Commentary: Greenspeak: When Rhetoric Creates RealityDean Foust
In less tumultuous times, Federal Reserve Chairman Alan Greenspan's ponderous speech about the New Economy in Berkeley, Calif., on Sept. 4 would have attracted little attention outside economic circles. But with world financial markets churning, Greenspan knew he would have a huge audience. So he inserted two paragraphs at the start of his address to assure investors that the Fed was prepared to come to the aid of the U.S. economy should it be sucked into the global maelstrom.
Greenspan never said what the Fed would do--or when. But that didn't stop traders from concluding that a rate cut was in the bag--sparking explosive rallies in Asia and Europe, and a record 381-point gain in the Dow Jones industrial average when Wall Street reopened on Sept. 8. And the Bank of Japan's move to cut rates the next day fanned speculation that a synchronized easing by the Fed was in the offing.
BIG CHANGE. The markets once again have gotten ahead of the Fed, moving on Greenspan's words, not on Fed actions. True, there was a marked change in Greenspan's tone since July, when he said the Fed was leaning toward an interest rate hike to cool a robust economy which remained--it seemed--unaffected by Asia's deepening distress. Now, with fears that the financial contagion overseas would infect the U.S., Greenspan felt compelled to rule out an imminent rate hike and open the door to an easing of monetary policy.
But Greenspan's carefully hedged pledge to "consider carefully...ongoing developments" suggests the central bank will need to see more signs of a weakening economy before cutting rates. "Greenspan didn't promise a rate cut, although that's what the markets wanted to hear," says Joel Prakken, a St. Louis-based economist. The Federal Open Market Committee's next move "is going to depend on the incoming data, and the domestic data haven't shown convincing evidence of a slowdown."
Nobody should be surprised that traders, investors, and economists made the most--and perhaps far too much--of Greenspan's Sept. 4 speech. It's the latest example of how the Fed chief uses his opaque public utterances to carry out a virtual monetary policy--or what Michael R. Englund, chief economist for Standard & Poor's MMS, calls Greenspan's "open mouth policy." The Fed has barely changed interest rates since 1995, yet throughout that time Greenspan's carefully timed rhetoric has sent stock and bond prices soaring and plummeting.
When the Fed chairman mused in December, 1996, that "irrational exuberance" might be building on Wall Street, traders decided a rate hike was in the offing. The result: The Dow plunged as much as 162 points the next day. But the Fed's only monetary response was to nudge up the federal funds rate--the rate for overnight loans between banks--by a modest quarter of a point three months later. That rate hasn't moved since March, 1997. "The Fed had a bias to tighten most of the time for the past 18 months--but didn't," notes G. David Orr, chief capital markets economist for First Union Corp. The markets figured that out too, and stocks headed for new highs.
Greenspeak isn't always aimed at the public, either. Greenspan's latest comments may have been intended for hawks on the Fed who--until recently--have been pressing for a rate hike to ward off inflation. The chairman has been far more worried about Asia's potential drag on the economy. Greenspan recently told confidantes he was relieved the Fed barely avoided a hike last spring. The Berkeley speech suggests Greenspan is "publicly lobbying the hawks to think about the possibility of a rate cut," says David D. Hale, an economist at Zurich Kemper Investments Inc.
Will Greenspan have to follow up his words with action--a cut at the Sept. 29 FOMC meeting? His comforting rhetoric may have slowed a sickening slide in the stock market. And by bolstering investor and consumer confidence, Greenspan may help keep the economic expansion going without a stimulative rate cut. The lesson for investors who bet on interest-rate moves: Watch what Alan Greenspan does, not what he says. Talk can be cheap, even if it comes from the mouth of the chairman of the Federal Reserve.