Federal Reserve's mid-year testimony was a lesson in the art of breaking the bad news
Doctors routinely have to break very bad news to patients and their relatives. Anyone who has been on the receiving end of the technique deployed in these situations will have found something disturbingly familiar about the tone and content of the mid-year testimony by Alan Greenspan, chairman of the US Federal Reserve, last week.
Messengers bringing unwelcome information have always faced the wrath or grief of those who receive it. Their reactions are likely to be extreme and dangerous; this is rarely the moment for cold clarity. Disastrous news is best delivered through a muddle of gradually more explicit hints, punctuated by silences and sighs. The recipients themselves then slowly arrive at the true realisation of their predicament.
Greenspan has said as clearly as he is able to that the US economy is not about to make a quick recovery. Key economic indicators are sending mixed messages at best but everyone in the markets knows there is more downside to come. The latest slew of US corporate results was dismal, there are projections of another 50% drop in the technology sector and a growing number of smaller financial fires blazing worldwide make for a hazardous environment.
Yet optimism is still rampant, at least on Wall Street. A poll of 56 firms by the International Strategy and Investment Group has found that six-month outlooks are more upbeat than they have been since 1994. Analysts are hoping revived consumer spending will bail out the economy, a bizarre conclusion given the sliding earnings forecasts in consumer sectors.
Over the past six months, the US Federal Reserve has cut interest rates further and faster than at any time for nearly two decades. The effect should be feeding through by now. Greenspan is not yet out of ammunition but concern is mounting that aggressive monetary easing is not having the desired effect, either on economic growth or the dollar.
The Fed reckons it can keep cutting rates because inflation is under control. But it is kept low largely by the strength of the dollar, which has appreciated more than 40% in the past six years and more than 15% in the past 18 months. It has provoked extraordinary sentiment. Proponents are defending it, like motherhood and apple pie, as a sign that the US is a better market than others, with innately higher growth and productivity. Why should the dollar lose value to bale out incompetent policymakers in Europe, Asia and Latin America?
Critics counter that far from being flawlessly managed, the US economy is arrogantly riding for a heavy fall. Projections for an imminent recovery are still over-optimistic. The strong dollar means inflation is simply being exported and US manufacturers are not as keen for a mighty greenback as US-based investors. Overshadowing everything is the $400bn current account deficit.
By any measure, the dollar should have fallen against the euro in recent months. But where the euro falls on bad news and fails to rise on good news, the dollar rises on good news and fails to fall on bad news. Economists call this an asymetrical response; doctors call it denial. Greenspan hasn't come up with anything to top his immortal phrase about the 'irrational exuberance' of the stock market, and it is not his job to achieve a target level for the dollar. But he's given a clear enough diagnosis : the economy is ailing, despite the shiny currency. It is bad news. How long will investors take to digest the full meaning of his testimony?
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