Greenspan Warns of Market’s Surge
Federal Reserve Board Chairman Alan Greenspan suggested Wednesday that the tremendous increase in the stock market over the last two years may have gone too far too fast, and he warned bluntly that the surge, if it continues, could backfire and hurt the economy.
For the second time in less than three months, Greenspan also raised the prospect that the Fed may soon raise interest rates in a preemptive strike to keep the economy’s growth rate and workers’ wage increases in check--possibly even before there is any really solid evidence that inflation may be intensifying.
Greenspan’s remarks, delivered during testimony before the Senate Banking, Housing and Urban Affairs Committee as part of his semiannual report to Congress, rocked Wall Street, sending stocks broadly lower and bond yields up. The bellwether 30-year Treasury bond yield leaped to 6.78% from 6.66% Tuesday.
The chairman’s warning came four weeks before a March 25 meeting of the Fed’s policymaking Federal Open Market Committee, which is expected to consider once again whether to raise interest rates in an effort to prevent a revival of inflationary pressures.
Analysts said later that although a rate increase seems more likely after Greenspan’s testimony, his remarks were intended only as a warning and do not necessarily mean interest rates will go up.
“He has opened the door--now the question is whether he’s going to walk through it,” said Robert G. Dederick, economist at Northern Trust Co. in Chicago. “Those who had foreclosed any tightening in March are going to have to recognize that it now is a reasonable possibility.”
Greenspan’s testimony was essentially his second recent warning about the surge in stock prices. In a Dec. 5 speech, he hinted vaguely that investors might be exhibiting an “irrational exuberance.” Those remarks also had an impact on the stock market, but after a one-day plunge of 144 points, the Dow continued to soar.
This time, however, the Fed chairman left no doubt that he is serious about the issue, warning that “excessive optimism” in markets “sows the seeds of its own reversal,” eventually leading to an “unwinding” that can plunge the economy into a recession.
He also broadened his warning against “irrational exuberance” to include other components of the nation’s financial system, such as the bond market and the bank lending market, particularly on home equity and auto loans.
While conceding that there is no way to know whether stock prices have become unduly inflated, Greenspan said that with continued economic growth making some investors giddy, there “are reasons in the current environment to keep this question on the table.”
He said caution about the extraordinary run-up in the stock market “seems especially warranted,” arguing that investors seem to be pushing prices up as though there no longer are any risks involved.
The stock market has soared about 3,000 points over the last two years, with the Dow breaking through the 7,000 mark earlier this month. The measure--the most popular yardstick for stock prices--has risen 8.6% since Greenspan’s December warning. Greenspan indicated that he intended both his warning about the stock market and his notice of a possible increase in the Fed’s benchmark short-term interest rates to serve as preemptive steps that he hopes will prevent the Fed from having to take more severe measures.
If the central bank does raise rates soon, it would be because such a long lead time is needed to affect money and credit policies--much as steering a large ship requires shifting its rudder early.
Greenspan noted that the Fed made similar preemptive strikes in 1994 and early 1995 that ultimately proved successful in holding down inflationary pressures while allowing the economy to continue to grow at a reasonable pace.
At the same time, however, he noted that interest rates already are substantially higher than they were in 1994 and ’95 and generally are more in line with inflation--a statement that analysts said implies that any tightening would be a slight one.
Characteristically, Greenspan did not specify what kind of conditions might prompt the Fed to tighten its policies over the next several months.
“It’s difficult for me to outline,” he told senators, because there is “no single pattern” that can be identified.
However, in earlier testimony, he expressed concern that the easing of insecurity about the job market may be beginning to encourage workers to seek larger increases in wages and fringe benefits, which later could add to labor costs and push prices up.
“Given the lags with which monetary policy affects the economy,” he said Wednesday, “we cannot rule out a situation in which a preemptive policy tightening may become appropriate before any sign of actual higher inflation becomes evident.”
For all his concern about “exuberance” in the stock market, Greenspan was generally upbeat about the economy’s performance, conceding that despite his fretting about inflation, “our economic prospects in general are quite favorable.”
In a formal report accompanying Greenspan’s testimony, the Fed forecast that the economy will grow between 2% and 2.5% in 1997, with inflation remaining at between 2.75% and 3%. It predicted the nation’s unemployment rate will remain unchanged at about 5.4%.
However, Greenspan rejected suggestions by some economists that the continuing health of the economy means that recessions are no longer possible.
History “is strewn with visions of such ‘new eras’ that have proven to be a mirage,” he said.
* MARKETS ROILED
Dow drops 55, bonds hammered. D11
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Tighter Credit On the Way?
Federal Reserve Board Chairman Alan Greenspan sounded another warning Wednesday that the central bank may soon raise interest rates. Although price inflation has yet to accelerate, Greenspan again raised the issue of “irrational exuberance” in the stock market, which the Fed could dampen with higher rates.
* The Fed Has Held Steady Since ’94. . .
Discount rate on 3-month Treasury bills, monthly closes and latest:
Wed.: 5.05%
* . . .And So Has Inflation. . .
Annual change in core consumer price index, excluding food and energy costs:
1996: 2.6%
* . . .But Soaring Stocks Worry Greenspan
Market value of U.S. stocks, as measured by the Wilshire 5,000 index. Year-end index value, in trillions:
Wed.: $7.69
Source: Bloomberg News
