Markets too high, warns Greenspan
Thursday 21 January 1999
As the US economy continues to show rapid growth with low inflation, Mr Greenspan delivered broad hints that a rise in interest rates may be the next move from the Fed, to head off prices rises, correct the stock market and raise the savings rate.
"The recent behaviour of profits underlines the unusual nature of the rebound in equity markets and the possibility that the recent performance of the equity markets will have difficulty in being sustained," he told Congress. "The level of equity prices would appear to envision substantially greater growth of profits than has been experienced of late."
Wall Street fell about 30 points on the first news of Mr Greenspan's words, but then corrected to stand about 100 points higher at midday. The market has been buoyed by much stronger earnings than expected from Microsoft for the last quarter of 1998, even though the company warned its results this year were likely to be less spectacular.
Mr Greenspan said that the "sparkling" performance of the US economy left few concerns about an imminent dip into recession. "Signs of an appreciable slowdown are scant," he said. But he warned that unless growth did slow down, there was a risk of inflation. "Some moderation in economic growth might be required to sustain the expansion. Through the end of 1998, the economy continued to grow more rapidly than can be currently accommodated on an ongoing basis."
The Federal Reserve cut interest rates three times at the end of last year, responding to a tightening in credit markets, the collapse of the hedge fund Long-Term Capital Management and the economic crisis in Asia, Russia and Latin America. But since then, it has apparently moved to a neutral position, with its next move possibly upwards.
Mr Greenspan warned that the Fed's action had been misinterpreted as a shift to underpin the stock market after last August's correction - a clear warning that it would not ease again if Wall Street falls. "We were not attempting to prop up equity prices, nor did we plan to continue to ease rates until equity prices recovered, as some have erroneously inferred," he said. "This has not been, and is not now, our policy or intent."
Indeed, the Fed chairman hinted broadly that fears of a stock market decline would not deter the Fed from raising interest rates. "While asset values are very important to the economy and so must be carefully monitored and assessed by the Federal Reserve, they are not themselves a target of monetary policy," he said. "And, we may question from time to time whether asset prices may not embody a more optimistic outlook than seems reasonable, or what the consequences may be of a further rise in those prices followed by a steep decline." The Federal Open Market Committee, the body which makes decisions on interest rates, meets on 2-3 February.
Mr Greenspan expressed serious concerns about the massive decline in the US savings rate, which dipped into the negative at the end of last year - indicating that people were spending more than they were saving. This was due to the massive run-up in stocks, he said, which had led richer Americans to spend their wealth. America's large and growing foreign indebtedness, caused by the decline in personal savings, high consumption and spending, was also a warning sign, he said.
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