Greenspan worried

[Louis Proyect <lnp3@xxxxxxxxx>]

washingtonpost.com
Greenspan Worries About U.S. Economic Health

By Nell Henderson
Washington Post Staff Writer
Friday, August 26, 2005; 2:03 PM

JACKSON HOLE, Wyo., Aug. 26 -- Federal Reserve Chairman Alan Greenspan
warned Friday that recent gains in U.S. home prices, stock values and other
forms of wealth may be temporary, and could easily erode if investors
become more cautious.

Such wealth has been boosted, in part, by very low interest rates,
reflecting many investors' belief that the recent years of relative
economic stability will continue, Greenspan suggested in remarks delivered
at the opening of an economic conference here focused on his 18 years as
Fed chief.

"This vast increase in the market value of [stocks, bonds, houses and other
assets] is in part the indirect result of investors accepting lower
compensation for risk," Greenspan said, adding, "Such an increase in market
value is too often viewed by market participants as structural and permanent."

Households and businesses have been able to spend more because it is so
easy to convert such wealth into cash, by selling or borrowing against such
assets, he noted.

"But what they perceive as newly abundant [cash] can readily disappear,"
Greenspan warned. "Any onset of increased investor caution" raises
borrowing costs, and thus "lowers asset values."

Greenspan said earlier this year that investors are not necessarily being
irrational in expecting the economic waters to stay calm. During the past
two decades, inflation has fallen to very low levels, and the economy has
experienced just two, very mild recessions. This experience contrasted
dramatically with the turmoil of the 1970s and 1980s, when inflation and
interest rates soared and the nation experienced the deepest downturns
since the Great Depression.

Speaking explicitly about the economy, but also implicitly about his tenure
as Fed chairman, Greenspan noted Friday that since 1987 the nation has
suffered two sharp stock market declines and the fallout from the Sept. 11,
2001, terrorists attacks while experiencing the shallowest recessions since
World War II. He also noted that the economy has so far managed "to weather
reasonably well the steep rise" in energy prices over the last two years.

Other economists have argued that good Fed policy has played a major role
in stabilizing the economy over the last quarter century.

Greenspan acknowledged that Fed policy has been "an important contributor
to the decline in inflation and inflation expectations" over that period.

He credited the Fed under his predecessor Paul Volcker for doing "the very
heavy lifting against inflation." Volcker, who served as Fed chairman from
1979 to 1987, pushed interest rates to double-digit levels to break
inflation and start driving it downward, causing a severe recession in the
early 1980s.

In addition, Greenspan said the Fed's major contribution in recent years
was its willingness "to recognize that the U.S. and global economies were
evolving in profound ways" and to tailor the central bank's
inflation-fighting strategies appropriately.

But Greenspan attributed the economy's "extraordinary resilience to shocks"
primarily to increased "flexibility," his term for the freedom of U.S.
financial markets to respond to events through changes in prices, interest
rates and exchange rates. That contrasts with the U.S. price controls and
heavier government regulation of many industries in the early 1970s, and
with other governments' restrictions on their own markets and industries today.

This flexibility means "economic imbalances," such as the outsized trade
deficit and the current housing boom, need not be solved through deep
downturns in economic growth or employment, he said.

"The more flexible an economy, the greater its ability to self-correct in
response to inevitable, often unanticipated, disturbances," he said.