WASHINGTON – By signaling another cut in interest rates, already at 40-year lows, Federal Reserve Chairman Alan Greenspan is using the “monetary equivalent of a corked bat” to pull the economy out of a slump, warns the former chief economist of Congress’ Joint Economic Committee.
Like embattled Chicago Cubs slugger Sammy Sosa, “Greenspan seems to be in a slump of his own,” said economist Brian S. Wesbury. “Apparently the slump seems so bad to him that he is willing to cut interest rates again as insurance against deflation. Never mind that gold prices are up sharply, the dollar is slumping and commodity prices are on the rise” – all danger signs of easy money.
He warned: “Greenspan is willing to use the equivalent of a corked bat to get the economy moving again.”
The Fed is expected to cut rates again at its June 24-25 meeting here. At 1.25 percent, the central bank’s benchmark federal funds rate is already at a 40-year low.
Wall Street traders are pricing in a 25-basis-point rate cut to 1 percent, coming on the heels of the European Central Bank’s half-point cut last week in its official interest rates. Many economists welcome another reduction in interest rates.
But Wesbury, vice president of Griffin Kubik Stephens & Thompson, a Chicago investment firm, advises against one, no matter how minor.
Though homeowner refinancings at record-low interest rates have helped buoy the flagging economy by putting more cash in consumers’ pockets, he says there is a downside to the low-rate environment.
“Low, or negative, real interest rates have a cost,” Wesbury said in his GKST Economics newsletter released yesterday. “They reduce the purchasing power of those on fixed incomes, undermine pension fund returns and hurt the earnings power of insurance portfolios, putting upward pressure on insurance premiums.”
What’s more, historically low rates expose lenders to costlier defaults, he says.
“When real rates are low, the pain of a bad or non-performing loan is acute,” he added. “It takes longer to dig out of any hole.”
Greenspan recently cautioned that there is a greater chance of deflation than inflation in coming quarters.
Wesbury argues that if there is deflation, “the Fed caused it” in 1999 and 2000 when it ratcheted up rates so high it tipped the economy into a recession, causing serial price-cutting in the tech sector and the auto industry. (To be fair, Greenspan more recently has had to overcome the Sept. 11 terrorism shock to consumer spending and business investment.)
Wesbury and a handful of other economists warned the Fed about deflation “as far back as 1998,” he said. “The Fed scoffed at these ideas, ignored the signals coming from gold, commodity prices and an inverted yield curve, and hiked rates until the economy entered recession.”
The Fed has since reversed course, but like before, it is overcorrecting, he warns.
“By cutting interest rates too far in the name of [an alleged] learning curve [over the unknown effects of deflation], the Fed is using the monetary equivalent of a corked bat,” Wesbury said. “The end result will be more damage from lower rates, more volatility in future interest rates and more confusion about what monetary policy can and cannot do.”
Wesbury, author of “The New Era of Wealth,” has been touted by the Wall Street Journal as one of the nation’s most accurate bond-market forecasters.