What Would Greenspan Do?

That’s the question the WSJ’s Greg Ip asks:

"Should the Fed worry more about rising inflation and raise rates further, risking a recession? Or should it worry more about growth and hold rates steady, risking higher inflation and a loss of credibility? The outlook for global stock and bond markets will hinge on the outcome of that decision."

As if we don’t know WWGD:  The short answer is, he would flood the system with liquidity. The longer answer involves opaque speechifying about systemic risks and global resilience and blah blah blah, as he released the hounds of M3 into the ether. (more money supply! Faster! Faster!)

The column references an academic study co-authored by Bernanke  that concluded "economic growth begins to slow roughly six months after the Fed
tightens monetary policy. But inflation doesn’t begin to ease until
about year has passed."

The net result of this is the conundrum we referred to  last week, with the Fed painted into a corner.

Here’s an excerpt from Ip’s column:

"The result often is an uncomfortable period when growth is slowing, inflation rising and the central bank facing a tough choice between higher rates and watchful waiting.

That may be where the U.S. economy is now. After a first-quarter surge, growth is slowing, as higher interest rates and energy prices take their toll on housing and consumer spending. It "seems pretty clear that the housing market is cooling," Mr. Bernanke said Thursday, though the slowdown is quite "orderly and moderate." But core inflation, which excludes food and energy, reached a one-year high of 2.3% in April.

Markets have gyrated on the economic crosscurrents and bond yields reflect a rising concern about whether Mr. Bernanke will hold inflation low over the long term. "With core inflation crawling up, a new central-bank chairman is clearly not going to want to let inflation expectations go up," Mr. Gertler said.

With the Fed having raised its short-term interest-rate target in 16 quarter-percentage-point steps to 5% since June 2004, some at the central bank appear to favor pausing soon to assess the impact of those moves on the economy."

Today’s futures look like hell (glad I got stopped out of longs last week). If we see a serious whackage today — and it sure looks like we might — that will resurrect the possibility of a pause in June.


Here is everyone’s favorite faulty comparison: 1994 vs 2000 vs 2005
click for larger graphic


Source: WSJ

As previously noted, the better comparo is 1973.


Trade safe today — it looks like it could get ugly out there.


What Would Greenspan Do? Bernanke Weighs
Risks of Rate Increases and Rising Inflation
WSJ, May 22, 2006; Page A2

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What's been said:

Discussions found on the web:
  1. The Nattering Naybob commented on May 22


    CAC, DAX & FTSE are getting pounded today, commodities pulling back big also. Not a good precursor.

    I expected a continuation of Fridays bounce until Thursdays PCE, but maybe not.

  2. DBLWYO commented on May 22

    A couple of critical points. First let me point out that walking a mile in the other guys shoes is always an interesting shift in perspective. While many in the finance community have railed against Greenspan’s excess liquidity nobody has done or fairly presented the alternatives – which might have been a major economic collapse. The 2K bust was the first investment-led cycle we’ve seen post WW2 and the three major prior examples (’29, ’07, 1870s?) led to multi-year problems. One ought to factor that in.

    Unfortunately the Fed is indeed in a box because inflation this time is not monetary but rather being driven by supply/demand imbalances starting at the very front of the economy with raw materials and energy. ‘Fortunately’ worldwide over-capacity and competition will keep a lid on things. Again, if one dives beneath the headlines to the real data and structural trends, “it’s different this time”.

    And on that note – as you’ve pointed out – we haven’t gotten an uptick in business spending because the outlook for consumer demand growth ain’t there. In other words after the stimulas has died there ain’t no more investment accelerator coming and we’ve seen the best there is for some time.

    So now we’re looking a gradual creep up to 3-4% inflation, a growth slowdown to 3-2.5% and still a deficit in cumulative new job creations of nearly 2 million.

    Delicate and interesting times. Rather than rail at Uncle Al and Little Ben perhaps we ought to be considering investment strategies.

    And oh yeah, btw, notice that the Ip column reflects very traditional, headline driven thinking. To the extent there’s any credability in my argument the structural gap in analysis between it and whomever drove the column is VERY worrisome.

    Also btw – isn’t the heart of this column a reaonsed examination of the data and the total context. In that spirit simply following along with lambasting Greenspan without asking where there any whys and wherefores leaves to many factors ill-considered.

  3. Emmanuel commented on May 22

    Isn’t this a recipe for stoking even more inflation, though, precisely what we don’t need at this point in time?

    As if we don’t know WWGD: The short answer is, he would flood the system with liquidity.

  4. jab commented on May 22

    Barry – More importantly what would Brian Boitano do?

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