$1 trillion would throw a nice party for Wall St.

February 17, 2002|By JAY HANCOCK

IN OCTOBER 1979 stock and bond markets went berserk because the government said the size of the money supply was $3 billion more than it really was.

The error was soon corrected, but an alleged $3 billion bump in the country's supply of cash, checking balances and whatnot shocked Wall Street because money-supply growth was thought to generate the severe inflation afflicting the economy at the time.

In these days of monetary laxity, $3 billion is a trifling rounding error, loose change on the national night table. The U.S. money supply is expanding at a speed that would have made former Federal Reserve Chairman Paul Volcker swallow his cigar.

Since last summer the broadest measure of American money has ballooned by $340 billion as the Fed bathed the nation with cash and credit in response to the Sept. 11 terrorist attacks. And that's not a calculation mistake. Of course it's normal for the Fed to lubricate when the gears grind.

Economic growth was already weak during the first half of 2001 as the stock market tanked, and the attacks on the World Trade Center and Pentagon threatened to plunge the country into a long, deep slump. Money creation by the government in such situations lowers interest rates, creates credit for marginal borrowers and keeps things from gumming up.

But it's not normal to print greenback Benjamins until the presses smoke.

In the last year the Fed has added almost a trillion dollars to a broad category of money called M3 that includes money market funds, certificates of deposit and dollars held in European accounts. This dwarfs the surges that used to bother the market in the 1970s.

True, the economy is bigger now and dollars are worth less, so it takes more money to get the desired stimulus. But a trillion extra dollars is a thousand-volt jolt any way you see it.

The increase in M3 last year was almost 13 percent, the biggest since 1972.

Maybe you remember 1972. It was the launching pad for the worst U.S. inflation since World War I. A decade went by before inflation again dipped below 5 percent. The Consumer Price Index increased 6 percent in 1973, 11 percent in 1974 and 13.5 percent in 1980.

An energy shortage and soaring oil prices helped fuel the spiral, but the main culprit was deemed to be the profligate Federal Reserve - along with deficit government spending on the Vietnam War.

Thanks largely to Milton Friedman, whose theory on the link between inflation and monetary growth was in its heyday in the 1970s, the money supply became the economic statistic du jour, as closely watched as consumer-spending data are today.

So it is with worry that economists with long memories view Alan Greenspan's recent pump-priming. With short-term interest rates at their lowest level in four decades and money washing in over the economy's gunwales, these analysts fear that inflation is about to perk up from its 1.6 percent budge last year.

Their concern is the same one Friedman spelled out in the 1960s. If a growing pool of dollars chases a limited amount of goods and services, prices will rise because more buyers with more money are bidding for the economy's wares.

Other money-supply measures besides M3 have risen sharply recently, although not as much. M1, which is basically cash and checking accounts, increased last year at its fastest rate since 1993. M2, which adds consumer money-market funds, savings accounts and small certificates of deposit, booked its biggest increase since 1983. But life, as usual, has more than two variables, and there are half a dozen forces that promise to keep inflation in check - monetary explosion or not:

Americans haven't fully recovered from the horror of Sept. 11 and still aren't spending with 1999 gusto, despite the enhanced access to cash and credit. That keeps demand and prices down.

Thanks to the global economy, the supply of products is much more flexible than 20 years ago. If anybody tries to raise prices some guy with a factory in China undercuts him in a nanosecond.

Consumers are better informed. Thanks to the Internet we can compare prices worldwide and force merchants to give discounts.

Worker productivity continues to grow, which enables companies to retain talent and boost profits without raising prices.

As labor markets have gotten more flexible, workers have lost their ability to extract big raises, which once helped drive inflation.

Americans don't expect inflation to pop up, so they don't behave in ways that will fuel it, such as demanding big raises.

Some analysts believe that falling prices, such as is happening in Japan, are a bigger danger than inflation.

Still, there's this matter of a trillion extra dollars sloshing around the U.S. economy. They've got to go somewhere. My guess is they'll find a home in the stock market.

Alan Greenspan worried once before that the Fed's open faucets were floating stock prices to ridiculous levels. He may do so again.

The great, late-20th-century bull stock market got its start in the second half of 1982, exactly when the Fed dropped its obsession with controlling the money supply and turned again to interest rates as the main monetary fetish.

Coincidence? Don't fight the Fed.

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