-Caveat Lector- ---- Begin Forwarded Message US Stock Market Greenspan's Asset Markets Bubble, bubble, world in trouble The US stock market is preventing global recession. If US consumers are to continue spending with vigour, equities may have to rise to yet more dizzying heights. This is frighteningly reminiscent of the political economy of the Japanese bubble of the late 1980s, on a global scale. For Alan Greenspan's Federal Reserve it also creates horrible dilemmas. The latest Economic Outlook from the Organisation for Economic Co-operation and Development estimates a 4.7 per cent expansion in US private consumption in 1998, accompanied by an 8.9 per cent increase in gross fixed investment. The resulting 5 per cent increase in domestic demand offsets a deterioration in the external balance of 1.6 per cent of gross domestic product. The result is GDP growth of 3.5 per cent and a boost to output in the rest of the world. Unfortunately, the US current account deficit cannot continue at 3 per cent of GDP indefinitely. Moreover, with equity markets fully recovered from the turbulence of August and September, valuations are once more at unprecedented levels. These high market valuations are driving the buoyant US spending: because households feel richer, they save less; because corporations find their assets more valuable, they build new ones. Research at the Federal Reserve suggests that the decline in US net private savings that lies behind the strong growth in domestic demand is largely explained by the increase in equity values. What lies behind the high prices of US equities? A part of the answer is the performance of the economy; another is one and a half decades of bullish markets. But a big part must be the conviction that they are underwritten by the Fed in order to sustain the expansion in domestic demand. The most revealing indication was the Fed's decision to cut the federal funds rate three times - in late September, mid-October and again in mid-November - by a total of three quarters of a percentage point, even though broad money continued to expand strongly. This policy was aimed at the security markets: it worked. Asset price bubble A close parallel is not hard to find. In the late 1980s the Japanese monetary authorities also encouraged an aggressive monetary expansion that fuelled an asset price bubble. This too was driven by the priority given to increasing domestic demand. The asset price inflation was, in effect, a solution, not a problem. And, for a while, it worked. But it also left Japan with horrible withdrawal symptoms. Supply the fix For the Federal Reserve similar dilemmas may well arise, as it seeks to sustain the growth in US demand. In view of what is happening in the world economy, the Federal Reserve has to supply the fix. But it too must worry about the ultimate fate of the junky. Critics of the Fed argue that the dependence of both the US and world economies on these very strong asset markets is its fault. If it had not been willing to allow the "irrational exuberance", identified by Mr Greenspan as far back as 1996, the balance of the economy would be far healthier today, they argue. Investors would have been better aware of the underlying risks, and the shocks of the past year and a half would have been correspondingly smaller. Today, therefore, the Fed could have had its cheap money policy without worrying about what it was also doing to asset prices. The response is that a bubble is only ever obvious in retrospect. Domestic inflationary pressures in the US have remained weak, and judging how to prick an asset price bubble is impossibly difficult, if one is also determined not to destabilise the economy. For all these reasons, the Fed could only warn of the risks, as it did. It could also look at the implications of asset price movements for domestic demand and inflation in framing its monetary policy, as it also did. This is a highly defensible point of view. But it has left the Fed with three big worries today. First, investors believe that in current circumstances, sustaining high asset prices is an implicit aim of monetary policy. Second, because they believe this, the risks they are prepared to assume are likely to grow - and grow. Third, if, or when, the price adjustment ultimately happens, the Fed may find itself trying to sustain demand in the teeth of a huge contrary wind. Households that have lost a vast amount of paper wealth must save. Then monetary policy may prove almost as ineffective in the US as now in Japan. The parallel may seem inconceivable today. Alas, it is not. The Financial Times, Dec. 19, 1998 DECLARATION & DISCLAIMER ========== CTRL is a discussion and informational exchange list. Proselyzting propagandic screeds are not allowed. Substance—not soapboxing! These are sordid matters and 'conspiracy theory', with its many half-truths, misdirections and outright frauds is used politically by different groups with major and minor effects spread throughout the spectrum of time and thought. That being said, CTRL gives no endorsement to the validity of posts, and always suggests to readers; be wary of what you read. CTRL gives no credeence to Holocaust denial and nazi's need not apply. Let us please be civil and as always, Caveat Lector. ======================================================================== To subscribe to Conspiracy Theory Research List[CTRL] send email: SUBSCRIBE CTRL [to:] [EMAIL PROTECTED] To UNsubscribe to Conspiracy Theory Research List[CTRL] send email: SIGNOFF CTRL [to:] [EMAIL PROTECTED] Om
