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Greenspan whips flagging economy on

By IAN CAMPBELL, Economics Correspondent

QUERETARO, Mexico, Nov. 6 (UPI) -- Having raced for 10 years, the horses are flagging. The U.S. economy no longer rushes ahead. But behind the horses old Alan Greenspan, the coachman, grimacing furiously, is cracking his whip. And leaning from the window of the carriage, a well-oiled passenger, his name might be Bush, is egging him on, waving his wallet.

These are the days of fiscal carrot and monetary whip. "Here, have your money back, and spend it!" cries President George. W. Bush. Meanwhile, Federal Reserve Chairman Greenspan does not spare the whip of stimulus.

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Tuesday the U.S. Federal Reserve's Open Market Committee announced their decision to make a tenth interest rate cut so far this year. The Fed will seek to guide the Fed Funds rate, its benchmark short-term interest rate, down by half of one percentage point to 2.0 percent, a 40-year low.

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Not content with that, the Fed hinted that it might be willing to cut interest rates still more. The Fed's statement reads, "For the foreseeable future, then, the Committee continues to believe that ...the risks are weighted mainly toward conditions that may generate economic weakness." The Fed wishes to leave no doubt: it is firmly on the side of easy money.

The stock market rejoiced at the half point cut and at the message. The Dow Jones Industrial Average, which had been about 50 points down when the FOMC decision was announced at around 230 p.m. local time, launched up to close 150 points (1.6 percent) up on the day.

This, too, must have been in line with Greenspan's wishes which have changed since his famous "irrational exuberance" remark in December 1996. Now he wants stock market exuberance, rational or not, for the Fed is concerned about the negative wealth effect from falling stocks and the damage done to confidence by a falling stock market.

So U.S. monetary policy and fiscal policy are both entirely oriented toward putting money back into the pocket of individuals and businesses and to regenerating confidence. But is the Fed's interpretation of what is wrong with the economy right?

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In its release the Fed said that "Heightened uncertainty and concerns about a deterioration in business conditions both here and abroad are damping economic activity." However, "the long-term prospects for productivity growth and the economy remain favorable", the Fed said, "once the unusual forces restraining demand abate."

This is vague language. It might or might not be referring to the events of September 11 which were, undoubtedly, "unusual" and terrible. But it is probably a mistake to weigh the terrorist attack too heavily in any assessment of the U.S. economy. Before it occurred the Fed had cut interest rates seven times this year but it was clear that the economy was still weakening. The preliminary estimate of GDP growth in the third quarter, which shows a 0.4 percent contraction of the economy, rests largely on pre-September 11 data. Perhaps the Fed's medicine had not had time to work; normally it takes more than a year for monetary policy to have real effect. But the fact remains that without the unwelcome intervention of the terrorists and the more welcomed ones of Chairman Greenspan, confidence and economic growth have been waning steadily.

The reasons are not hard to see. Businesses that had over-invested in productive capacity during the 1995-2000 boom have been cutting back investment hard at double-digit annualized rates this year; and now employment is beginning to suffer, even if, at 5.4 percent, the unemployment rate remains low by historical standards. And the wealth effect that once lined Americans' pockets and encouraged dissaving and spending is gone; the Dow Jones industrial average closed well up today, but still down by 18.2 percent on its Jan. 14, 2000 high of 11,723.

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So after all this deterioration in the economy and the stock market, but with stimulatory policies in place, is the time not right for a recovery in both?

Look again at housing. In August this year existing home sales rose to 5.54 million units, an all-time record, the National Association of Realtors tells us. This was the culmination of a long bull run for the housing market. Rising real estate prices have been a part of the United States' asset price boom. Greenspan has been a part of it. Long term rates have not fallen, it is rumored, as much as the U.S. Treasury and the Fed would like. But low mortgage rates have nonetheless helped to stoke up demand for housing.

The NAR's chief economist, David Lereah, commenting on the terrorist-influenced downturn in the market in September, said in a press release that "the fundamentals of the U.S. economy remain favorable" and that "there are many factors pointing toward a housing upswing next year."

An upswing? Was it not in August -- just over two months ago -- that the housing sales boom reached its peak?

It is this belief that the U.S. economy can keep delivering more that drives much of the comment from economists in Wall Street and outside it. Yet in truth the risks for the U.S. economy are enormous. Its horses have galloped up a high mountain road. Perhaps there is a safe route ahead. But to the side there is certainly a chasm.

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That chasm has been opened up by the 1990s' asset price bubble. What happens after the prices of stocks and property have climbed so high, so fast in a period of sustained rapid growth in investment and consumption? We do not know.

Investment has plummeted this year. Consumption has not yet fallen at all; its growth has merely slowed. That suggests to your correspondent not that the recovery is about to begin but that the downturn has much further to run--has not, in fact, really begun. In other words, the exhausted horses of the US economy need to slow down some more, to recover from the furious pace of the past years, when they ran on a stimulatory drug called asset price inflation.

But instead of letting them rest, letting the correction take place, coachman Greenspan and passenger Bush are urging them on, with new stimulation.

What will be the effect of that? Will the economy be left still weak in 2002 but with the government in deficit and with interest rates close to the floor? Is U.S. monetary policy inviting a Japanese-style fate? That must be the danger.

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