn Rand and a recurring nightmare about, and an obsession with, inflation. It was investors' fears of the Fed, prompted by Greenspan's own inflation paranoia, that led Greenspan to threaten an interest rate increase, and helped send stock prices tumbling.
Market prices dropped last week because they were over-inflated and that's what balloons do when you prick them. Greenspan helped play the role of the prick this time by threatening to hike interest rates, shaking a sensitive market uneasy about the possibility of a court-ordered split-up of Microsoft. Investors panicked, and sold as if they had some massive belated realization that most dot-com stocks have the same intrinsic value as Confederate scrip.
But last week's tumble was not entirely investors' fault. A whole posse of equity analysts employed by the very brokers who sell the shares and do the investment banking for the companies, has cheered along the stampede of online stocks. For years investors have been told that stocks are worth what people are prepared to pay for them, regardless of the failure of these companies to turn a profit.
But the strange goings-on along Wall Street are not the reason that Greenspan is threatening to spoil the party. It is his single-minded obsession with, and strange definition of, inflation.
Like most nightmares, there is a large element of irrationality and imagination in Greenspan's inflation fixation. For Greenspan, "inflation" is augured by the faintest hint that ordinary employees may be getting pay hikes, or even that too many people are getting jobs, because that may embolden people to ask for a raise. "I do not consider the minimum wage as a positive force in our society," he told Congress in 1998.
For some reason, paying top executives huge salaries and even bigger stock options has not triggered any inflationary fears in the Fed chief so far. Even paying huge amounts for worthless companies is not inflationary in the Fed's book. If blacktulip.com has a valuation greater than half the world's economies, that's no problem for them.
Indeed, Greenspan has resisted attempts from other Fed officials to take action that might have deflated some of the puff from the balloon economy. Above all, he fought grimly against attempts to limit the margins on brokerage accounts. By March 2000, the NYSE member firms alone had extended $278.5 billion in credit to wannabe millionaires. That was 5 percent increase from February, which was itself an 8 percent spike from January's number. This contributes to a real inflationary spiral in the stock markets, and accelerates the fall when the bubble bursts as stock is sold to meet margin calls.
But there is a pattern here. When Long Term Capital Management went bust, losing untold billions of leveraged money in derivatives trading, it was Greenspan who came to its rescue. When a third world country is left high and dry by the tides of the global currency market, the Fed talks of moral hazard to emphasize why its people should pay up. When it's Wall Street bankers, the Fed quickly throws a life preserver. One simple moral solution would be to declare that any margins or other debts incurred in playing the market are gambling debts, and hence under many legal systems, unenforceable. That, however, seems unlikely.
Greenspan's actions are based on a chain of dubious premises. He thinks the U.S. economy is growing too fast. Words like "breakneck" appear when he testifies before Congress about the pace of American economic growth. In fact, historically, the U.S. economy has been growing quite slowly in comparison with other global economies. The real achievement of the 1990s was that American economic growth was pretty much uninterrupted. But it takes an act of considerable faith to give Greenspan's continual application of the brakes credit for that. It is just as reasonable to assume that it would have grown faster, fueled as it is by lots of foreign money that keeps flooding into the U.S. economy.
Greenspan's peculiar economic philosophy holds that sound money is everything. This from someone who in the '60s was advocating a return to the gold standard. We can deduce that he would just as soon have zero growth if it meant a sound dollar with no inflation. Rationally speaking, as long as the growth rates are higher than inflation rates, there is no problem for anyone except people who buy bonds on fixed interest, and those who keep their money under the mattress. For the majority of us who do neither, our assets and incomes will rise with inflation. For people like Greenspan, and bond-buyers, this is obscenity, an immoral assault on the foundations of capitalism.
And what if Greenspan followed through on his threat? If the Fed spikes interest rates, it may tempt some money from the equity markets into bonds. The problem is that the Treasury isn't issuing as many of them now that federal budget surpluses are paying down the national debt. But rate hikes reduce capital spending as companies face higher interest charges. That means that unemployment goes up, and, so does any tendency for employees to ask for more money. The increases are unlikely to have any direct effect on consumer spending since American consumers run up so much credit, and because most banks are charging a usurious spread -- the highest ever between what they pay for money and the rate at which they lend it to others.
The chain of cause and effect gets more tenuous with every link, which is why economics is as exact a science as phrenology or astrology in its application. It can always provide a retrospective explanation, but is lousy at prediction.
And no one has mentioned the biggest macroeconomic problems that the country has. The U.S. trade deficit is running near $30 billion a month. If any other country ran such a deficit and such an overseas debt, the International Monetary Fund would be enforcing austerity measures and calling for reduced government spending. This deficit is paid for because foreigners are prepared to accept the U.S.'s biggest and most distinctive export -- greenbacks. But a rate increase has its most immediate affects on the manufacturing industries that are struggling to keep up with consumer demand. If their efforts are hampered, and consumers keep spending, then the deficit could get worse.
If the market correction continues, and only the gamblers and the high-fliers lose their money, then the rest of us may not have to worry. But there is the lemming effect on the economy. There may be a Darwinian effect as the people who put their money into dot-com IPOs are weeded out of the financial gene pool. What we really have to watch is the damage that may be caused to the real economy by Greenspan's irrational and obsessive despondency.