Fed Keeps Its Eye on Price Inflation, Not Stock Inflation

Federal Reserve Board Chairman Alan Greenspan left interest rates alone on Tuesday, and the stock market, naturally, greeted the news with another rally.

If you’re Greenspan, that’s probably not the hoped-for reaction. The man who posed the question of what constitutes “irrational exuberance” in financial markets did so when the Dow Jones industrials were at 6,400, in December 1996. That was 2,400 points ago.

Greenspan has wisely stopped trying to jawbone Wall Street lower. He knows a losing battle when he sees one. Even so, he has spelled out on several occasions why he might worry about a sharp inflation in asset values, including stock prices. Mainly, he doesn’t want a replay of Japan in the late 1980s and early 1990s, in which an asset “bubble” would form, helping propel the economy by making companies and individuals feel extraordinarily rich. Then the bubble bursts, taking the economy with it as companies and individuals suddenly feel a whole lot poorer than they might have felt if so much of their wealth hadn’t been tied to Wall Street’s swings.

Historically, the Fed hasn’t focused on the stock market’s levels. But then, as we keep hearing over and over, there has never been a stock bull market like this one.

“I worry that it’s not the economy driving the stock market today, but that the stock market could be driving the economy,” says Rao Chalasani, a veteran market analyst at Everen Securities in Chicago.

But measuring that “wealth effect”--how much additional spending consumers indulge in because their investment portfolios have ballooned--is far more art than science. Imagine the Fed announcing that it is raising interest rates because “we think maybe people are feeling too rich, and they might be spending more money than they should be, based on the size of their mutual fund portfolios.”

Not likely.

What the Fed will need to have in hand before it tightens credit in this economy is strong evidence that inflation--in the prices of goods and services, rather than in stocks--is on the rise. And so far, there’s little sign of that.

While wages overall are rising significantly, reflecting the paucity of workers in many fields and many regions, the consumer price index in February registered inflation at a 1.4% annualized rate. It was just in late 1996 that inflation was running at a 2.8% annualized rate. So that’s a 50% drop in the official inflation rate in two years.

Moreover, a report from a Chicago manufacturing trade group on Tuesday put its member companies’ prices-paid index--their cost of materials--at a new two-year low. (See story, D3)

That may be reflecting the first wave of cheaper imports from depressed Asia. It also may reflect that basic commodity prices have continued to slide this year. Even with the recent rebound in crude oil prices, the Commodity Research Bureau/Bridge index of 17 key commodities was at 228.89 as of Tuesday, below its level of 229.14 on Dec. 31 and near a four-year low.

And now look what’s happening: The dollar is soaring anew against the Japanese currency, topping 133 yen on Tuesday. If this keeps up, Japanese cars and other exports to the United States will get cheaper. More downward pressure on inflation.

All of which leaves the Fed on hold, at least through the second quarter, argues John Bollinger, who writes the Capital Growth Letter in Manhattan Beach. Greenspan, Bollinger says, knows that the central bank must be consistent in its message to financial markets. That message has long been that the Fed’s primary mission is to keep inflation at bay. If there are no significant inflationary pressures to combat, the Fed’s role is to leave well enough alone.

What about soaring price inflation in the stock market? Greenspan may be worried about it, but he has apparently given up thinking he can, or should, do anything about it.

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Tom Petruno can be reached via e-mail at [email protected]

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Down and Out

After a slight bounce in January, the Commodity Research Bureau/Bridge index of 17 key commodities continues to hover near four-year lows - another sign of subdued inflation.

Tuesday: 228.89

source Bloomberg News