Monday, July 28, 2003

From today's FT:
From Mr Steven Morris.

Sir, Avinash Persaud suggests that Federal Reserve chairman Alan Greenspan's "deflation mongering ... was merely a ruse to hide (a) switch to an inflation policy" that he sees as a necessary condition for the strong economic rebound he is so desperately attempting to create ("The Fed takes a dangerous stance", July 23).

This is interesting to ponder, but the point is moot. Whether intended or not, the liquidity the Fed has pumped into the economy has already created inflation, in the form of an inflated property market, as unsustainable as the dotcom mania.

Mr Greenspan's hope has been that extracting wealth from home equity would help Americans compensate for egregious stock market losses and a (continuing) recession while record low interest rates would buy time for the rest of the economy to recover. Three years into Mr Greenspan's scheme, we find homeowners and consumers alike awash in record levels of debt and everyone still waiting for "the recovery".

In the past few months the Fed has been playing fast and loose with either its fear of deflation or a denial of its presence. This has led to almost unprecedented chaos in the fixed income markets and a significantly higher, market-driven interest rate environment.

Rates are still historically low, we are told. That is true; but do professionals honestly believe that a roughly 30 per cent increase in long-term rates in merely four weeks will have no consequences for the economy?

Just look at the prices of housing equities. Since mid-June, the parabolic rise in the share prices of home-builder companies has ended and the shares are now down about 20 per cent across the board. The housing sector of the stock market has topped out. The housing market has also topped out; but this has not yet been reflected in the economic data.

Mr Greenspan's policies have succeeded in creating a housing bubble, widespread indebtedness and another frothy stock market.

If the Fed chairman's call on the economy is wrong again, you will be hearing a lot more about deflation than inflation in the coming months.

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