Common Sense
Wrong Again on the Fed
By James B. Stewart
March 21, 2001
SmartMoney.com Poll
RARELY HAVE I heard so many whining Wall Street economists. You know who I mean. They started predicting another emergency Fed rate cut over a month ago. When that failed to materialize, they started upping the ante on Tuesday's regular Federal Reserve board meeting, clamoring for a three-quarter-point reduction. When the Fed cut rates "only" a half point, they were incensed.
Somebody obviously listens to these guys, for with each self-induced disappointment, the market sold off, dragging every major index into a bear market and the Nasdaq to its biggest decline ever.
This is preposterous.
I have been on vacation for a week, and sometimes distance lends perspective. I feel strongly that the market is reacting irrationally and that investors should invest in stocks now for the long term. That doesn't mean the market is about to take off. As I said in my first column, as an investor you can be absolutely right, but the market may take years to come to the same conclusion. In the short term the market is often driven more by emotion than reason. But eventually reason prevails.
Let's take a look at each of the stated reasons for the recent despair on Wall Street:
A three-quarter-point rate cut was needed and would have turned the market around; a half-point cut isn't enough and will hurt corporate earnings and stock prices.
This was the immediate cause of Tuesday's decline, yet it's hard to take seriously. Does anyone really believe a difference in a quarter point matters? Or conversely, that a half-point cut won't matter? The Fed has already cut a full point-and-a-half in a little more than two months, a record. Given the minimum of six months that it takes for the economy to respond to rate cuts, it's too soon to assess the impact of the first move, which came on Jan. 3 — let alone the other two. Moreover, the Fed said it's closely monitoring the situation and clearly implied that it will cut again before its scheduled May meeting if circumstances warrant it. What more should investors want?
The Fed doesn't care about stock prices; if it did it would have cut at least three-quarters of a point to send a message to Wall Street.
The media have really jumped on this one. But this is even more nonsensical than the first. The stock market and the economy aren't parallel but separate universes. The stock market is part of the economy. When the Fed acts to bolster the economy, it's providing the underpinnings for a strong stock market. Alan Greenspan isn't choosing one constituency over another: He wouldn't be doing any of us a favor by recklessly lowering rates, igniting inflation and setting the stage for a real recession. It's true that falling stock prices undermine the so-called wealth effect, which may act to curb consumer spending. In the policy statement that accompanied Tuesday's rate cut, Greenspan & Co. made it clear that they're aware of this, and have factored it into the Fed's decision-making.
The Fed has lost its ability to influence the economy, given the high level of consumer debt, excess capacity and inventories and slumping foreign economies.
Let's put aside the fact that this is completely inconsistent with the first premise (that a bigger cut would have turned things around). Haven't we heard a variation of this before? Just last summer, some economists were claiming the Fed had lost its ability to slow down the economy by raising rates, citing the strength of the New Economy and surging productivity. Remember when folks were running around saying that tech companies were impervious to higher interest rates? That sure turned out to be wrong. So how can these people now say with a straight face that the Fed can't stimulate the economy? As Alex Berenson noted in the New York Times, investors are ignoring the time-honored adage "Don't fight the Fed." They did it last year, when the Fed was raising rates, to their peril. And now they're doing it again, selling into a series of Fed rate cuts. Unless economic principles have been stood on their head, the recent rate cuts will stimulate the economy. The question is not whether but when.
