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Outlook: Alan Greenspan; this time it's serious

On the fed chairman's latest warning, accessing the internet via electricity cables, and WH SmitH
Alan Greenspan, chairman of the Federal Reserve, rarely gets quoted entirely accurately on anything. So it was perhaps inevitable that his uncontentious observation yesterday that it was not realistic "to look for a continuation of stock market gains of anything like the magnitude of those recorded in the past couple of years" should have become distorted on some of the more unreliable news wires to the bald assertion that stock prices were "unrealistically high". Plainly, there is a world of a difference.

All the same, what he actually did say was sobering enough. Mr Greenspan's normally delphic testimony to the US House of Representatives was, for a change, unambiguous. Mr Greenspan is not a believer in the "new paradigm", the theory that the US has abolished the business cycle, that the economy is on a sustainable glide path of low inflation and high growth out into the indefinite future. Mr Greenspan is far too wise an old bird to call the theory so much hooey; the American public doesn't like to hear that kind of thing. But he might well have done.

Choosing his words carefully, Mr Greenspan said: "Short of a marked slowing in the demand for goods and services and hence, labour - or a degree of acceleration of productivity growth that appears unlikely - the imbalance between the growth in labour demand and the expansion of potential labour supply of recent years must eventually erode the current state of inflation quiescence, and with it the solid growth of real activity". What he is saying here is that to head off inflationary pressures in the US economy, the Fed needs to slow the demand for labour. The only way it can do this is in time honoured fashion - by raising interest rates.

Mr Greenspan was less clear on timing, but a small rise in rates when the Fed's open markets committee meets next month now looks highly likely. What will this do to the markets? When Mr Greenspan warned of "irrational exuberance" in financial markets last December, they took not a blind bit of notice. Since then the Dow Jones Industrial average has risen a further 30 per cent. On that occasion, however, there was nothing in the way of action to halt the rise in asset valuations, only words. This time round he looks intent on going further by pricking the bubble with a rise in rates.

Furthermore, regardless of whatever action the Fed takes, the implication of what Mr Greenspan is saying here is quite bearish. Financial markets have priced in an optimistic outlook, he said. One characteristic of this process is a continual upward revision of longer term corporate earnings forecasts which has driven price earnings ratios to levels never before seen at this stage of the economic cycle.

Running parallel to this has been a marked increase in the perceived rate of return for new business ventures which in turn is leading to a sharp increase in capital investment. In other words, we have here all the elements of a dangerous speculative spiral. Mr Greenspan would not want the market to crash. But he is saying as plainly as he can; cool it, or we will all be sorry.