Gee, Fed, you don't have to fight us

The Economy


Among the hundreds of investment aphorisms that have emerged through the years, one of the most enduring counsels: "Don't fight the Fed."

In other words, when the Fed is bent on slowing the economy or bringing down stock prices by raising interest rates, it's not smart to bet against it. Rising rates crimp corporate profits and make bonds and money-market investments more alluring -- two factors that draw money out of stocks, pushing prices down.

Right now, Federal Reserve Chairman Alan Greenspan has vowed to do just that: The central bank's policy-making committee has raised interest rates four times since June, and more increases are expected -- including one this month.

Against this backdrop, there's a small but growing group of critics who think the Fed's aggressiveness is ill-advised, since this campaign to slow growth and stymie stocks ignores an aphorism that the financial markets themselves are delivering as they stubbornly resist receding. The market's message: "Don't fight the economy."

One who preaches caution to Greenspan is Charles Kadlec, a managing director and chief investment strategist with J.&W. Seligman Inc. & Co., a New York investment firm, and the author of "Dow 100,000: Fact or Fiction."

Greenspan's efforts to slow the economy defy what the economy and stock markets are telling us: The United States has become so productive and so competitive that the economy can grow faster than was ever thought without sparking inflation. That means there's justification for the high premium stocks currently carry. The upshot: Interest rates are already artificially high, and further increases could damage the economic Camelot that Greenspan & Co. helped build, Kadlec says.

"I think this [credit-tightening] policy is definitely unsustainable," he said. "If the Fed goes too tight for too long, people will be thrown out of work. -- If public policy remains too aggressive, there's a real risk of disrupting the international monetary system."

Not everyone agrees, of course. Most -- including Kadlec -- believe that Greenspan has been masterful at managing the expansion. And most believe that stewardship will be just as excellent for years to come. There are even factions among market-watchers who believe that the Fed has acted too slowly, letting wealth and debt get way out of hand and leaving the central bank behind the curve.

Kadlec, however, wishes that the Fed would be less aggressive, centering his argument on several observations. Take interest rates. For years, the U.S. government has run an annual deficit, forcing it to borrow huge amounts in the financial markets. That makes for higher interest rates, since the government competes with other borrowers, including foreign governments, consumers and corporations both here and abroad.

With a surplus, however, there's less borrowing, which means interest rates should be lower. And yet the "yield" (the interest payout as a percentage of what the bond trades for in the marketplace) on some U.S. bonds is a full percentage point above similar bonds of the European Economic and Monetary Union -- though most of the 11 countries in that group are running huge deficits, Kadlec says.

Greenspan's worries about high stock prices are also a mistake, Kadlec and others contend. The Dow Jones industrial average, despite its slide this year, is up more than 60 percent from its average level in December 1996, when the Fed chairman made his still-famous remark about "irrational exuberance." The Nasdaq composite lingers in record territory. But those indexes are averages, Kadlec notes, and owe their high levels to perhaps 25 stocks that have been exceptional performers. And, as averages, those indexes mask the fact that many stocks have experienced significant declines.

Fed-watchers have been particularly puzzled by the recent turnabout in Greenspan's view of productivity. Increases in productivity -- the ability to boost output without adding workers -- are a key reason the U.S. economy has been able to grow so briskly without sparking inflation. Productivity has been improving at twice the pace seen during the economic upturns of the 1970s and 1980s and has accelerated recently -- which is surprising since this measure of efficiency tends to fall off sharply late in an economic cycle.

In his recent testimony to Congress, however, Greenspan stunned the experts by actually linking productivity to inflation. In this new view -- which he says is observation, not theory -- rising productivity heightens the expectation for higher corporate profits, which in turn drives up stock prices and causes our personal wealth to burgeon. As a result, because of the "wealth effect," we feel richer and spend more. As demand rises, so can prices. The end result: Inflation.

That line of logic contradicts basic economic theory, which has left some Fed-watchers wondering if Greenspan is either trying to stack up still more "evidence" in an effort to jawbone the stock market lower, or to underscore the need for more interest-rate increases. Kadlec hopes that, in its zeal to keep managing the expansion, Greenspan and the Fed don't unintentionally short-circuit the Golden Goose Economy it helped create.

Pushing up interest rates that are already artificially high is a bad strategy and tightening credit to push down stock prices is misguided and misplaced, he says.

"Because of these rate increases (and the pressure they seem to be putting on stocks and bonds), my father called me and asked: `Why is the Fed attacking me?'" Kadlec says. "Why is the Federal Reserve claiming the authority and the responsibility for managing the rate of wealth creation enjoyed by 250 million Americans?"

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