WASHINGTON, Oct. 2 (UPI) -- The Federal Open Market Committee cut short term interest rates again Tuesday, for the ninth time this year, dropping the Federal Funds rate to 2.5 percent, from 6.5 percent at the beginning of the year and to its lowest rate since 1962.
Face it, nothing's happening and they're running out of room.
In addition, the Fed has been pumping reserves into the economy since Sept. 11, and seems unlikely to reverse this trend.
After a period of 10 weeks during which M3 money supply had risen only 1.5 percent per annum, in the week to Sept. 17, the Fed increased money supply by a gigantic 2.2 percent, $164 billion, in one week.
The slow growth in M3 in July and August, in spite of repeated Fed interest rate cuts, had suggested that recession was imminent; the increase in the week of Sept. 17, while justified because of the Sept. 11 tragedy, will if not reversed unleash inflation as well.
In a related development, the White House and Congressional leaders are currently in discussions about a $60 billion stimulus package, in addition to the $40 billion of additional spending on military, reconstruction and the airline wish-list that has already been announced. On the advice of Alan Greenspan, it seems likely that they will not implement either of the three possible tax cuts that might actually stimulate the economy over the medium term, i.e. bringing forward the marginal rate cuts in spring's tax cut package, cutting capital gains tax rates, or cutting the corporate tax rate.
Instead, they seem likely to give corporations relief via faster depreciation allowances, which will simply favor capital intensive industries at a time when the economy is already suffering a severe hangover from a capital spending binge, and give low income consumers some help with social security payments, which however compassionately conservative will simply provide a short term fillip to consumption.
The current economic scene reminds one of a 50's science fiction movie, maybe "War of the Worlds." Desperately, the gallant defenders of civilization fire off ammunition at the oncoming Martians; in this case, by the end of 2001, nine (possibly ten or eleven) rate cuts and two tax cuts.
However, nothing seems to stop the Martians' inexorable advance, and their deadly Heat Ray swings from side to side, vaporizing first the feeble dot-coms, then U.S. corporations like Midway Airlines and Federal-Mogul that had appeared to be a permanent part of the landscape.
On this analogy, at present rate of progress, we are likely to spend the years from 2002 onwards as a colony of Mars.
The reason for the current economic downturn, and the reason it has further to go, as written by both my UPI colleague Ian Campbell and myself many times, is the incredible and unsustainable overvaluation of the U.S. capital markets in the late 1990's.
When Greenspan decried "irrational exuberance" in December 1996, the Dow Jones Index was at 6,400, having risen by more than 50 percent over the previous two years, from a level that was itself almost 50 percent above the peak of the 1987 stock market boom. Today, after eighteen months of wailing and gnashing of teeth, the Dow is still at 8,800, almost 40 percent above the level at which it was "irrationally exuberant."
By the standards of the Wilshire 5000 Index, the broadest stock market indicator, we have lost 5,200 points from the peak, from 14,700 to 9,500; on historical valuation norms we have probably about another 5,200 to go, assuming the index does not overshoot its equilibrium value (which it almost certainly will.)
This unwinding of the $17 trillion of wealth that was poured into the U.S. investor's pocket in the late 1990's, and which was inevitably reflected in his spending patterns, will of course cause consumer spending to drop very much further --- if the consumer's propensity to spend new-found wealth is only 10 percent, then spending is first increased, then decreased by $1.7 trillion, a total swing of $3.4 trillion, or over 30 percent of Gross Domestic Product, between the late 90's and the early '00's. While that change is being spread over several years, there seems no way that we will not see at least one year in which consumer spending drops by 5 percent. Such a drop would be unprecedented in the postwar period; it is this, which leads us to expect a recession more severe than any since the 1930's, possibly accompanied by a troubling burst of inflation due to lax monetary policy.
This is my principal problem with Greenspan's policy, as well as the Administration's, in 2001 (I would be more critical of his 1996 omission since he saw the problem then and did nothing, whereas in 2001 he has simply been working off the wrong playbook.)
With interest rates now considerably closer to zero than to where they started the year, with Keynesian tax cut stimulus by the end of the year used not once but twice, and with no further room to pursue supply-side tax cuts that might actually rekindle growth over a 3-5 year timeframe, neither the Fed nor the Administration will have ammunition left to counter the inevitable negative wealth effect and consumer spending downturn in 2002-03. Consequently, there will be no force, other than possible economic recovery in Japan and East Asia that can pull the U.S. out of the morass it will have entered.
At the beginning of 2001, a deep recession was inevitable. A deep recession, lasting a decade was not. Now, both length and depth of the recession seem foreordained.
In the War of the Worlds, a secret Earth weapon, the common cold, eventually defeated the Martians. That, however, was a novelist's trick; in real life there are rarely such unexpected rescuers. Better start learning Martian, guys; there's a long period of economic winter ahead.
