April 22, 2001

Economists Puzzled by Fed's Quick Interest Rate Cuts

Arm-chair economy-watchers were ho-humming the stock market freefall until Federal Reserve Board Chairman Alan Greenspan tossed in a sudden, big cut in interest rates – the fourth already this year – sending the market soaring again.

What unnerves survivors of the 1929 Great Depression is a statement by Fed member Anthony Santomero. He says recovery from the slowdown-cum-recession is "just around the corner."

That was the placebo preceding the worst worldwide economic collapse in history.  Greenspan’s rationale last week is a similar gem of obfuscation:

"Capital investment has continued to soften, and the persistent erosion in current and expected profitability -- in combination with rising uncertainty about the business outlook -- seems poised to dampen capital spending going forward."

 Translation: "Fasten your seat belts."

Suddenly, Greenspan seems fixated on the stock market – a symptom, not the cause, of economic malaise.

The stock market has little effect on the economy. At best it is a barometer of what crapshooters believe the economy will do for issuing corporations six months to a year down the road.

Neophyte stock purchasers seldom look at the "price/earnings" (PE) ratio of the companies they bet on. In the olden days, a PE 10 was the most extreme measurement tolerated. The price of a share of stock was no more than ten times its annual earnings per share.

In other words, it would take ten years for a stock investor to recover his/her investment via the company’s profits. The daily Wall Street Journal stock listings reveal that PEs of 50 are common. Those of 100 or more are not unusual. Fools searching for the last fool.

Nevertheless, human nature being what it is, the collective crowd of crapshooters  over the years will produce a small, net profit overall for the market– not necessarily big hauls for individuals. For example, a market basket (mutual) of stocks is a better investment than dead money in the Social Security Trust Fund. Bonds are even better.

If Greenspan is spooked by the recent free-fall of technology stocks – reflecting a decline in consumer spending – he is chasing a will-of-the-wisp. His job is to provide low-cost capital for expansion of competitive production (read that "jobs") not stimulate consumer spending (read that "inflation").

Undoubtedly Greenspan is looking over his shoulder at some warning signals. The unemployment rate inched up to 4.3 percent last month as thousands of jobs were eliminated. Retail sales were down.  

The Fed has control of only two, weak, tools – the federal funds rate at which banks lend money to each other overnight, and the discount rate at which it lends directly to banks for longer terms.

Both rates have been cut by two, full percentage points so far this year – a drastic move. The federal funds rate now is 4 percent and the discount rate 4.5 percent. Consequently, the key "prime lending rate," for best borrowers, ticked down a half percent to 7.5.

It is worrisome that consumers have felt the longest bull market in history was forever. They took on a record amount of debt. The average, monthly credit card balance is said to be more that $8,000. Congress is working on a bill that would make it harder for individuals to wiggle out of debt by personal bankruptcy.

Lower interest rates, of course, will take off some pressure on debtors. But a pound of flesh is still due.  

The Fed, lenders, Congress and the Bush administration must keep their eyes on the world economy. Forty percent of our production is exported to foreign buyers. We must buy from them so they can buy from us.

If our spending declines, so will our balance of trade; and so will our jobs. Japan’s economy is near collapse. Europe’s meat-animal industry is wiped out. Mexico is struggling to feed a hungry population. Canada has trouble meeting its welfare obligations. Saudi Arabia is milking the rest of us without mercy.

While the Fed watches inflation, other economists should monitor the consumer confidence index, housing starts, automobile inventory, private debt load and unemployment claims.

Most of all, government must cut taxes right now. A total tax load of 40 percent – federal, state and local – is close to being unbearable.

Under the best of circumstances, economic remedies require six months to a year to take effect. Consult the stock market barometer – but don’t bet on it.

 PARTING SHOTS

The Army chief-of-staff last October ordered all soldiers to be issued black berets and ordered a third of them from China. We can expect Monica Lewinsky to demonstrate the proper, rakish wear. La de da. Let us demand the first load be shipped in our plane on Hainan Island.

* * *

Steven Spielberg, award-winning movie producer, has resigned from the Boy Scouts advisory board to protest banning avowed homosexuality – thus simultaneously illustrating the personal standards of Scouts and the movie industry.

By Lindsey Williams, columnist for Sun Coast Media Group newspapers