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Greenspan says a weak rebound may not last long

PHOTO: AP

An economic recovery that's just beginning may not have enough strength to endure, Federal Reserve Chairman Alan Greenspan said, suggesting to investors and economists that he remains open to cutting interest rates for the 12th time in 13 months.

"Despite a number of encouraging signs of stabilization, it is still premature to conclude that the forces restraining economic activity here and abroad have abated enough to allow a steady recovery to take hold," Greenspan told the Bay Area Council Conference in San Francisco.

"I would emphasize that we continue to face significant risks in the near term," he said in the first speech on the economy he's given since October.

US Treasury yields fell as the Fed chairman's remarks boosted investor optimism that policy makers may reduce their benchmark interest rate from a 40-year low of 1.75 percent when they meet at the end of the month.

"This is telegraphing that there will be another cut in interest rates," said Sung Won Sohn, chief economist at Wells Fargo Co in Minneapolis.

"I would emphasize that we continue to face significant risks in the near term."

Federal Reserve Chairman Alan Greenspan

"He sees the recovery proceeding in fits and starts rather than at a steady pace."

Business profits and investment "remain weak," Greenspan said. Rising unemployment and stock prices still below their highs of the past two years may restrain consumer spending.

Markets react

The 5 percent note maturing in August 2011 rose 3/4 point, pushing down its yield 12 basis points to 4.86 percent following Greenspan's remarks.

Stocks fell on concern the recovery would be delayed. The Dow Jones Industrial Average dropped 80 points, or 0.7 percent, to close at 9,987.53. The NASDAQ Composite Index fell 25 points, or 1.2 percent, to close at 2,202.46.

The economy fell into recession in March and contracted at a 1.3 percent pace in the third quarter of last year. It will probably grow at a 0.7 percent annual rate in the first three months of this year after contracting at a 1 percent pace in the fourth quarter, according to the January Blue Chip Economic Indicators survey of more than 50 economists.

There are "tentative indications that the contraction phase of this business cycle is drawing to a close," Greenspan said.

"Arguably, our economy has not been weakening cumulatively in recent weeks."

Recent economic indicators have been ``more mixed'' lately, with inventories falling at an "extraordinary" pace, he said.

"With production running well below sales, the potential positive effect of the inevitable cessation of inventory liquidation on income and spending could be significant," Greenspan said.

Stable prices

Also, industrial commodity prices have been stable in recent weeks, and semiconductor prices have firmed, he said. Low mortgage rates and good weather have spurred home sales. And automobile sales, though down from October and November incentive-induced highs, "have remained surprisingly resilient," he said.

"But that impetus to activity will be short-lived unless the demand for goods and services itself starts to rise," Greenspan said.

A number of factors are working against a pickup in demand, he said.

Mortgage rates have been rising in recent weeks, and that "is likely to damp housing activity and equity extraction," he said. The pace of home refinancing has "dropped noticeably'' as rates have risen.

While declining oil and gas prices have "clearly provided support" for consumer spending, they will provide "only a one-shot boost to consumption, albeit one that is likely to take place over time," he said.

Futures contracts suggested energy prices are likely to stabilize or rise, mitigating the effect of the earlier price drops on spending.

The "steep decline" in stock prices since March 2000 has also curbed household spending, Greenspan said.

"Although stock prices have retraced a portion of their losses, the restraining effects to the net decline in equity values presumably have not, as yet, fully played out," he said.

Businesses have little ability to pass on costs, while productivity -- though still high -- has fallen. "The result has been that profit margins are still under pressure," Greenspan said.

The Labor Department on Friday reported that prices paid to factories, farmers and other producers, fell 0.7 percent last month, the third decline in a row. That made last year the tamest year for wholesale inflation since 1986.

Most important to the economic outlook is the likelihood that unemployment, currently at a 6 1/2 year high of 5.8 percent, will continue to rise.

"Job losses can be expected to put something of a damper on consumer spending," Greenspan said.

The Fed's 11 reductions in the benchmark overnight bank lending rate last year, to 1.75 percent, have helped boost demand, as has the phase-in of tax cuts enacted last year. Offsetting that, however, has been a rise in market interest rates based on investors' perceptions the economy is recovering.

Hopes dashed

Greenspan said the Sept. 11 terrorist attacks on New York and Washington made the recession a certainty. Prior to that, there were "tentative signs" the economy had begun to stabilize, "contributing the a hope that the worst of the previous cumulative weakness in world economic activity was nearing an end," he said.

"That hope was decisively dashed by the tragic events of early September," Greenspan said.

"If ever a situation existed in which the fabric of business and consumer confidence, both here and abroad, was vulnerable to being breached, the shock of Sept. 11 was surely it," he said.

Nevertheless, the US economy has an "exceptional degree of resilience and flexibility," he said.

Long-term, the outlook for the US economy "remains bright," Greenspan said.

"If the recent more favorable developments continue and gather momentum, uncertainties will diminish, risk premiums will fall, and the pace of capital investment increase," Greenspan said.

While the pace of investment won't be as "frenetic" as in 1999 and early 2000, "the evidence strong suggests that new technologies will present ample opportunities to earn enhanced rates of return," Greenspan said.

Technologically driven increases in productivity provided the foundation for the decade-long expansion, and will again lift living standards, he said.

And the spread of technology itself will limit the length and depth of the recession, because computers have enabled businesses to respond much faster to signs of economic weakness.

"To be sure, a great deal of real economic pain has been felt over the past year and a half," he said. "But imbalances have not been allowed to fester."
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