Greenspan Keeps Up The Optimism

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Greenspan keeps up the optimism

With war over, all the Fed chairman can do is talk up the economy and wait for the effect

Edmond Warner

Saturday May 3, 2003

The Guardian

Alan Greenspan's latest testimony before Congress confirms just why President Bush has persuaded the septuagenarian chairman of the US Federal Reserve to stick around for just one more term of office: Upbeat, but conservatively so; convincing, but sufficiently noncommittal to leave all options open. In a word, reassuring. The Fed chairman does optimism with a practised understatement that other politicians and their appointees must watch with envy.

Gordon Brown was given yet another roughing up this week on account of his rose-tinted view of Britain's economic prospects - this time by a Commons select committee. Greenspan's view of his own patch is arguably as unevenly weighted, but markets just want to believe him. Reward, perhaps, for digging them out of past mires.

With the war in the Gulf behind us, Greenspan took the opportunity to assess the prospects for the US economy. While acknowledging that the peace is too fresh to allow a clear view of current conditions, he believes "the economy is positioned to expand at a noticeably better pace than it has during the past year".

More boldly, he went on in his testimony to claim: "The enhanced flexibility inherent in that [long-run growth trend] imparts resilience against shocks of the kinds that we have experienced in the past few years." This is one man's economic version of a post-war victory parade. The US has pulled through, its economic essence intact.

The principal engine of economic acceleration cited by the Fed chairman is capital spending by the private sector, encouraged by rising equity markets, declining pressure on profit margins as oil prices recede and improving demand from households themselves responding to lower inflation and cheaper money. And, of course, a collective sigh of relief from industry and individuals alike that war is over.

None of these beliefs is unreasonably held, especially because Greenspan admits that the timing and extent of the anticipated acceleration are clouded in uncertainty, and that "lingering business caution could be an impediment". Indeed, they appeal to an intuitive sense that there must be some catching up to do after a couple of years of despondency.

'Modestly encouraging'

Unfortunately, much hinges on the ability of economic agents to shake off that despondency and invest in a slug of self-confidence. This must involve burying the memories of the recent troubled past, or at least boxing them for contemplation. This is asking a lot of Americans' capacity for optimism.

In the near term there is a very good chance the US will enjoy a mini growth spurt. Anecdotal evidence suggests most businesses have investment projects waiting to be de-iced. Only a proportion have to be activated for the net effect on the economy to be positive. In this context, Greenspan describes a growing backlog of orders for capital goods as a "modestly encouraging sign".

Catching up and catching fire are very different matters, however. Successfully investing to improve productivity has been one of the motors powering America's relative success. Its industrialists will not have forgotten the trick. What matters now is whether they can stomach the risks attached to increased spending in search of the next productivity upwave.

One scenario facing the US is that companies continue to shave away at their workforces, securing marginal gains in productivity, but rising unemployment then dampens consumption. A weak pricing environment would translate productivity improvements into falling inflation rather than rising corporate profit margins. In this event, capital spending may fail to gain any traction.

While this would lead to disappointingly anaemic economic growth, it would not necessarily spell stagnation. Much, again, would depend on the collective psyche.

Rolling the tax dice

In particular, America's ability to close its eyes to the travails of its main trading partners. The recent weakness of the dollar will help counter the effects on US exports of European and Japanese woes. But the lesson from these economies remains that when you think it can't get any worse, it most surely can.

The Federal Reserve and the US administration have each, in their own way, done what they can to bolster economic confidence. Interest rates have been slashed and might - regardless of Alan Greenspan's carefully couched optimism - be cut again next week. President Bush has rolled the tax-cutting dice, albeit a pair loaded in favour of the wealthier interest groups. There is little either can now do but to keep talking things up while they wait to see their effect.

Financial markets have adjusted to reflect the mood of the Fed chairman. Share prices are up on a few weeks back, but no higher than at the start of the year. Money markets sense less chance of policy stimulus, but little whiff of the inflationary risk that might accompany a recovery. Believers, but not yet evangelists. Memories remain too fresh for that yet.