The Fed official who cried `bubble' long before it burst

January 29, 2003|By JAY HANCOCK

LAST summer, Fed Chairman Alan Greenspan claimed "it was very difficult to definitively identify" the late-1990s stock bubble until it was too late to do anything about it.

Perhaps it was, for Alan. But one of his colleagues in the sanctum sanctorum of U.S. monetary policy saw the bubble early, saw it for what it was and urged Greenspan and the other money shamans to attack it.

"Apparently I am not as convinced as others that the problems to which we ultimately will have to react will be consumer prices," Jerry L. Jordan admonished his colleagues on the Federal Open Market Committee on Nov. 11, 1997.

"The problem may ... be ... in asset [stock] markets, as suggested by historical episodes in this country, notably in the 1920s, and in Japan in the late 1980s."

We know what Jordan said because the Fed's hermetic deliberations are taped and delivered up as transcripts five years after the fact. The 1997 texts surfaced Thursday, and they show that, at least in the middle stages of stock mania, Jordan repeatedly warned of a coming bubble, to no effect.

"I see a growing chance that the 1990s will be viewed at least as one of, if not the, most prosperous decade of the century," Jordan told Greenspan on May 20, 1997, a day when the Dow Jones industrial average rose 76 points to close at 7,303.

"There are some scholars who say that errors made starting in 1927 sowed the seeds of what happened in 1929 and [the Depression] afterward," he added.

"I find some of the analysis of what occurred and how it looked and felt in that period rather compelling ... I expect to end my career in the next decade, and I don't want it to be labeled `the Great Contraction.' "

Jordan is president of the Federal Reserve Bank of Cleveland. In 1997, his line of thought was quite contrary for a central bank that had spent three decades obsessing over the Consumer Price Index.

Since the 1950s every U.S. economic expansion had ended with a burst of wage and product inflation that forced the Fed to raise interest rates to maintain the purchasing power of the dollar. The inflation gauge was the brightest light on the Fed's dashboard, a one-stop policy cue. If it flashed red, the Fed raised rates to slow growth. If not, the Fed let the economy rip.

Jordan, who retires this month and whose spokeswoman said he was unavailable for an interview, argued that soaring stock and other asset prices might ultimately damage the economy just as much as higher prices for everyday consumables.

A starch-collar monetarist - that is, a disciple of Milton Friedman who believes the size of the money supply is the key to economic fluctuation - Jordan pulled out Friedman's classic, A Monetary History of the United States, in late 1997. The Dow was close to 8,000, an Asian economic crisis had quashed global inflation and U.S. consumers were about embark on a wild shopping spree.

Friedman, Jordan told his Fed amigos, had showed that inflation did not precede the 1930s Depression. Inflation had not foreshadowed more recent slumps in Japan, Mexico or Asia, Jordan added, "but that did not mean they did not have a problem."

And inflation's absence in 1997 didn't mean the United States didn't have a problem. The Fed's growing U.S. money pool might be draining not into wages and prices, as everybody had feared, but onto Wall Street, Jordan suggested. It was stock inflation.

Greenspan and other Fed members knew the argument. In late 1996, when the Dow was about 6,400, Greenspan had given his famous "irrational exuberance" speech questioning whether stocks were too expensive.

In February 1997 Greenspan remarked, "If I were allowed to invest in the market, which they do not allow around here, I don't think I would be doing it very forcefully!" according to the new transcripts.

That spring the Fed was full of good intentions about making "pre-emptive" strikes against inflation and launching "messages" at the markets, but then four things happened to leave the ammo in the box:

1. Asia collapsed, which required Fed easing. 2. Russia collapsed, which necessitated more of the same. 3. The feared Y2K computer bug prolonged the loose money policy. 4. Greenspan bought the "new era" arguments that suggested extraordinary growth could go for years without breeding imbalances.

Jordan dissented, vociferously. A nonvoting member on money policy in 1997, he got a ballot in 1998 and wasn't shy about using it. Five times he voted, usually alone, to increase rates, tighten the money supply and quash the exuberance. Five times he lost, and the Dow headed to the moon.

At the time, his objections were generally misinterpreted as the result of old-fashioned inflation fears. But the 1997 transcripts show that, probably more than anybody else at the Fed, he feared soaring stock prices for their own sake.

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