Watching the bubble

March 29, 2000|By Rob Elder

WHEN THE Federal Reserve jacked up interest rates last week for the fifth time in nine months, I called my friend Tim the Economist. Our conversation went something like this:

Q. Does this mean it's going to cost more to finance cars and houses, and I'll pay more to carry a balance on my credit cards?

A. Yep.

Q. Then why did they do it?

A. Alan Greenspan is controlling inflation.

Q. What inflation?

A. Actually, when you factor out oil and gas prices, which are high for other reasons, there isn't any. But as chairman of the Federal Reserve, Mr. Greenspan worries that the rate of growth in the economy is not sustainable.

Q. So he's trying to squelch "irrational exuberance"?

A. Actually, Greenspan only used that term once, months ago. But everyone remembers, because it was so Greenspanian. And because a lot of people think it accurately describes what's going on in the stock market.

A. So the Fed regulates the market?

Q. Not officially. But the chairman is concerned about the wealth effect.

Q. What's that?

A. Think of it like dominoes: Technology provides increased productivity, businesses make more profits, investors buy stock in those companies, stock prices shoot up, stockholders feel rich.

When Americans make money they don't save it, they spend it. Pretty soon we have too much money chasing not enough stuff. That drives up wages and prices, all the dominoes fall over and we have inflation.

Q. So high stock prices could help cause inflation?

A. Exactly. Also, some technology companies are worth billions on paper, but may never make a profit. Skeptics say this has created an economic bubble that's bound to burst.

Q. Then Greenspan is trying to drive stock prices down?

A. He'd never say that. He distinguishes between the market and the sustainability of overall economic growth. But they are obviously related.

Q. Why not just go ahead and shove interest rates up a whole point, instead of a quarter?

A. Well, the minutes of the rate-setting committee's meeting show that some members argued that a quarter point was not enough. But Greenspan's going slow because no one knows how much is enough.

Q. Then why do anything at all?

A. Because unemployment is at a 30-year low, and we're running out of workers. That will put pressure on wages and prices. Then we'll have inflation for sure.

Q. What about that bubble?

A. No one can actually prove it's a bubble until it pops.

Q. How will we know?

A. If it's a bubble and it pops, you'll know. You guys in Silicon Valley are at ground zero. You'd better hope that Greenspan turns that burstable bubble into a slowly leaking tire.

Rob Elder is editorial-page editor of the San Jose Mercury News.

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