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Magic lost in US rate cuts

When stock markets are this sick, the automatic reflex is to call for Doctor Greenspan. But the sage of global economics, the US accountant-in-chief, and the man responsible for its longest post-war boom is now looking overstretched. On Friday, the Dow Jones slumped by nearly 5 percent to 8,019.

Greenspan has already handed out a hefty dose of tonic, slashing short-term interest rates from 6.5 percent to 1.75 percent. US 15-year mortgage rates reached an all-time low last week.

On protectionism, the 56 percent increase in the budget deficit, and the suggestion that the current account deficit is a meaningless concept, Greenspan has publicly clashed with members of the Bush administration.

His biannual check-up to Congress last week was a prearranged appointment. But rather than dole out more monetary medicine, he was conducting some collective psychotherapy for the notably skittish US equity markets. The broad message appeared to be "I'm doing what I can, now you have to help yourself."

Greenspan reflected on the infectious greed of the telecom and dotcom booms and pointed to the perverse incentives created by a combination of poorly targeted stock ownership plans and the temptation to harvest massive increases in market capitalisations.

He advocated a tightening of the criminal penalties for corporate malfeasance, and the expensing of stock options on balance sheets.

Such is the state of distress on Capitol Hill, that congressmen practically gave a running commentary on how the Dow was inching up as he spoke.

Greenspan pointed out that the fundamentals of the US economy were rosy, with high growth, impressive productivity, and non-existent inflation.

But the stock markets, which normally lead an economy into recovery, have slumped. The market psyche appears to be in polar opposition to that which prevailed in the years that followed his 1996 speech on irrational exuberance. Where there was once a mad dash for newly traded shares and a feeling that if you weren't buying, you were missing out, now the markets are still waiting for the next blue chip company to be outed as a figure-fiddler.

Some in academic circles and on Wall Street argue that Greenspan's benign approach to setting interest rates in the 1990s helped fuel the dotcom boom, giving rise to the so-called "Greenspan put."

Marcus Miller argued that there was a risk of moral hazard if Greenspan cut rates every time the NASDAQ plunged. "I wish he'd been saying some of these things when the market was absolutely booming, but the moral hazard really now lies between auditor-consultants and companies, in relationships that we thought were watertight," he said.

Greenspan railed against accounting problems but seems sanguine about the chances of further corporate scandals. He seems more exercised by price deflation. This seems to imply that the US might be too efficient, or its markets too free, for the relentless expansion of profits and price-earnings ratios. Productivity may be surging, but there is very little pricing power for companies.

All of which raises the spectre of deflation and the Japanese experience. Although the state of the US banking system is in no way comparable to the malaise in Japan, broad macroeconomic similarities have prompted the Fed to take a closer look.

Its Preventing Deflation: Lessons from Japan's Experience in the 1990s explored the lessons about policy when inflation and interest rates are close to zero. In January the Fed discussed hypothetical scenarios requiring the use of unconventional methods of monetary policy. The Bank of Japan has talked about direct purchases of corporate bonds, and even equities. Greenspan is probably not exercising that ultimate put just yet.
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