Business

Waiting for Mr. Greenspan

America's top banker may be on the verge of raising interest rates

JOHN SCHOFIELD March 24 1997
Business

Waiting for Mr. Greenspan

America's top banker may be on the verge of raising interest rates

JOHN SCHOFIELD March 24 1997

Waiting for Mr. Greenspan

Business

America's top banker may be on the verge of raising interest rates

JOHN SCHOFIELD

The high priests of finance will assemble in their white-pillared temple at 9 a.m. on March 25. Once there, the 12 members of the U.S. Federal Open Market Committee will take their appointed places around a massive mahogany-and-granite table in the boardroom of the Federal Reserve building in Washington. For the next two hours, Fed chairman Alan Greenspan, 71, will hold court while a succession of experts attempt to divine the economy’s direction. Just after an 11 a.m. coffee break,

Greenspan will reveal his own insights and recommend a future course. The plan will be discussed and put to a vote. At precisely 2:15, the decision will be announced, the secret unveiled: will interest rates hold steady or rise to rein in the rapidly growing U.S. economy?

In an instant, the answer will flash throughout the world’s major markets, provoking sighs of relief from trading desks or igniting paroxysms of panic that will send stock prices reeling. If Greenspan and his committee raise the key lending rate, which currently stands at 5.25 per cent, the decision will not have come without a warning. Haunted by the demons of inflation that he sees waiting in the wings, Greenspan has sounded the alarm for months about rising price pressures and spiralling stock markets, which have gained a whopping 136 per cent since the end of the last U.S. recession in March, 1991. The Fed chief is also worried that America’s rock-bottom unemployment rate of 5.3 per cent will push up wage costs and unleash inflation. Even the most Pollyannaish prognosticators say the question is no longer if Greenspan will raise rates, but when.

Whether the increase comes this month or on May 20, when Greenspan’s committee meets again, one thing is clear: no time will be a good time for Canada.

In the past few months, the country’s recession-battered economy has been slowly rising to its feet. With interest rates at a 40-year low, housing starts hit an annualized rate of 158,900 in February, a level not seen since June, 1994. The brisk pace of new construction and the hot market for existing homes in some cities is boosting the demand for big-ticket items such as furniture and major appliances. But so far, there is no sign of an upsurge in the job market: in February, the unemployment rate stood frozen at 9.7 per cent. “The economy has really only started turning over on all cylinders,” says Andrew Pyle, the vice-president of fixed-income research for ABN AMRO Bank Canada. And the engine of growth could sputter or stall out if U.S. interest rates begin climbing.

Despite the harm that higher rates could inflict on the economy, Bank of Canada Governor Gordon Thiessen would find it hard to resist ratcheting up Canadian rates. The last time Canada strayed from Washington’s lead, it paid a heavy price. The year was 1994. When the U.S. Federal Reserve Board raised its lending rate by a quarter of a percentage point that December, the bank stood its ground, hoping to ride out the storm. The sudden show of independence spooked international money traders, who began unloading Canadian dollars by the boatload. The loonie plummeted to 71 cents

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(U.S.) before the Bank of Canada came to the rescue, raising rates by 2% percentage points in the first three months of 1995. While the Canadian economy is considerably stronger now, Pyle says, Thiessen is unlikely to risk a repeat of 1994.

South of the border, Greenspan is facing pressures of his own. An inflation hawk, the Fed chairman is known for keeping a close watch on wage rates and wholesale prices, ever fearful that tighter labor markets will give workers an excuse to demand pay hikes—and that those increases will in turn prompt companies to raise prices. Critics say that since he took the helm at the Fed in 1987, Greenspan has consistently overestimated the risk of inflation and has repeatedly raised interest rates unnecessarily.

Last week, four Democratic Congressmen sent a letter to Greenspan urging him not to raise interest rates until there is clear evidence that inflation is on the rise. “We should fear inflation, we should not fear the ghost of inflation,” said Senator Tom Harkin of Iowa, one of the letter’s authors. If anything, Harkin said, rates should be lowered to spur more growth. Greenspan, however, told a House banking committee earlier this month that he will not wait for inflation to rear its head before taking action.

Even if U.S. interest rates do rise, most economists predict the increase will be minor—half a percentage point at most. Anything more is simply uncalled for, says Steve Saldanha, an economist with Canada Trust. “Never has U.S. inflation been this low this far into an economic growth cycle.” Next month, the U.S. economy enters its seventh year of expansion, the third-longest period of growth since the Second World War.

In fact, with the economy in full bloom, the sluggish pace of inflation in the United States has defied all expectations. U.S. payrolls in February swelled by a higher-than-expected 339,000 workers—exactly the sort of increase that would normally be expected to push up incomes. Nevertheless, annual wage increases show no sign of breaking beyond a moderate three or four per cent, the Federal Reserve said last week in one of its regular checkups on the economy, released every two months. Wage increases may even be slowing down, according to figures compiled by the U.S. labor department in February. “There’s nothing here that leads me to believe that we have a pace of wage

growth that would push up inflation,” said chief White House economist Janet Yellen, a former member of the Federal Open Market Committee who frequently locked horns with Greenspan on monetary policy.

Even diehard inflation fighters such as Greenspan acknowledge that the textbook rules that once governed pricing seem to have changed. Employing a 1990s buzzword, a growing number of analysts claim the economy has entered a “new paradigm” in which prices remain stable even in the face of strong growth. “Powerful forces have evolved in the past few years to help contain inflationary tendencies,” Greenspan said last summer.

Among the forces acting against inflation are rising international competition and the rapid spread of new technology. Spending on high-tech equipment in Canada has increased an average of 17 per cent a year since 1991, boosting productivity to unprecedented levels. At the same time, labor-saving technology has allowed industries to slash costs by shedding thousands of jobs, leaving the survivors deeply worried about when their turn will come. The resulting climate of insecurity has tamed workers’ wage demands, reducing the pressure on firms to raise prices.

Even when costs do rise, corporations now think twice before passing them on to consumers. ‘When I started in business, you were really worried about your competitor in Vancouver and your competitor in Tennessee,” Finance Minister Paul Martin told Maclean’s recently. ‘Today, you don’t know where your competitor is coming from. Boy, that makes you not raise your prices.”

The new economic climate has had the opposite effect on stock prices. Heartened by the convergence of strong growth, low inflation and cheap interest rates, investors have been pouring their money into the stock market, propelling share prices to new heights. Meanwhile, Greenspan watches warily on the sidelines, grumbling about “irrational exuberance” and “excessive optimism.”

Second-guessing the Fed chairman has become an obsession among market analysts. Stock prices gyrate with each new piece of economic news, dropping precipitously whenever fresh evidence of growth hints at an impending rise in interest rates. Last week, the Dow Jones industrial index posted its fifth-biggest point drop ever, diving 160 points when the U.S. commerce department revealed that retail sales in February were stronger than anticipated. A day later, the index rebounded on news that wholesale prices actually fell 0.4 per cent last month. Skittish investors wish that Greenspan would just go away. No one man, they say, should hold so much sway over the markets.

Greenspan remains unmoved. “History,” he said recently, “is strewn with visions of such ‘new eras’ that, in the end, have proven to be a mirage.” Inflation is not dead, he warns—it is merely sleeping. For how long is anybody’s guess. In the meantime, a lot of consumers and investors are tossing and turning. □

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INFLATION’S RISE AND

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