Interest rate boost sustains myth of a robust economy

September 22, 2004|By JAY HANCOCK

ALAN GREENSPAN raised interest rates again yesterday, and the White House was probably thrilled.

That's something you don't see every election year. Sitting presidents are famously worried, obsessed even, with obtaining low rates to juice the economy to induce warm feelings for current management.

In 1972 Fed Chairman Arthur Burns was accused of ignoring dangerous inflation signs and expanding the money supply to ensure Richard Nixon's re-election. As if to atone, later Fed boss Paul Volcker disregarded White House bleats, raised rates past 15 percent to fight inflation and doomed Jimmy Carter in 1980.

In an extraordinary public outburst in 1988, Fed Chairman Alan Greenspan criticized the Reagan administration for pressuring for lower rates. Four years later, Greenspan was blamed for keeping rates too high, impeding the economy and contributing to the defeat of George H.W. Bush.

But yesterday's Fed decision to raise its main interest rate - even in the face of persistent economic weakness - can be seen as currying presidential favor just as much as the rate cuts of other years.

"The president has great confidence in Chairman Greenspan," White House spokeswoman Claire Buchan said after yesterday's bump, from 1.5 percent to 1.75 percent.

Don't adjust your picture. President Bush probably isn't really happy with higher rates. But for Greenspan not to have moved yesterday would have stripped Bush's re-election campaign of a major charade: that the economy is fine.

Holding rates steady would have signaled a weaker economy, a fumbling administration, danger ahead. For Bush, such negative publicity would far outweigh any direct economic effects of a higher cost for borrowed money.

And the economy is not "spreading prosperity and opportunity," no matter how often Bush says it. Even the people on Wall Street, not famous for being rabid Democrats, have figured this out.

"We don't have a booming economy," says David Rosenberg, Merrill Lynch's chief North American economist. "We do not have a booming stock market. We don't have booming inflation."

The economy is weak enough that Rosenberg believes the Federal Reserve might stop raising rates as soon as the political heat dies down - right after the election.

Merrill Lynch had already forecast more restraint from the Fed than other research houses did, predicting the central bank's overnight lending rate would top out at only 2.5 percent next year. Many seers believe the Fed wants to get back to 3.5 percent if the economy is healthy enough to withstand it.

But continued economic torpor and tame inflation prompted Rosenberg to call this week for only one more bump - in November, to 2 percent - through the end of 2005. He thinks the Fed might even have to furnish stimulus by lowering rates again next year.

Bush will probably have the worst job-creation record of any president since Herbert Hoover. The country still has almost a million fewer jobs than when he took office, and over the summer employers added an average of only about 100,000 jobs a month, less than the growth of the work force.

Economic output slowed sharply in the second quarter to a 2.8 percent annual rate, according to initial estimates, and many analysts aren't calling for much better performance in the year's second half.

There are bright spots, such as manufacturing and home construction. But the economy is far from gaining the "traction" Greenspan keeps talking about, let alone the prosperity claimed by Bush.

Even analysts who expect continued Fed tightening next year focus on accelerating inflation as the possible trigger as much as underlying growth.

"If you look at the core crude goods and the core materials indexes ... you'll see that those prices have gone up at least 20 to 30 percent on a year-over-year basis," says Sharon Stark, chief fixed income strategist for Baltimore broker Legg Mason Wood Walker. "Inflation risks do lie in the cost of raw materials."

She expects the Fed to take a breather in December, assess fourth-quarter data and then continue heading toward a 3 percent federal funds rate next year - but only if the economy picks up.

The Kerry campaign casts doubt on whether that will happen, as you might expect.

But so does the bond market. The yield on the 10-year Treasury note has fallen eight-tenths of a percentage point since June, signaling meager expectations for growth and inflation.

And so, perhaps, does the Federal Reserve. Despite yesterday's rate increase and the Fed's assessment of "modest" improvement in job growth, "there seems to be a little less bravado and enthusiasm over the big economic rebound story," says Rosenberg.

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