By JACOB M. SCHLESINGER, Staff Reporter of THE WALL STREET JOURNAL
WASHINGTON -- Who's afraid of Alan Greenspan? Not Sy Picon.
For all the commentary devoted these days to the Federal Reserve chairman's campaign to cool the economy, Mr. Picon, a Northern Virginia entrepreneur, considers the central banker barely relevant to his prospects.
Higher interest rates -- the Fed's tool for drawing capital out of the system -- aren't making money scarce for SyCoNet.com Inc., a Manassas, Va., distributor of Japanese animated videos such as Pokemon and Speed Racer. "Everybody knows the Fed's going to raise rates in February, but as this comes closer, VCs are throwing even larger amounts of money at us," chortles Mr. Picon, who recently received a $5 million line of credit from a Florida venture-capital fund.
His backers, he says, "are looking for home runs, returns of 10 times, 30 times, over the next two to three years." In that environment, even a full percentage point increase in the cost of funds wouldn't be too menacing.
On the Rise Again
It's been half a year since the Fed started nudging up its main monetary benchmark, the federal funds rate target, to rein in the galloping economy. Markets are braced for another quarter-point move on Feb. 2, and anticipate two or three additional increases by midyear. Broader rates are moving, too. Yields on the 30-year Treasury bond have risen more than 1.5 percentage points in the past year. Hovering near 6.70%, they are at the highest point since mid-1997.
An interest-rate increase can often take months to ripple through the economy, so it may be too soon to judge the effect of the Fed's actions so far. Yet the impact to date has been practically undetectable. In December, employers around the country created 315,000 jobs, 40% more than in November, even adjusting for seasonal factors such as the usual holiday rush of business. Retailers last month reported their most brisk business since the spring of 1996, excluding the volatile sales of cars. For all of 1999, retail sales grew faster than in any year since 1984.
Economist Rosanne Cahn of Credit Suisse First Boston Corp. recently defied conventional thinking by raising her 2000 forecasts for both how high interest rates will go and how fast gross domestic product will grow. "Monetary policy works primarily through convincing people that the future is going to be less rosy," Ms. Cahn says. "But that signal's not getting through."
Ignoring the Warnings
The signal certainly isn't getting through to the stock market. Traditional market theory holds that rising rates will make interest-bearing investments more attractive, and stocks less so. But after a brief rate scare jolted stocks early this month, the Dow Jones Industrial Average has resumed its ascent, leaping 140 points Friday to close at a new record high of 11722.98. The technology-laden Nasdaq is back above 4000 and just shy of its peak. Both markets were closed Monday for the Martin Luther King Jr. holiday.
"Nothing short of a massive rate hike is going to start luring money away from the stock market," says Jack Bouroudjian, senior vice president of futures and options at a unit of Commerzbank AG in Chicago. "It's very difficult to compete with interest-rate products when people see 15% to 20% returns in the stock market."
Even housing, the sector considered most sensitive to higher rates, hasn't been hit too hard. "We just had the busiest December that I've ever seen, and it has continued into the first two weeks of January," says Allan Brandt, a Denver-area luxury homebuilder. He sold five homes worth half-a-million dollars or more each last month, one-third his total for 1999.
No one thinks the Fed has become impotent, of course.
The economy likely would be growing even faster if rates weren't rising.
The increases to date have only reversed three rapid reductions implemented
in late 1998 in response to the global financial crisis, and thus mark
a return to earlier monetary conditions, not a long-term tightening. And
those 1998 cuts are
widely cited as dramatic evidence of Mr. Greenspan's powers, since they stopped short what was turning into a worldwide panic.
With Mr. Greenspan now having reversed course and moving
to curb investors' enthusiasm, many analysts think it's only a
matter of time before the stock market suffers a Fed-induced correction. After all, the last time the Dow so defiantly ignored rising rates was in the months leading up the 1987 crash. A similar collapse in 2000 could quickly dry up consumer spending, corporate investment and venture capital financing.
Yet it also seems the knobs Mr. Greenspan turns to tweak the economy aren't as tightly wired as before. The banking sector, which is the most directly affected by the Fed's actions, isn't as important in supplying credit to the economy as it used to be: Bank lending covered just 27% of all private-sector borrowing last year, down from 38% a quarter-century ago. Meanwhile, with the U.S. leading the world into a new economic era, the credit flowing from investors overseas appears almost unbounded.
Traditional theory holds that higher interest rates cool the economy through various channels. As borrowing gets more costly, companies and consumers alike cut back. Rising rates should also knock the stock market, and thus curb the creation of wealth that has fueled so much consumer spending in the expansion.
But nine years of unbroken prosperity have cushioned the impact of higher rates. While corporate borrowing has soared in recent years, companies with ever-rising profits can more easily afford higher borrowing costs. Many businesses can now easily finance expansion from huge cash reserves built up from years of fat profits.
Costco Wholesale Corp. is an example. In the early 1990s, the Issaquah, Wash., company borrowed heavily to build its network of discount bulk-grocery stores. But today, the company has paid off much of its debt, and will fund its ambitious $900 million-plus capital-spending plan for the fiscal year ending Sept. 30 -- up more than 10% from last year -- entirely through cash on hand and anticipated earnings. "We're not borrowing money, so interest rates are irrelevant to us in figuring out how to expand our business," says Bob Nelson, Costco's vice president of finance and investor relations.
Many consumers feel cushioned as well. They see that jobs are plentiful and inflation is barely perceptible. And they have hefty stock-market gains that they can use to help finance big purchases. As a result, the two major measures of consumer attitudes-the Conference Board's consumer-confidence index and the University of Michigan's consumer-sentiment index -- are at or near all-time highs, even though two-thirds of the families surveyed in each poll expect higher rates in 2000.
Intense competition and new financial instruments have
also helped shield consumers from higher rates. Consumers wary of taking
on a 30-year fixed-rate mortgage of more than 8% can choose between an
array of competitive adjustable-rate mortgages that charge a half-point
less, at least for the first few years of the loan. Adjustable mortgages
now make up
about a third of all home loans, up from just 8% at the end of 1998, according to HSH Associates, a Butler, N.J., financial publisher that tracks the mortgage market.
Adjustable-rate loans do become pricier in the later years
of the contract, "but a lot of our buyers only own a home for seven years
anyway," says Ted Mahoney, a Boston-area homebuilder. With "different mortgage
options appearing, demand hasn't really abated, to be honest," adds Mr.
Mahoney, who builds four- and five-bedroom colonial-style homes in New
Let's Make a Deal
Auto buyers are also finding competitive credit easy to come by. "Manufacturers are offering cash back or lower interest rates, offering to finance you at 3% instead of 8%, to nullify the impact of a rate increase by the Fed," says Frank Ursomarso, a Wilmington, Del., car dealer. The average rate paid for by customers at his dealerships was 8.25% last month, down from 10.25% the same month a year earlier. That, despite an increase in the fed funds rate to 5.5% from 4.75% during the same period. The fact that some of his suppliers, notably General Motors Corp., cut the base price of cars last year further undercut the Fed's attempts to cool demand by raising purchase costs to consumers. Last year, sales hit a record high for the American auto industry.
The result: "Markets continue to roll forward," Mr. Ursomarso says. "I would suspect I'll turn in a performance this month the same or ahead of last January."
Out of Sync
Then there's the stock market. Stocks have historically moved up and down in rough correlation with bond prices, which move inversely to interest rates. But a Lehman Brothers index of stock and bond prices shows the link was severed last year -- shortly before the Fed start raising rates -- and the gap has continued to widen through early this year. Investors appear to have adopted a new paradigm: They are gambling on gorilla-size gains in technology companies, and are less interested in aiming for single-digit returns.
The surge in stocks, meanwhile, has the perverse effect of undoing what the Fed is trying to do. For many companies, what matters most is the cost of capital, not necessarily the source. While borrowing money is getting costlier, raising money in the stock market isn't.
Goldman Sachs Group attempts to measure these trends with its "financial conditions index," which blends interest rates, stock prices and exchange rates to measure the ease of access to capital. The index suggests the Fed moves have, in the broader scheme of things, been a wash. As of last Thursday, the latest date available, the index stood at 96.5, or down slightly from its 96.7 level just before the Fed started tightening last June. With the market's jump Friday, current conditions are even easier.
A Single Tool
This unusual turn of economic events has made Mr. Greenspan seem increasingly like the man from Oz. His pronouncements carry great weight; yet his actual powers appear fairly modest.
Mr. Greenspan primarily has only one tool to manipulate the economy, the federal funds rate, which is the price banks charge each other to borrow for very short terms -- usually just overnight. The amount of money directly affected by the fed funds rate is minuscule: a mere $125 billion to $150 billion on a given day in an economy of nearly $9 trillion. But movements in the fed funds rate generally ripple through other interest rates.
With rare exceptions, Mr. Greenspan considers moving the rate only every six weeks. And then, he doesn't have a lot of options to consider. The question he faces in February is simple: whether to keep the fed funds rate target the same, to lift it a quarter-point, or, at the outside, to lift it a half-point.
In the very years that Mr. Greenspan's stature has skyrocketed, he has used his authority sparingly. For the past five years, the fed funds rate target, currently 5.5%, has jiggled within the narrow band of 4.75% and 6%. For more than two of those years -- January 1996 through August 1998 -- the Fed took action just once.
Victim of Success
Mr. Greenspan is, in some ways, a victim of his own success.
One reason investors, executives and consumers remain so stubbornly ebullient
in the face of higher interest rates is that they believe that the Fed
chairman has perfected the art of fine-tuning the economy. Higher rates,
to many, won't cause a recession, but rather will neatly snuff out any
paving the way for an even longer stretch of rapid growth. Because so many Americans believe in Mr. Greenspan's ability to keep the economy growing, his rate hikes aren't quelling what he once famously termed their "irrational exuberance."
"In the '60s and '70s, when the Fed acted this way, people thought times would get worse and unemployment would be an issue," says Michigan's Mr. Curtin. Now, most people "don't expect it to threaten their jobs or income security."
More dramatic actions by the Fed would no doubt grab the attention of companies, consumers and Wall Street. And some analysts fear that the economy's imperviousness to the Fed may eventually force it to take more dramatic action.
"This has created an awkward situation for the Fed," Lehman Brothers economists Ethan Harris and John Llewellyn wrote in a recent commentary. "Because only one brake is working, it must push even harder on the brake pedal." That "raises the risk of a monetary 'accident' should the stock market suddenly reacquire fear of the Fed."
Write to Jacob Schlesinger at firstname.lastname@example.org