As the voting finally begins in Iowa next week, political pundits and pollsters tell us the next President will be one of four men. It probably makes no difference to Federal Reserve Chairman Alan Greenspan which of the four will make it. Each of them have paid him the kind of obeisance usually reserved for deities. Vice President Al Gore and Senator Bill Bradley, the Democrats, openly assume they need not worry about economic growth in their administrations because Greenspan will take care of that. They can concentrate on devising new social programs to occupy the flood of revenues flowing from his wisdom. Texas Governor George Bush, coached by former Fed Governor Larry Lindsey, also assumes that it is Greenspan's genius that has produced the hot stock market and economy. He intends to cut tax rates by a miserly amount, but we can imagine Greenspan persuading him to go easy. Arizona Sen. John McCain is so sure Greenspan is the Master of the Universe that he promises to keep him propped up in his chair even if he dies during a meeting of the Federal Open Market Committee.
So why is the 30-year bond trading at 6.75%? There is no good reason, except that Greenspan has used the only tool at his command, the fed funds rate, to prevent the economy from growing at a pace and in a way it would much prefer. It would be much healthier and much less costly, if, for example, Greenspan tomorrow morning announced that he and his Fed colleagues decided to forget about the overnight fed funds rate -- and instead would hold gold at its current $285 per ounce through liquidity management. The markets would rush to lock in 6.75% and in no time at all bid the long bond at least below 5%, where it'was twelve months ago. In other words, the yield on the long bond has climbed 200 basis points entirely on Greenspan's supposition that a phantom inflation lurks on the horizon. Instead, it was Greenspan who allowed a monetary deflation to ravage many vital parts of the world economy by starving the economy of dollar liquidity at a time of legitimate demand. Now, by pushing up interest rates to their current level and warning of more to come, Greenspan & Co. have become a burden to the world economy and a great expense to American taxpayers. In debt service alone -- given the spreads over the average maturity of the public debt -- we estimate the cost of these monetary errors at $82 billion annually.
There is no relief in sight from this mismanagement. To be sure, there are benign interpretations of Greenspan's speech last week to the New York Economic Club, which suggest he only may do another 25 or at most 50 basis points during the course of the year. We did not read the speech that way and neither did the market, which continues to price in 100 bps in order to satisfy the Fed's insistence on slow growth to prevent "wage inflation." In his speech, Greenspan did throw in a negative comment about the Phillips Curve, the idea that too many workers cause inflation. But that is only because he now has the more politically correct formulation provided by Alfred Broaddus, president of the Atlanta Fed. As we noted in an e-mail brief January 11, Broaddus has concocted the outrageous hypothesis that while the stock market rise anticipates future increases in actual production, the inferred wealth is causing people to spend faster than that production is showing up. Ipso facto, demand outruns supply and we get price inflation. Wealth creates inflation!! We thought Greenspan might resist such nonsense, but there it was in his New York speech: "[A]ppreciating values of ownership claims on the capital stock, themselves a consequence, at least in part, of accelerating productivity, [have] spurred private consumption to rise even faster than the incomes engendered by the productivity-driven rise in output growth."
If Greenspan is willing to buy this kind of ad hoc analysis, he is willing to forget everything he learned about markets over the last half century. In his mind's eye, the new high-tech economy draws sustenance from a finite pool of capital: "Increasing perceptions of wealth have clearly added to consumption and driven down the amount of saving out of current income..." On this line of reasoning, if the good part of the economy wants to grow at 6% annually, he has to keep interest rates high enough to cause the bad part of the economy to grow at zero percent, so his non-inflationary ideal of 3% can be averaged. Such, he believes, is the unavoidable price that must be paid to globalize. Wednesday's Fed statement, meant to clarify questions about its bias, indicates the only possible way interest rates can be reduced is with economic weakness. Throughout the history of the world, those economies that are strongest command the lowest interest rates in the private markets -- just as the most productive households can borrow at will at preferential rates. Not in this new Greenspan universe.
There is practically universal agreement on Wall Street that the Fed will raise the funds rate when it meets February 1. This requires that Greenspan explain why the inflation that will require higher rates now and perhaps in the future is nowhere yet in sight. In his New York speech, he offered several reasons, including "the global economic crisis of 1997 and 1998," which sank commodity prices (when it was actually the Fed's monetary deflation that wrecked Asia). The more persistent reason for the lack of inflation, he explained, are those same high-tech Internet innovations that are driving up equity prices on Wall Street. That's right. The Internet is deflationary! By increasing efficiency, the Internet is lowering prices, or at least preventing prices from rising: "Indeed, the increasing availability of labor-displacing equipment and software, at declining prices and improving delivery lead times, is arguably at the root of the loss of business pricing power in recent years." No, it is not. Wages and prices rose during the inflationary 1970s even as computer power was expanding, unemployment was climbing, and middle-management was being displaced. The cause was monetary errors by the Fed after gold was abandoned as the unit of account. It may appear that Internet productivity is holding down prices, but it is again the Fed's monetary policy errors. Over the centuries since prices have been tracked, technological advance translates into higher wages, not lower prices. It is more Greenspan ad hockery.
Does all this mean the long bond will remain at its current lofty yield through 2000? No. It means the funds rate will go at least to 5.75% on February 1 from 5.5% and go no lower this year. This still leaves room for the long bond to rally to 6% or better if Greenspan signals there's no need to hike funds the other 75 bps. The inversion of the yield curve from 10 to 30 years, with the 10-year today trading four bps above the long bond, is the first sign the market is now making this bet. Of course, if bonds rally, so will stocks, and wealth, and "excessive" consumer buying. Greenspan can turn the rally on or off as he wishes, to suit his mood. How nice to be Master of the Universe.