Everyone in the money business wants to know one thing this week: What will Alan Greenspan do?
This Tuesday, the Fed chairman meets with the Federal Open Markets Committee to set interest rates. Financial handicappers almost unanimously predict that, with inflation having undeniably reared its ugly head, the Fed will take a more hawkish stance and raise rates a half point.
That bump is pretty well priced into the stock market. But I'm hoping for a surprise. An on-the-brink situation like the one the economy faces calls for decisive action. The Fed should order a three-quarter-point hike immediately.
Greenspan's need to balance concerns of too-little-too-late vs. too-much-too-soon reminds me of another '90s visionary. I'm speaking of the "pain management" specialist who visited me periodically during my post-surgery hospital stay a few years ago. The crucial thing, she explained, was to stay one step ahead of the pain. Once it started coming on, it would be far more difficult to stop. She encouraged me to ask freely for medication if I felt any discomfort, a suggestion I was happy to comply with. Yet somehow I was never dosed into oblivion, just the pleasant edge of lucidity.
Greenspan is our economic pain-management specialist. Judging by the unprecedented duration and vigor of the current expansion -- the Greenspansion -- he is every bit as effectual as my hospital-approved pusher. Maybe even more so: Where she had an entire pharmacopeia to choose from, Greenspan and his Fed cronies can only prescribe two drugs -- higher rates or lower ones. Such broad-spectrum metabolic treatments and a stolid, cryptic bedside manner are all the chairman's got, and his sure-handed dispensing has kept us a step ahead of economic pain for a long time.
But we've reached a critical point in the economy's care. Five times in the last 11 months, Greenspan has detected inflationary symptoms. Each time, he doled out a quarter-point rate hike, the smallest dosage available to prevent undue economic swelling. Unfortunately, the low-dose boosters haven't worked all that well. April's unemployment rate sank to 3.9 percent, a 30-year low, while wages rose. Consumer confidence remains strong, and consumer prices, even excluding volatile energy products, are creeping up. Despite last week's reports that retail sales and wholesale prices are retreating, analysts blamed last month's unseasonably cool temperatures for discouraging Americans from building a spring wardrobe, and attributed the dip in producer prices to sharply lower oil prices. Wall Street may have reacted positively to the news, but the economy remains on inflation alert.
It's essential to nip this sort of inflation in the bud, before everyone starts to raise prices in a self-fulfilling, viciously circling anticipation of higher costs. An unexpectedly high interest rate jump is the most effective way to do it.
One reason? Precisely because the market doesn't expect it. "That was one of the most important lessons of 1994 and one that should not be lost on the Fed today," says Morgan Stanley chief economist Stephen Roach. "The Fed is now in danger of falling behind the credibility curve and the only way to regain the upper hand is with a policy surprise."
The Fed needs to reassert its potency. The economy and the stock market are confidence games. To some extent, things have gone well simply because people have believed they were in good hands. Chalk it up to the placebo effect. If Greenspan acts too gingerly and we see signs this summer that inflation has not only arrived, but is unpacking its bags, it could spell the end of his cult. For the market's long-term faith in him to continue, it needs evidence that the central bank is still a player.
And if analysts are right, there's little point to holding back. Nearly every report, analysis or prognostication about Tuesday's Fed session follows a curious pattern: First, it predicts or calls for a half-point rise. Then in the next sentence, it says that the inflation threat is big enough that rates will have to rise even further this summer.
If they're going to climb more in a few months, why not push them up now? The risk of goosing them too high is unnecessary recession. But we're only talking an extra quarter-point here; any recessionary pressure from a 25 basis-point imbalance could be fixed with relative ease. Inflation doves might argue that an additional quarter-point up won't do that much to ward off inflation. True enough. The value of a dramatic three-quarter-point move would be to signal that Greenspan & Co. are on the case -- that they're going to keep us ahead of the pain.