Fed Chief Sees Plunge as Healthy Correction
Offering reassurance to skittish financial markets, Federal Reserve Board Chairman Alan Greenspan reminded investors Wednesday that the American economy is “robust” and predicted that the stock plunge earlier this week will be viewed by history as a healthy correction.
Overheated stock prices “were primed” to drop, Greenspan told the Joint Economic Committee in Congress, and if the crisis in Asia had not triggered the sell-off, some other force would have.
With Wall Street listening intently to the televised testimony, Greenspan found a silver lining in the financial turmoil, suggesting that the drop in stock prices might bolster the U.S. economy in the long run by moderating demand and holding down inflation.
The message struck a chord with investors and helped settle financial markets, though stocks gave up large gains early in the day to close only modestly higher.
In volatile trading on Wednesday, the Dow Jones industrial average ended 8.35 points higher, to close at 7,506.67, and market volume ebbed considerably from the record-shattering pace on Tuesday, when the Dow rebounded with a 337-point gain after Monday’s 554-point plunge.
The market on Wednesday peaked in the morning with a 123-point gain in the Dow, but then succumbed to several waves of selling in the afternoon that at one point drove the widely watched blue-chip index down more than 41 points.
Greenspan’s remarks did not appear to soothe jagged investor nerves in Asia. Markets there headed back down in early trading today. In Hong Kong, the Hang Seng blue-chip index, which had gained nearly 19% Wednesday, plunged 4.79% in the first two hours of trading. Tokyo’s Nikkei index lost 2.89% to close the morning session at 16,370.53 points, and the Seoul composite index lost 3.5%, to 488.72.
As usual, Greenspan refused to respond to committee members’ overtures to discuss what the Fed might do about interest rates in the weeks and months ahead. Analysts, however, read a great deal into Greenspan’s testimony.
“What the markets didn’t hear was more important than what they did hear today,” said David Wyss, economist at DRI-McGraw Hill Inc. “The market was worried that Greenspan would warn once again that growth was unsustainable or inflation was dangling like a thin thread over our heads. He didn’t say anything like that.”
Greenspan’s comments convinced him that the central bank will leave interest rates unchanged for the rest of the year, Wyss said.
In his testimony, Greenspan spoke with unusual clarity, offering a textbook lesson in Economics 101. He pointed out that profits go up and down, businesses fail and “nobody bats 1,000%” in choosing investments.
Repeatedly, Greenspan steered the committee’s focus back to the fundamental soundness of the business climate. “Our economy has enjoyed a lengthy period of good economic growth, linked, not coincidentally, to dampened inflation,” he said.
The current business expansion is “about as solid as any I have ever seen,” said Greenspan, who has more than four decades of experience in economic analysis and forecasting.
Even after the bounce-back on Tuesday and Wednesday, investors and corporate managers will be appropriately chastened, said the Fed chairman, who stunned the nation’s stock markets last year when he accused investors of “irrational exuberance.”
Greenspan said investors appear to be paring back their expectations of both foreign and domestic profits of U.S. corporations. And the pace of business expansion will move more slowly because individuals have less wealth and businesses cannot raise money as cheaply in the equity markets as they could before Monday’s plunge.
The result is a welcome dampening of demand “that should help to prolong our 6 1/2-year business expansion,” he said.
If the financial markets now return to calm and stability, “it is quite conceivable that a few years hence we will look back at this episode, as we now look back at the 1987 crash, as a salutary event . . . . “ the Fed chairman said.
“The foundation for good business performance remains solid,” he said, offering a theme of steady encouragement in the face of the market’s volatile behavior.
Greenspan firmly rejected the view that had seemed to emerge on Wall Street and in some corporate suites that age-old business cycles have somehow been modified--that recessions can be minimized and even eliminated. This so-called new paradigm also seemed to suggest that stock prices can do nothing but rise.
But Greenspan suggested that the mini-crash was inevitable, alluding to the financial turmoil and currency devaluations in Asia in recent months. “If it was not developments in Southeast Asia, something else would have been the proximate cause for a reevaluation” in the securities markets, he said.
Although the market turmoil clearly takes the pressure off the Fed to raise interest rates, Greenspan vowed that the nation’s central bank would remain vigilant in searching for signs of a reborn inflation.
“It is terribly important to make sure this recovery continues . . . the greatest threat is the onset of inflation,” he said in an exchange with Rep. Maurice D. Hinchey (D-N.Y.), who noted: “There is no inflation anywhere in the economy.” Hinchey wants the Fed to act immediately to drive down interest rates.
“Most of us at the Fed disagree with the position you are taking,” Greenspan told Hinchey.
* CALMER MARKET: Dow rises only 8, but trading is heavy and some warn of further turmoil. D1
* BROKER PITCHES: Investment companies juggle advertising amid customers’ concerns about service. D1
