Greenspan factor lulls the markets

Vatchara Charoonsantiku and Thanong Khanthong say financial markets are expecting Alan Greenspan to pull off another magic trick to save the US economy.

AGAIN, a rabbit jumped out of the hat of the magical Alan Greenspan, chairman of the US Federal Reserve Board. On Thursday, he signalled that borrowing costs would have to be raised to defuse the growing imbalances in the overheating US economy.

The financial markets have been so entertained by the maverick performance of Greenspan that the Dow Jones Industrial Average advanced more than 50 points and the Nasdaq more than 100 points. They all shrugged off this impending move to put a slight brake on the US economy, believing that when worse comes to worst Greenspan will pull off his trick to keep the economy humming robustly, if not eternally.

Such trust in a federal reserve chairman is unprecedented, even mythical. There is a saying in Wall Street that Greenspan can walk on water. As Paul Krugman, the MIT economic professor, put it in his recent Bangkok speech, the financial markets are so confident in the Fed chairman that they are tempted to say ''In Greenspan, we trust''.

In his 12-year reign, Greenspan has successfully guided the US economy through its longest period of economic expansion. By February, the US economy will have enjoyed the longest-running expansion streak in its history.

So successful is the Greenspan legacy that US President Bill Clinton has decided to appoint him to a fourth four-year term. The sentiment is that Greenspan will be able to bring the US economy to a soft landing. But can he pull out another rabbit?

That remains to be seen. But the rise in equity prices and incomes have been so spectacular that there is a growing concern over the bigger increases in real demand. This will create a threat in unsustainable macroeconomic imbalances. If that is to happen, it will be the start of the recession that the Fed tries to avoid.

In a speech to the Economic Club of New York, Greenspan spoke at great length to explain the phenomenal growth of the US economy, buoyed by productivity growth and a revolution in information technology that has helped US businesses to cut costs.

''One result of the more rapid pace of IT innovation has been a visible acceleration of the process of 'creative destruction', a shifting of capital from failing technologies into those technologies at the cutting edge,'' he said.

''The process of capital reallocation across the economy has been assisted by a significant unbundling of risks in capital markets made possible by the development of innovative financial products, many of which themselves owe their viability to advances in IT.''

Moreover, he added, IT has also helped US businesses to manage their inventory stocks and worker redundancies more efficiently by reducing the delivery lead times and related work hours required for the production and delivery of all kinds of goods, from books to capital equipment.

Greenspan spent much of his time pointing out the importance of IT in helping to raise output per hour in the total economy and narrowing the uncertainties earlier faced by US businesses. This, in turn, has led to a robust economy with low inflation. And the productivity-supply growth benefits the stock market, creating a wealth effect never before witnessed in the US history.

Nonetheless, he warned that this wealth effect is likely to create aggregate demand beyond the increases in supply. In other words, there might be a risk of inflationary pressure and financial pressures looming that could undermine the present expansion. Greenspan indicated that the Fed will be taking a pre-emptive stance to prevent the imbalances from getting out of hand.

''Regrettably, we at the Federal Reserve do not have the luxury of awaiting a better set of insights into this process. Indeed, our goal, in responding to the complexity of current economic forces, is to extend the expansion by containing its imbalances and avoiding the very recession that would complete a business cycle,'' he said.

This remark was taken to mean the Fed is set to nudge up its short-term interest rates during its meeting on Feb 1 and Feb 2. The financial markets have already discounted a rise of 0.25 per cent. But what will transpire if the Fed decides to go for a 0.50-percent increase all at once?

Let's wait for another rabbit from Greenspan's hat.