Half pregnant with the Fed

By Gerard Jackson
web posted October 18, 1999

Last Tuesday's decision by the U.S. Federal Reserve not to raise rates in preference for a tightening bias is a bit like being half pregnant, unless one believes in the existence of monetary tightening in the absence of rising rates. That the markets certainly do not was evidenced by the subsequent drop in stock prices. Far from calming market fears Alan Greenspan's indecisive action only succeeded in giving Wall Street a severe anxiety attack. (At this rate the US might even slip into a Prozac led boom). My guess is that Greenspan is now as confused and as fearful as the markets about the economic situation.

However, not all are displeased with Greenspan's dithering with some actually calling his action (or is it inaction?) "brilliant". Others provided a less flattering and certainly more accurate description, failing to see how badly rattling domestic investors and unnerving global financial markets will establish economic stability.

Because the Fed seems to have achieved relative price stability with little apparent sign of rising prices on the horizon, many commentators have assumed that rate rises are unnecessary, even though tightening labour markets have caused them some concern. This has led to the view that labour will be the real resource constraint facing the US economy in the near future. What has escaped this particular variety of commentators is the simple economic fact that a situation of genuine labour shortages only arises when capital accumulation rapidly exceeds the labour supply. Otherwise, tightening labour markets are the result of loose money policies. It is the latter, I believe, that applies to the US.

The view that present wage movements, the boom in consumer spending and the current account hold the key to monetary policy is circular reasoning because it fails to see that these factors are a product of the Fed's monetary policy. Now the gap in real consumer spending and after-tax incomes has widened enormously since mid-'97. Figures for consumer spending should have alerted commentators to the serious of the situation. Consumer spending for the first quarter raced ahead at 6.7 per cent, falling to 4 per cent for the second quarter with no sign of the trend slowing. No wonder the current account has reached a record proportion of GDP.

How in heavens name can a people continue to spend in excess of their incomes? The answer, once again, is credit expansion. The Fed has flooded the economy with credit which has sucked in enormous quantities of goods. That this destabilising process might be linked to the recent jump in gold and oil prices is something that has been largely ignored by the media and Wall Street economists.

In a world untainted by Keynesian fallacies these trends and figures would never even have been allowed to emerge. Unfortunately, things are so bad that they are not even seen by most commentators as flashing warning signals. All in all, a heavy price is going to be paid for failing to heed the lessons of history and economics. The irony is that Greenspan knows this.

Reprinted with the kind permission of Australia's premier free market magazine, The New Australian.

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