Looking For An Excuse, Greenspan Finds The Greenback

Suddenly, Alan Greenspan sounds a lot like Wayne Angell, the Federal Reserve Board's former superhawk.

On July 15, the Fed chief extolled the economy's "ideal combination of rising activity, falling unemployment, and falling inflation." But only five days later, when he squared off with the Senate Banking Committee at his twice-yearly report on monetary policy, he not only intensified his anti-inflation rhetoric but elevated the policy role of the dollar. Even Angell, now resident Fed critic for Bear, Stearns & Co., lauded Greenspan's remarks.

The Fed chairman sounded as if the weaker dollar might provide one more excuse to make another preemptive strike against inflation, despite accumulating signs that the economy is already slowing. Fed watchers now expect another hike in interest rates at the next policy meeting on Aug. 16. And the move could be a big one--a 50 basis-point increase in both the federal funds rate and the discount rate, now at 41/4% and 31/2%, respectively.

PLAIN SPEAKING. But why tighten at all? The Fed's own forecast for 1994 implies that second-half growth will slow to between 2.5% and 3%, from 3.5% to 4% in the first half. Private economists are starting to worry the Fed will do too much. "The risk is that the Fed will overtighten and end up slowing the economy more than necessary to hold inflation in check," says Bruce Steinberg at Merrill Lynch & Co.

Greenspan seems ready to take that risk. He pointed to shortages of construction workers and truck drivers, slower delivery times, and rising prices of raw materials as signs that the economy is approaching full capacity. He also threw in the Angellian concern over higher gold prices. Not particularly compelling stuff.

But what might give Greenspan a more persuasive cover for another rate hike is the weaker dollar. Traditionally, the greenback's role in interest-rate policy has been about nil. That's why his statement that in recent weeks what "has worried me most, clearly, is the weakness in the dollar" is an unusually blunt comment from a Fed chairman.

It's not as if the Fed is about to rush to the aid of the downtrodden dollar. Rather, Greenspan's quote was in the context of U.S. inflation--that the weaker dollar was a sign "that inflationary pressures as viewed out in the world are clearly not coming down." Put that way, the Fed chief has a more orthodox excuse for another hike.

However, it may well be true that U.S. monetary policy can no longer ignore the powerful influence of international currency markets. "There's no question that the increased integration of global markets is having an impact," says Charles Lieberman at Chemical Bank. Not only is a sagging dollar inflationary, it's a sign that Japanese and German investors are eschewing U.S. assets, especially bonds, which also hurts the U.S. economy.

That's why Greenspan may favor a big rate hike. In his testimony, he said the Fed began tightening on Feb. 4 with quarter-point moves to ease the shock to the financial markets, but by May 17, the markets were ready for a half-point hike. Besides, the markets almost universally pooh-poohed those quarter-point increases as inadequate. And if the Fed does have a tacit agenda to reverse the dollar's decline, one more baby step won't do it. Indeed, a discount-rate boost, while not important in the U.S., makes a loud noise around the world.

Despite the dollar, Greenspan may simply believe that another big hike is necessary to ensure that inflation is preempted. Toward the end of his 31/2 hour testimony, after all committee members except Chairman Donald W. Riegle Jr. (D-Mich.) had left, Greenspan mused frankly: "What if we are wrong?" He then made it clear that at this point, when price pressures start to emerge, he would prefer to make a policy error on the side of restraint. To be sure, the Fed must be vigilant against inflation, but while Greenspan's new hawkishness may help the dollar, it places the expansion at risk.

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