Column

ACT NOW, OR RISK A CRASH

Alan Greenspan must raise U.S. interest rates to shore up the dollar

DONALD COXE March 1 2004
Column

ACT NOW, OR RISK A CRASH

Alan Greenspan must raise U.S. interest rates to shore up the dollar

DONALD COXE March 1 2004

ACT NOW, OR RISK A CRASH

Column

Alan Greenspan must raise U.S. interest rates to shore up the dollar

DONALD COXE

THE SUPPOSEDLY staid and cautious Alan Greenspan, chairman of the supposedly staid and cautious Federal Reserve, is looking more and more like a riverboat gambler. Week after week, he places big bets on a big economic recovery that will bring big gains in employment without also bringing back inflation.

Greenspan no longer has blue chips to bet, and he may soon run out of red chips. The currency for which he is responsible keeps depreciating against the currencies of the other players on the global table—even the Russian ruble. Yet he continues to lend it out at the Wal-Martian bargain rate of one per cent. The Bank of Japan lends out its money at virtually zero, so Greenspan isn’t the most aggressive central banker around, but this is what the Fed was charging during the Depression. (Japan has a huge current account surplus, so it can do what it wants.)

Why does the Fed continue to price its money so cheaply with the economy strengthening? Why is the Fed taking such a chance on a panic run on the dollar by failing to pay foreigners an interest rate that would keep them invested in the weakest major currency? Candidates for the Democratic presidential nomination tell voters that Bush is responsible for creating the worst unemployment situation since Herbert Hoover’s day. In reality, the nation’s unemployment rate is about one-fifth the level reached in those grim times, the stock market is strong and the complaint one hears most frequently is about the tasteless halftime show during the Super Bowl.

WHY is the Fed taking such a chance on a panic run on the dollar by failing to pay foreigners an interest rate that would keep them invested in the weakest major currency?

Even that archetypal symbol

of American strength/weakness—the steel industry—seems to be regaining its longlost potency. Its financial Viagra comes from an unlikely source—soaring prices. Hot rolled coil steel, the benchmark product for such big steel-consuming industries as automobiles, now sells near US$500 a tonne, up from less than US$200 two years ago. But scrap steel sells now for US$350 a tonne, far more than what real steel sold for two years ago. So robust is demand for scrap that the U.S. steel industry is going back to the White House to ask for protection: this time against scrap prices. Most U.S. steel producers now rely on scrap steel, from sources such as discarded cars and building demolition sites, rather than iron ore. Now, these companies bleat that China’s huge demand for scrap is killing them, because high prices for steel don’t offset the high prices for scrap. They want an embargo on scrap exports. In other words, the guys who begged Bush for protection against steel imports are now trying to block a form of steel export.

Americans are scared that this could be the first economic recovery that doesn’t make things right again. Greenspan talks of economic growth in the 4.5to five-percent range, which should be more than enough to restore traditional American optimism. But his version of rational exuberance, which used to be infectious, no longer wows Main Street, even though Wall Street still loves his cheery forecasts.

Two problems prevent the good news from the economy’s top line from creating jobs, the voters’ bottom line. First is the trade deficit. It rose 17.1 per cent last year, more than five times as fast as the economy, to US$489 billion, up from US$418 billion in 2002. Canada remains a big contributor to that deficit, despite the strong loonie: Canada’s 2003 positive balance of trade with the U.S. was US$54.4 billion, up from US$48.2 billion. Of course, China remains on top, running a US$124 billion surplus, up from US$103 billion.

That U.S. trade deficit explains why American manufacturing jobs are melting like ice in Lake Michigan in March. But another trend—offshoring—is causing even more widespread angst. As white-collar jobs migrate to Asia on the Internet, a natural Republican constituency made up of callcentre operators, personnel managers, programmers, architects, radiologists and accountants migrates to the Democrats. For the first time, more college-grad Americans are unemployed than non-graduates. The widely watched monthly University of Michigan consumer sentiment index sent the stock market reeling on Feb. 13, when it was reported at 93.1, down a huge 10.7 points.

The Fed has a long record of holding down interest rates after a recession until jobs come back. That is in part a political decision; Congress and the administration would be inflamed if the Fed tightened rates in a job-loss environment. But the basic reason for the low rates is that wages soften during downturns and don’t tend to climb until a new boom is well-launched. Since employment costs are roughly two-thirds of overall costs, it’s hard to get inflation back to the front burner if wage growth is subdued—or non-existent.

But Greenspan watches commodity prices for signs of returning inflation, particularly scrap steel, oil, copper and gold, and their price increases show that business’s non-employment costs are rising sharply at a time when the dollar is falling steeply. The longer he waits to defend the dollar—and most economists believe he won’t raise rates this year— the more he risks a 1987-style dollar crisis, leading to a stock market crash.

Greenspan was new in his job back then. So he knows what he must do. Soon. U]

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments, dcoxe@macleans.ca