A Fed Celebrity Death Match?

The DR presents a special ‘Wednesday Guest Essay’: “When Greenspan and Meyer spar over inflation, someone may lose an ear.”


It smells like a fight to me.

In the near corner, just out of his warm bubble bath and wearing the powder blue trunks is Fed Chairman Alan Greenspan. And in the far corner, sporting the solid black trunks, is Fed Governor Larry Meyer. Being neither prizefighters nor kings, these guys aren’t battling for money or for a come-hither woman named Helen.

They’re central bankers – so, of course, they’re fighting about inflation. Ladies and gentlemen, are you rrready to rrrumble? The Tale of the Tape, so to speak, gives a sense of each fighter’s thoughts about inflation, present and future

In a May 24 speech, Meyer said this: “Given that labor markets remain tight, that inflation remains above the rate that I would find acceptable over the longer run, and that core inflation has been edging higher…” In a June 6 speech, he stressed: “We have to be concerned that as we ease [The Fed Funds Rate]… we do not, at the same time, create conditions that would lead to higher inflation.”

Meyer’s thinking stands in stark contrast to that of Greenspan, who believes that inflation is contained and will stay that way going forward. In his May 24 speech, the chairman did note “some apparent deterioration in actual and expected CPI inflation,” but he downplayed these developments by turning to a kinder inflation measure, the core PCE price index. “There has been little acceleration in the broader index of core personal consumption expenditure prices,” he declared.

He went on to forecast: “With energy inflation probably peaking and the easing of tightness in labor markets expected to damp wage increases, prices seem likely to be contained.”

In a June 4 speech to the International Monetary Conference, Greenspan reiterated his views on the current inflation picture: “What we see…at this moment is a very extraordinary lack of pricing power in the American economy, which means, in effect, that the cost increases are not following through into significant pressures on prices but rather on profit margins.”

Greenspan’s view – and hence the Fed’s official view – rests on the notion that inflation is already contained, and that mass firings, slower economic growth and a lessening of energy inflation will keep the lid on in the future.

Now that these two heavyweights have thrown a few jabs, how do we score the fight? Although the bout is still in the early rounds, Meyer is ahead on my card – not because he’s inflicted a lot of pain, but because Greenspan’s punches have been so feeble.

In fact, the big guy’s emphasis on the core PCE price index makes him seem like he’s gasping for air. Sure, that index is rising at only a 1.7% year-over-year rate, but during the first quarter, it posted the biggest increase (2.6%) we’ve seen in six years.

The acceleration of inflation measures confirms that many companies out there do have some pricing power and are, in fact, raising prices. So I’m subtracting a point from Greenspan for a low blow.

I’m subtracting another point for failure to separate – that is, for clinging desperately to “easing pressures on labor and product markets” as an inflation damper. Pressure in the labor market has been easing for more than a year now – employment growth peaked in May 2000. What has wage growth done since then? It has accelerated. The year-over-year increase in average hourly earnings speeded up to 4.2% from 3.4%. Other measures of wage growth, such as those released alongside the productivity numbers, show increases of 6% and more.

We hear a lot about mass layoffs, and we know the current unemployment rate has risen to 4.4% from a cyclical low of 3.9% last autumn. Yet wage growth is still accelerating. Unfortunately for Greenspan, his easing-tightness-in-labor-markets notion packs no punch at all if it doesn’t bring slower wage growth along with it.

Greenspan appears to be choking on his mouthpiece, while Meyer impresses the judges and the audience with solid jabs. He believes the kindly factors that helped keep inflation low in recent years have disappeared – every last one of them:

Non-oil import prices? They were falling at rates greater than 4% less than three years ago, but now they’re declining at just 0.6%. That’s a swing of more than 3.4 percentage points.

Energy prices? They were plunging at double-digit rates less than three years ago, but now they’re rising at double-digit rates. Besides a change of direction, there’s a 20-point swing.

Oil prices? Down 44% less than three years ago, they’re rising at a 9% rate now; a change of direction plus a 50-point swing.

Health care prices? Rising at a rate of just 2.5% less than four years ago, they’re shooting up at a 4.6% rate now. That’s the fastest increase since 1995, and a two-point swing.

Unit labor costs? They were falling at a 0.5% rate as recently as last year, but they’re climbing at a 3.4% pace now. That’s a four-point swing plus a change of direction.

Productivity? It was growing at 5.4% as recently as last year, but now it’s growing at a 2.5% rate; a three-point swing.

That’s at least six good shots to the jaw. Now that Meyer has Greenspan in the corner where he wants him – the kindly inflation factors are gone and core price increases have been accelerating as a result – he can turn to the punishing body blows that lend his argument its power.

He can refer to the fed funds rate, which has been lowered by 250 basis points in less than five months. He can use the real funds rate, which now stands at its lowest level since July 1994. He can bring in the M-2 measure of the money supply, which has now accelerated by almost two and a half percentage points, to 8.1%, in just nine months. Not since 1983 have we seen such money-supply growth. Bam, bam!

Finally, Meyer can invoke the gap between the 10-year Treasury note and the three-month Treasury bill, which now stands at 169 basis points, its fattest since January 1995, and an indication that debt markets see faster inflation than they have in more than six years. Bam, bam, bam.

That’s too bad for all of us, because a Meyer victory carries much worse consequences. If a bigger inflation problem emerges, the Fed will have to take back some, and perhaps all, of the easings it recently pushed through. And a higher fed funds rate won’t help stocks or bonds.

Because he is a thoughtful, methodical and real-world fighter, Meyer has the edge over Greenspan, who seems to rely mostly on hope and who gives the impression of someone running around the ring with arms flailing, looking for a way out.

So I pick Larry to win this fight – and it won’t surprise me if, at some point, Alan tries to bite his ear off.

James Padhina,
June 27, 2001

for the Daily Reckoning

Not much happened yesterday. Nothing much was supposed to happen. The big news happens today – when the Fed announces whether it will lower rates by an additional 25 basis points…or by 50.

A month ago, Alan Greenspan acknowledged that: “A central bank can contain inflation over time under most conditions. But do we have the capability to eliminate booms and busts?” The answer, in my judgment, is no, because there is no tool to change human nature or to predict human behavior with great confidence.

Nevertheless, nearly everyone expects the Fed Chairman to do what he cannot do: “Monetary policy and tax cuts will work,” opines Mario Gabelli in Barron’s. “For the next 6 to 12 months, price targets are 1550 on the S&P and 12,500 on the Dow,” adds Abby Joseph Cohen. “There is no recession,’ she says.

“Investors and pundits alike have taken the explosion in money growth as virtually de facto proof that the Federal Reserve has succeeded in engineering a monetary reflation and, ultimately, an economic recovery,” writes the Prudent Bear’s Marshall Auerbach. “If only it were that easy.”

“History is not on their side,” reports a lead article in the International Herald Tribune. “For the past 30 years, each time payrolls in the U.S. have shrunk as much as they have recently,” the paper explains, “they have continued falling for months and a recession has ensued or has already been under way.”

So what will happen this time? Just to add to the drama…you should realize that things can’t stay as they are. Either the economy will pick up – or it will get worse. Eric, what do you have to report?


From Eric Fry on Wall Street:

– Merrill Lynch & Co. – a kind of concubine to the new economy – slashed its second-quarter profit projections by 37% due to weak stock market conditions. The news sent shares of MER tumbling.

– On the news, the Dow fell more than 100 points early in the day, before managing to pare its losses to 32 points by the closing bell. The Nasdaq managed a second straight day in the Black by moving ahead 13 points to 2064.

– But who cares about yesterday? Today is the day that Greenspan and the boys at the FOMC will cut one interest rate and, in so doing, cure millions of economic maladies.

– By cutting rates six times in six months, Greenspan’s gang promises the future will be better…you’ll see.

– Unfortunately, the here-and-now remains obstinately sluggish as America’s balance sheets – both professional and personal – steadily deteriorate.

– In American households, debts are growing while assets are shrinking. Household wealth created by appreciating stock portfolios and real estate equaled an extraordinary 82% of wage and salary income over the six years ended 2000, according to the Fed’s “Flow of Funds” data.

– A lot of folks came to consider this “normal.” It isn’t. Last year, household wealth destroyed by a falling stock market equaled 67% of wage and salary income in the year ended March, 2001. Is wealth destruction any less normal then wealth creation?

– A Daily Reckoning reader and New York City resident reports that while strolling around Manhattan last weekend, he was shocked to see how many businesses are either closed or closing. “On the three blocks of Bleecker Street near my apartment, there are five papered-over store fronts. Elsewhere, more than a few boutiques have going out of business signs. One upscale antique store even had a desperately optimistic window sign: ‘SPECIAL ALAN GREENSPAN SALE – How low will he go?'”

– Many of Manhattan’s trendy shops and restaurants that once catered to dot-commers are no longer packed to the rafters. Several formerly “hot” eateries, like Eureka Joe Coffee Lounge, have closed their doors. Eureka Joe had the dubious distinction of being dubbed the city’s “Internet economy power center” in a 1999 issue of Business 2.0.

– The gold price continued its winning ways ahead of today’s Fed meeting by climbing $2.30. Does the gold market know something? Greenspan & Co. will almost certainly cut rates again and yet, almost no one expects the Fed’s easy monetary policy to awaken the inflation bogeyman.


Back to Bill…

*** Well, for every yin there’s a yang. Greenspan has been trying to put money into the economy by lowering interest rates. But interest is not only an expense…it’s also an income item for many people. There are $2 trillion in money funds and another $3 trillion in interest-bearing CD’s and bank deposits. Currently, the money funds are paying a paltry 3.63% on deposits – nearly equal to the inflation rate of 3.6%.

*** The greatest fear for the economy is that aggressive rate cuts will ignite inflation. No problem, says Greenspan. “With energy inflation probably peaking,” the Fed chairman told an audience on May 24th, “and the easing of ‘tightness’ in labor markets expected to damp wage increases – prices seem likely to be contained.” Not all governors at the Fed agree. More from grantsinvestor.com’s James Padhina in Wednesday’s guest essay below…

*** What else? How about a real “money machine”? Karim Rahemtulla, who runs our venture capital club, tells me he’s found a business that is a ‘no brainer’. The company – which will present its business plan to our group in Boston on August 28th – is in the gift certificate business. Sales are rising at more than 100% per year.

Bill Bonner

(If you’d like more information on the Supper Club, e-mail Vicky Beard: vbeard@agora-inc.com)

The Daily Reckoning