Heed Greenspan

Tuesday’s hike in short-term interest rates by the Federal Reserve, though a small one, was sobering economic news, and the pressures behind the increase are even worse news. Yet the markets here and in Latin America, where the hike will hit with a multiplying effect, have hardly taken notice. Clearly, the markets’ confidence in Fed Chairman Alan Greenspan’s ability to steer the economy is part of the explanation.

Despite the now legendary obliqueness of Greenspan’s speeches, it seems no one is left in doubt about his intentions. Wall Street and foreign financial analysts had long expected the Fed to tighten interest rates and accounted for it in pricing stocks and bonds. So, when the hike arrived, it had been fully expected.

But Greenspan’s underlying message, delivered with perhaps too much subtlety to be clearly heard by the markets, is one of caution about the health of the economy.

Greenspan sees the inflationary pressures on the U.S. economy building up. The economy was hot enough to create more than 300,000 jobs in July--more than the labor market can fill--and productivity, which determines the cost of labor, is not rising fast enough. The upward pressure on wages, combined with the rising cost of raw materials, clearly spells higher prices in the future.

The impact of the latest interest rate hike on consumers is likely to be modest, and in truth the two small interest rate hikes this summer still leave rates below those of last summer. Interest rates on cars are already high enough to account for the increase, and mortgages have risen in recent weeks in anticipation of the Fed’s hike.

The effect on the emerging economies, especially in Latin America, will be much greater. For these countries, which need to borrow billions of dollars to keep afloat, the cost of credit is going up. With their flagging economies, countries like Ecuador, Venezuela, Colombia and Argentina already are having a hard time servicing their foreign debt. Private investors, who were burned in the financial meltdown in Russia, Brazil and Southeast Asia, are reluctant to return and those that do are demanding higher returns for the added risk.

Clearly, with the adroitness with which he has guided the U.S. economy through eight years of growth, Greenspan has earned the respect of markets here and elsewhere. Now, they need to listen harder to his message, which tells of a bumpy economic road ahead.