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The Emperor Has No Clothes

Posted by: Michael Mandel on May 04

Alan Greenspan and his Fed friends have raised short-term interest rates 8 times over the past year. Yet the best efforts of the “second most powerful man in Washington” seem to have come to naught, as long-term rates, including mortgage rates, have actually fallen over that stretch.

The Fed’s inability to push up long rates has been variously blamed on a global savings glut, lack of growth in Europe and Japan, and exposure to kryptonite (oh oh, scratch that last one).

But here’s a disturbing thought: Could Greenspan finally have lost his preternatural ability to control the economy?

After all, it was never quite reasonable that an institution as small as the Fed should be able to influence an economy as large as the U.S. The monetary base, which arguably is what the Fed controls directly, is less than $800 billion. By comparison, households and nonprofits own about $60 trillion worth of assets. That's a heck of a difference.

It may be getting harder these days for the Fed flea to control the economic whale. A bigger and bigger chunk of the financial system is out of the Fed's control, what with globalization and the explosion of new asset classes such as hedge funds.

If this is true, one consequence would likely be increased volatility, with booms and busts a more important part of the financial and economic landscape. Such volatility needn't be a horrible thing, but it would have some interesting implications for investors and for politicians, especially the ones in Washington who are debating private accounts.

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Reader Comments

norman ravitch

May 6, 2005 12:37 PM

Greenspan is a disciple of that nut Ayn Rand. What can you expect?

Christopher Lovette

May 7, 2005 05:06 PM

Mr. Greenspan has, over the years, postponed some economic pain in spite of structural imbalances in the U.S. economy, but eventually the Piper must be paid.

Justin Samuels

May 8, 2005 11:55 AM

I too think that Greenspan postponed some structural imbalances in the US economy. And if he's serious about bursting the real estate and the oil futures bubbles interest will likely have to be a lot higher than the current 3.0%

Also Greenspan's .25 rises are designed to give predictability to the markets. The Fed will likely need to get more aggressive, and to get rid of these measured increases. Forunately, there's debate in doing just that at the fed.

Alex Solomon

May 8, 2005 10:58 PM

It's funny,Michael,I've been saying that the Emperor has no clothes to many of my friends for a while now.But for a different reason;The Fed is no longer the Emperor.The fast and furious trading-desk money is the new Emperor,and the new world order is Leverage.Most people do not make a connection between the recent spiraling or bubble in real estate and the unjustified and uncontrolled runup in many commodity prices like copper,coffee,soybeans,and of course crude oil and gasoline prices.But they do have a very simple thing in common-Leverage.If our elected officials would demand the CFTC use its authority to curtail rampant and leveraged speculation by raising the futures'margin requirements,much of this bubble of commodity inflation will deflate almost instantly.In the oil case,if anyone is wondering,figure this: Despite the fact there is no shortage of supply(3 year high in supplies on hand as of last week API data)and only 3-4 percent demand increase,also official figures,we are staring at $50-60dollars per barrel today,when two years ago OPEC could not budge up the 19dollars level.A triple!...Wait,it gets worse...You can still control today,on NYMEX,a contract of 42000barrels of gasoline(about $62000 worth)with a $4400 downpayment-read margin.That friends,in simple math is about 15:1 leverage.It is this tail that's wagging the dog that no one in authority seems to be doing anything about that costs everyone of us, needlessly.

Jack Krupansky

May 11, 2005 11:41 AM

The obvious candidate for explaining the persistent flattening of the yield curve is diminished inflation expectations of market participants. Maybe more than a few people believe that the Fed is being *much* too aggressive at tightening rates (or at least its talk of "inflation pressures") for an economy that really isn't booming (not >4.5% real GDP) and that a mini-recession or even some deflation might be just around the corner after the Fed finishes snuffing out the current "boomlet".

Yes, the fact the 10-year interest rates remain "low" is a "conundrum", but only if you mistakenly believe that long-term inflation is taking off.

It is worth noting that longer-term crude oil futures prices are "predicting" a decline from current prices (known as backwardation), illustrating the fact that at least some significant subset of market participants are *not* forecasting the kind of inflationary pressures that Fed "hawks" and their supporters continue to tout.

Finally, persistently low 10-year interest rates simply tell us that there is a glut of credit, and the net result of an oversupply of credit tends to be lower rates of interest. Many companies are struggling to *reduce* their debt, *not* increase it.

Has anybody noticed what sad shape the airlines and car companies are in? Or how technology companies are struggling?

Why are so many people so unable to comprehend some of these basic and seemingly obvious facts? The reason is because people become attached to "stories" that fit their biases, rather than focus on the true "state of the economy".

Finally, I'd note that foreign governments are increasingly holding longer-term debt relative to traditional holdings of short-term treasuries, and that this "unusual" demand is pushing prices up and yields down. I've seen *no* coverage of this in the media. Could there be a "story" there?

-- Jack Krupansky

Ellen Mitchell

May 16, 2005 12:08 PM

Does anyone seriously think that inflation is running at a rate less than the 4% so far measured? And real interest rates are less than zero? Somebody out there still believes the Federal Reserve has the power to control prices including Chairman Greenspan. The yield curve is flattening and heading toward inversion and markets believe the Fed's actions will cause a recession. Are we all in for a surprise? China backs its currency policy by buying dollars and then US Treasuries. Speculators anchor their complex strategies with US Treasuries. Both those actions can change. What can't change is the enormous twin American deficits, vast demands in transfer payments, and wreckless borrowing at the consumer level. Tomorrow's PPI and Wednesday's CPI could be a shocker. Would anybody actually consider buying a new 30-year Treasury at 5%?


March 27, 2007 09:45 PM

If you have something to sell, especially technology, inflation is zero % to almost 15% deflation.

If you have debt, or wish to acquire something like energy, well inflation is 4-10 percent depending on what you acquire, how efficient it is, and how credit worthy you are.

New cars, better technology, and information transfer cost the same or are cheaper than three years ago.

If you are a cash buyer, inflation is neutral and a profit can still be made but is not guaranteed.

In the virtual world, however, where impulse defies reality; inflation can be 2-10 times original cost.

Thank you for your interest. This blog is no longer active.



Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.

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