Greenspan Grabs World Spotlight As Stocks Gyrate

When Federal Reserve chairman Alan Greenspan testifies before Congress today, billions will be at stake.

If the cautious central banker gives the slightest hint that the Fed will raise interest rates to prevent a rebirth of inflation, the bond and stock markets will react - but investors aren't sure in which direction, up or down.

It's a crucial time for the economy. An actual rate hike would hit the pocketbooks of Americans holding home equity loans, credit-card balances, or variable-rate mortgages. If the Fed misreads trends and slows the economy too much, more workers would face unemployment. Abroad, finance ministers hope the US economy continues its forward pace, shoring up their nations' exports. Wall Street is jittery.

Most likely, Mr. Greenspan will be vague in his mid-year report to Congress, Fed observers say. Like many central bankers, he is famous for obtuse statements that camouflage the Fed's interest-rate intentions.

"He will say there is less tolerance and less excess capacity in the economy and somewhat tighter labor conditions," anticipates Henry Kaufman, a Wall Street economist. "He will call for significant monetary vigilance."

The chances of the Fed acting have just diminished, economists say. The fall in stock prices in the past week has shrunk the wealth of investors modestly, especially the rich.

"It could have some impact on consumer spending on luxury goods," says Roger Brinner, an economist at DRI/McGraw-Hill, an economic consulting firm in Lexington, Mass. Sales of Lexus and Mercedes automobiles, expensive personal computers, and upscale furnishings and appliances could suffer.

That could ease Fed worries that the economy is growing at an inflationary pace.

Joel Prakken, chairman of Macroeconomic Advisers, a St. Louis economic consulting firm, calculates that for every $1 decline in the financial assets of people, spending on goods and services shrinks by about 3 cents, spread over three years.

Between July 5 and Tuesday's market close, the total value of stocks shrunk by $372 billion to $6.126 trillion, according to the Wilshire Associates Equity Index. But stocks listed on the major US markets are still worth about $1 billion more than at the start of the year and far more than the $5.5 trillion a year ago.

Mr. Brinner says stocks are now slightly underpriced in relation to the earnings of the companies behind them and the comparative attraction of bonds, which now yield about 7 percent.

Economists see several factors influencing both the Fed and stock prices:

Statistical economic indicators. Consumer prices, it was reported Tuesday, edged up just 0.1 percent last month, the best inflation performance since November. Production in the nation's factories, mines, and utilities posted a solid 0.5 percent increase.

Investors did not seem particularly cheered by the Clinton administration's Tuesday prediction that the federal deficit will shrink to $116.8 billion this fiscal year ending Sept. 30. That is down $29 billion from the administration forecast last March, and even more from the actual deficit of $164 billion in fiscal 1995.

The new deficit prediction was based on an assumption the economy will grow 2.6 percent this year, when measured from the fourth quarter of 1995. The administration had earlier forecast that gross domestic product, the nation's output of goods and services, would grow only 2.2 percent this year.

So far this year, consumer prices have been rising at an annual rate of 3.5 percent, a full percentage point higher than the 2.5 percent increase experienced during 1995. But some economists see the pickup in inflation this year as the result of a temporary jump in energy and food prices.

Interest rates. Seeing the bustling economy, many Fed watchers have predicted a 0.25 percentage-point boost in short-term interest rates soon, perhaps even before the next Fed meeting Aug. 20. But June's consumer-price report, showing only a tiny upturn, will make it more difficult for the Fed to present a "politically viable" argument for doing so, Brinner says

"It is politically risky for the Fed," particularly in this election season, says Paul Kasriel, an economist at Northern Trust Company in Chicago. "There is no political constituency for fighting inflation. Inflation psychology is only in the minds of those who work in Wall Street and the Fed."

As usual, economists' view on the economy varies. But both Brinner and Mr. Prakken expect a slowdown in the months ahead, responding to the rise in interest rates in recent months.

"The Fed doesn't have to raise interest rates, but it might," says Prakken, whose former boss, Laurence Meyer, just joined the Fed as one of seven governors.

Business profits. Mr. Kaufman expects corporate profits to remain "quite strong." Though some high-tech and biotechnology firms reported disappointing earnings, helping kick off the market drop, other sectors have reported higher profits, such as financial services and automobiles.

Few economists, however, expect a profit-killing recession, even though stock prices are regarded as an important leading indicator of the economy's future course.

Foreign investors. In recent days, a decline in the dollar against major foreign currencies indicates that foreigners are pulling money out of the US market, Kaufman says.

Wages. Many on Wall Street are waiting to see what happened to total employment costs - a key factor in inflation - in the second quarter of this year. This number, to be released by the Labor Department July 30, reflects hourly costs of workers, payroll taxes, and the cost of benefits such as health care. Average hourly earnings have risen 3.6 percent in the 12 months ending in June, more than the 3 percent increase in consumer prices. Thus for the first time in years, workers have enjoyed a rise in living standards. But benefits did not rise so fast, at least in the first quarter. This offset the cost for employers of rising wages.

The Clinton administration welcomes the rising wages. But bond-market investors fret that this could kick off faster inflation, eat at the real value of their bonds, and depress bond prices should the Fed decide to counter that inflation by raising interest rates.

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.




Save for later


Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items


Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items


Failed to save

You have already saved this item.

View Saved Items