Commentary: Alan Greenspan, The Bull

Feb. 16, 2001 -- Federal Reserve Chairman Alan Greenspan's wonderfully bullish testimony before the Senate Banking Committee earlier this week initially had the desired effect — stocks rallied.

A market that many analysts say is "oversold" — by which they appear to mean that it has gone down a lot since the Federal Open Market Committee rate cut on Jan. 31 — rose a bit.

Stock prices later drifted into the red after Greenspan didn't imply in his testimony that the Fed will cut interest rates any sooner than expected.

Fed Chief's Testimony

What did Greenspan say? He was more upbeat than ever about the U.S. economy, and by implication the stock market, than any Fed chairman I can recall. He almost sounded like a "New Era" Wall Street analyst pounding the table for a tech stock that has hit a bad patch and needs defending.

The basic message: Despite the slowdown, the U.S. economy is enjoying "one of these remarkable periods of technological advance" that will continue to boost labor productivity and noninflationary growth for a good long time, say, 10 years.

Here is one paragraph from the relevant New Era section of his testimony:

Although recent short-term business profits have softened considerably, most corporate managers appear not to have altered to any appreciable extent their long-standing optimism about the future returns from using new technology. A recent survey of purchasing managers suggests that the wave of new on-line business-to-business activities is far from cresting. Corporate managers more generally, rightly or wrongly, appear to remain remarkably sanguine about the potential for innovations to continue to enhance productivity and profits. At least this is what is gleaned from the projections of equity analysts, who, one must presume, obtain most of their insights from corporate managers. According to one prominent survey, the three- to five-year average earnings projections of more than a thousand analysts, though exhibiting some signs of diminishing in recent months, have generally held firm at a very high level. Such expectations, should they persist, bode well for continued strength in capital accumulation and sustained elevated growth of structural productivity over the longer term.

The crude Wall Street translation? Yes, fourth-quarter earnings disappointed. But CEOs I talk to are still bullish. And the First Call/Thomson Financial consensus earnings estimates for 2002 and beyond have yet to be marked down. Capital expenditures are going to come back. No worries.

You can well imagine why Greenspan might take a bullish tone in public. He is extremely concerned about consumer confidence. So, it's not a time for plain speaking. Much better to emphasize the positive while aggressively cutting interest rates to make your forecast come true.

What's a Fed Boss to Do?

What is Greenspan's alternative at this point? He is boxed in.

On one hand, he has all the credibility in the world for having overseen the Fed during a period of time of remarkable growth, job creation and, of course, financial asset appreciation.

On the other hand, he knows that all that prosperity has engendered severe excesses that must be corrected. Corporate investment in technology has been way overdone.

Consumer spending has far outstripped the rise in incomes. Many companies and households are carrying far too much debt into this slowdown. Families have massively increased their exposure to the volatile stock market. We are significantly overstored. And the trade deficit isn't getting any smaller.

He seems to have decided that his best bet is to make the case that the excesses can be taken care of relatively painlessly. He is essentially jawboning us. Listen to this graph from his testimony:

Although consumer confidence has fallen, at least for now it remains at a level that in the past was consistent with economic growth. And as I pointed out earlier, expected earnings growth over the longer run continues to be elevated. If the forces contributing to long-term productivity growth remain intact, the degree of retrenchment will presumably be limited. Prospects for high productivity growth should, with time, bolster both consumption and investment demand. Before long in this scenario, excess inventories would be run off to desired levels.

Greenspan's greatest worry seems to be that some stick-in-the-mud types don't believe sufficiently in him and the new economy. He said as much today:

This very rapidity with which the current adjustment is proceeding raises another concern, of a different nature. While technology has quickened production adjustments, human nature remains unaltered. We respond to a heightened pace of change and its associated uncertainty in the same way we always have. We withdraw from action, postpone decisions, and generally hunker down until a renewed, more comprehensible basis for acting emerges. In its extreme manifestation, many economic decision-makers not only become risk averse but attempt to disengage from all risk. This precludes taking any initiative, because risk is inherent in every action.

Evidently, the real economic danger here is investors and corporations not taking enough risk. Who ever would have thought we would hear a Fed chairman telling us to be less risk-averse in the face of mounting economic uncertainty?

Perhaps this truly is a new era. Perhaps we will not have a severe recession. Greenspan had better hope that he is right. He puts his credibility, and the Fed's, at stake with such testimony.

What's Everyone Else to Do?

So, what should a prudent person do?

Sell the rallies into any Greenspan appearance? Sell the rallies into the next FOMC meeting? Then move back in for a trade after the selloff. Or just go to cash if you are an investor who does not trade like a maniac?

Greenspan is mortal. And if Greenspan is ever seen to be wrong in his bullish confidence about the economy, people might get worried about whether he really does have everything under control.

They might wonder whether his crystal ball really provides the kind of visibility he claims for it. They might recall that he mistakenly tightened monetary policy going into the 1987 crash. They might recall that he did not see the recession of 1990 coming. They might remember that he was behind the curve on the Asian crisis of 1997.

Greenspan has been a great Fed chairman. We will see whether he is omniscient and omnipotent to boot.