Since he started boosting interest rates in May
1999, Alan Greenspan, the chairman of the Federal Reserve, has
singlehandedly tried to cool off an economy and stock market
that he viewed as overheated.
On Tuesday morning, four years to the day after he first warned
of "irrational exuberance," Mr. Greenspan proclaimed victory.
In a speech, he noted that the stock market, home-building,
car sales and demand for consumer durables were all down. Meanwhile,
unemployment claims and lending standards were up. With the
economy losing momentum, he said, the Fed must "remain alert
to the possibility that greater caution and weakening asset
values in financial markets could signal or precipitate an excessive
softening in household and business spending."
Traders took this convoluted prose as a clear signal: The asset
bubble had been pricked. The economy was slowing. And the Fed
might start thinking about lowering interest rates as soon as
Jan. 30, 2001, when its Open Market Committee meets.
Very quickly, the soundtrack on Wall Street changed from "Stormy
Weather" to "We're in the Money." Investors -- stunned into
inaction by recent market declines -- emerged from their bunkers
and gobbled up stocks. The Nasdaq spiked 10.47 percent, its
biggest single-day gain ever. (The Dow Jones industrial average
rose a less impressive 3 percent.)
Mr. Greenspan showed once again that he can move markets with
a few well-chosen words. But it is also abundantly clear that
the markets move Mr. Greenspan. And by the time the Fed meets
to consider its stance on interest rates, the environment may
have changed; Mr. Greenspan may be worried not about a slowing
economy, but about an overheated stock market.
I hate to pour cold water in everybody's eggnog. But the rally
on Tuesday wasn't particularly rational. e-Bay soared 17 percent,
Cisco rose 13 percent and Network Appliances spiked 38 percent
-- all on a day in which Apple Computer announced that its revenues
for the next quarter would fall well short of expectations.
The rise in these stocks was not fueled by any improvement
in earnings or by a rebound in consumer demand for the goods
and services of these companies. It was a result of wishful
thinking, prompted by the Greenspan announcement, for a return
to the days of cheap, easy money.
That wishful dream could continue, the market declines of yesterday
notwithstanding. There is the possibility of a Santa Claus rally:
the market gains momentum as holiday cheer builds and the Fed
appears to be in a giving mood. Then the January effect could
kick in. That's the annual phenomenon whereby billions of dollars
in year-end bonuses and profit-sharing checks flow into mutual
funds, thus jacking up stock prices further.
January is also likely to bring the inauguration of George
W. Bush -- a prospect that contributed to the rally on Tuesday
and that could serve to create inflationary pressures. Mr. Bush
has pledged to eliminate the estate tax and cut marginal tax
rates. The mere expectation of such actions could stimulate
excessive demand for everything from stocks to mink stoles.
And Mr. Bush has shown little interest in deficit reduction.
Add high energy costs and tight labor markets, and you've got
a recipe for the Fed to adopt a policy of watchful waiting --
not easing interest rates immediately.
Of course, if Mr. Greenspan indicated that the Fed wouldn't
cut interest rates, stocks would fall -- and fast. That would
remove the threat of asset inflation -- meaning that the Fed
could once again safely consider cutting interest rates.
After Mr. Greenspan's speech on Tuesday, it was tempting to
think that "irrational exuberance" had been conquered once and
for all. But investors' swift reaction to his low-key victory
speech proves that we still have a long way to go.