Taking stock of point man

The Economy

Professor co-writes book on Greenspan

September 05, 1999|By William Patalon III

ASK UNIVERSITY of Maryland history professor David B. Sicilia to explain the 108-point drop in the Dow Jones industrial average Aug. 27 and he'll likely ascribe it to the "Greenspan Effect."

It's an apt label, demonstrating the increasing influence economists, professional investors and workaday consumers believe Federal Reserve Chairman Alan Greenspan has on the financial markets -- not just in the United States, but abroad, too.

"The Federal Reserve should not have the effect on the securities markets that it does, given what we call its `levers of power,' " says Sicilia, whose specialty is business and economic history. "The question is: Why does it?"

The search for an answer led to the new McGraw-Hill book "The Greenspan Effect: Words That Move World Markets," which Sicilia co-wrote with Jeffrey L. Cruikshank, a friend and Boston public relations expert. The hardback, due on store shelves within weeks, is essentially a decoder ring for all statements Greenspan.

Sicilia, 44, of Ellicott City and his cohort scrutinized 3,000 pages of Greenspan speeches dating to 1987, studied the news stories that resulted, and finally showed how the capital markets reacted. From these toils emerges a work that not only gives investors tips on how to grasp the essence of Greenspan's messages, but also presents some fascinating insights into the little-understood, but constantly evolving thought processes of the always-measured U.S. central banker.

For instance, "he has publicly tried to deny that he can move markets but the fact is, he does," says Sicilia.

And Greenspan knows it: When he testifies before Congress about the economy, staffers periodically hand him notes about how markets are reacting to his comments, Sicilia observes.

The "Greenspan Effect" is particularly relevant now, with investors wondering if the Greenspan-led Fed will announce the year's third interest-rate increase when its Greenspan-led policy committee meets Oct. 5. There's an old market maxim known as "three steps and a stumble," which implies that three interest-rate "steps" ultimately lead to a "stumble" in stock prices. Investors are looking for any hints about what the monolithic Fed might do. And since Greenspan is the Fed, investors are watching the Fed chief to see what clues he might drop.

Consider, for instance, the Aug. 27 speech in Jackson Hole, Wyo., where the Fed chairman was the opening speaker at an annual conference for central bankers and economists with the Kansas City Fed as host.

In essence, the baritone banker's message was that U.S. assets like stocks and homes have risen so far and so fast that their valuations are now a major influence on the vitality of the U.S. economy. Consumers are effectively saving nothing out of their paychecks, reasoning that the stock market will save for them. Not only does that free up more money to spend, it gives consumers the confidence to spend it.

That clearly worries Greenspan, who more directly than usual asked whether we might not be in a speculative bubble, a frenzied mania in which investors bid asset prices up well beyond their actual worth. Manias have swirled all too often through history, from the tulip-bulb frenzy in 17th-century Holland to the bubble in stocks and real estate in 1980s Japan. As Japan's woes show, manias invariably end in a ruinous collapse.

The worries of the avowed inflation fighter in turn worried the stock market's perma-bulls, who interpreted his comments to mean that he thinks high stock prices are inflationary. If so, they reasoned, the Fed might well raise rates again to bring stock prices down.

Prices fell.

Sicilia concludes that the "Greenspan Effect" typically lasts a few days, although the market then returns to whatever long-term trend is in force at the time. That was borne out in the aftermath of the Jackson Hole speech: The Dow fell 108 points that day, another 176 on Monday and 84.8 points on Tuesday, before rebounding to gain 108.6 points Wednesday.

Ironically, says Sicilia, interest rates aren't the most powerful tool the Fed uses to manage monetary policy. That would be "open-market operations," where the central bank either forays into the open market to buy securities -- which lowers interest rates and bulks up the money supply -- or to sell them -- which squeezes the money supply and pushes rates higher.

But that's hard for consumers and investors to see and to measure, so they fixate on what the Fed does with interest rates, Sicilia says. And to understand what the Fed is doing, people fixate on Greenspan, who personifies one of the few American institutions that operates under great secrecy -- though with great success. People desperately want to feel like someone -- an actual person -- is at the helm, so that they can remain confident, and count their money as the economy continues to surge.

"Politicians were long ago discredited," Sicilia explains. "They get caught up with Watergate, Vietnam, Monica Lewinsky; there's a feeling that they're not at the wheel. Meanwhile, there's all this stuff going on -- like derivatives, and the global financial crisis -- that a lot of people just don't understand.

"There's a basic human desire to personalize things, which is why they focus on Alan Greenspan instead of on the Federal Reserve. The Fed is an institution in a big, heavy building. But he's a person. There's a crying need to feel that someone is in control, who knows what's going on."

And, as this economic expansion reaches record duration, that "someone" is Alan Greenspan, lauded as the steward of these prosperous times.

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