Thu, May 17, 2001 page21

• US Fed has router it wants to sell you

  STIMULUS The Fed looks intent on helping high-tech companies work down their inventories as it continues to lower rates despite consistent demand in other sectors

  • By Caroline Baum / BLOOMBERG
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  Wall Street has so much invested in the New Economy and the technology boom, now gone bust, that it often forgets there's more to life than servers and routers and semiconductor chips.

  In fact, there's a whole non-tech world out there. In dissecting government statistics on capital expenditures, Jim Bianco, president of Bianco Research in Barrington, Illinois, found what he's long suspected.

  "While technology and telecom have done poorly, the rest of the economy is scraping along," Bianco says. "This is true not only for stocks but for high-yield and investment-grade corporate bonds as well." In his latest research commentary, Bianco looked at various indexes -- the Standard & Poor's 500 Index, and high-yield and investment-grade bond indexes, all with and without tech and telecom. In every instance, the conclusion was the same: "While tech has been booming and busting, the ex-tech and telecom index has been muddling along," Bianco says.

  Muddling along is not exactly a desired state for the US economy. But it's not something that requires constant CPR from the Federal Reserve. When you consider that capital spending outside of technology and telecommunications "has been in a 20-year downtrend, it's pretty clear Alan Greenspan is worried primarily about high-tech capex," Bianco says. "Why ease inter-meeting [on April 18] to address a two-decade decline in non-technology capital expenditures?"

  "Does Greenspan want to get corporate America to invest in more routers and servers?" Bianco wonders. Why, if corporate America has more than it can handle already? Capital expenditures as a share of gross domestic product rose to 13.85 percent last September, near the all-time high of 13.94 percent in December 1981, when oil and gas exploration was at full tilt. The over-investment in energy only became apparent when the price of oil plummeted to US$10 in 1986.

  From the high two decades ago, capital expenditures as a share of GDP went straight downhill to a low of 9.7 percent in March 1992. When the high-tech spending boom kicked in in the mid-1990s, capex rose from less than 3 percent of GDP in 1994 to over 7 percent in late 2000. In other words, "high-tech capex went from roughly one-quarter of all capex to over half of all capex Tuesday," Bianco says. "The question is, was this necessary investment or over-investment?" If the answer is the latter, and the economy does have a surfeit of capital equipment, then why is the Federal Reserve lowering interest rates to stimulate more of it, Bianco wants to know.

  "Alan Greenspan, Router Salesman," he says.

  As widely expected, the Fed lowered rates Tuesday by 50 basis points to 4 percent. Policy makers reiterated their concern about the decline in capital spending, erosion in profitability and uncertain business outlook, as if it's ever certain.

  What was new and different this time was the mention of an old nemesis, inflation -- not as a risk but for its curiosity value.

  "With pressures on labor and product markets easing, inflation is expected to remain contained," the Fed said.

  Remain contained? Every measure of inflation is currently accelerating. The inclusion of a reference to inflation -- making it a non-issue issue -- is significant because it indicates a sensitivity on the part of the Fed to market signals of rising inflation expectations.

  Long-term interest rates have been rising since mid-March and are at their highest level in six months. Expected inflation, as reflected by the difference between the yields on nominal and inflation-indexed bonds, rose in response to Tuesday's rate cut to the highest level in a year.

  Granted, at 2.2 percent, expected inflation is still low. But it's moved up from 1.4 percent in January.

  Clearly the market senses the Fed has strayed far afield from its normal metier and is now intent on helping the Ciscos and Intels of the world work down their inventories.

  What sort of yardstick will the Fed use to know when it's done enough? In mentioning inflation and claiming it's contained, the Fed called attention to the elephant in the room. The beast of burden is not going to leave because the Fed tells it to.
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