- The Washington Times - Sunday, August 12, 2001

Among the many uncertainties now blocking the path to a sustained stock market rally and economic recovery, the mystery of Alan Greenspan's policy targets clearly has become a key impediment.
Instead of clear monetary rules, the Fed chairman's long-running reliance on an ad hoc approach continues to baffle investors and business people as they puzzle through the latest indicators du jour.
He has widely hailed, for example, the accelerated productivity growth accompanying the late-1990s technological revolution for lifting the economy's noninflationary growth "potential." For a time last year, though, rising productivity was instrumental to Mr. Greenspan's rationale for continued Fed tightening, under the twisted logic that expected future gains were feeding an excess of aggregate demand over currently available supply.
And while he regularly professes to reject the rigid Phillips Curve/NAIRU prescription for monetary regulation of economic expansion, Mr. Greenspan's fears about the "shrinking pool of available workers" continued to justify a tightening bias until it was clear the economy was stopping in its tracks late last year.
Early on this year, we were told that "consumer confidence" was key to avoiding recession, keeping markets on edge over variations in the ephemeral confidence data.
As it became clear that the economy was continuing to decelerate despite relatively benign consumer confidence figures, however, nary a word was heard about confidence again. Similarly, Mr. Greenspan was nearly certain in the first part of the year that the economy was experiencing a normal "inventory correction," leaving the distinct possibility that the Fed easing could end abruptly upon any sign that the inventory drawdown had run its course. Since it became obvious that the inventory "overhang" was the effect, not the cause, of a depression in high-tech capital investment, the inventory correction rationale has also lost standing.
Missing from all this, though, is the slightest recognition of an array of market price indicators that continue to point to the Fed maintaining an overly tight stance. At one time, such signals — broad commodity indexes, gold, Treasury yields and the dollar's foreign exchange value — were significant factors in Mr. Greenspan's policy perspective. Indeed, earlier in his tenure the Fed chairman unabashedly professed an adherence to basic price rule principles.
In one 1994 congressional appearance, for example, he stated that commodity market signals provided more useful and timely information than the official government data on prices, unemployment, national income, and so forth.
"Signals from financial and commodity markets may warn about the development or easing" of inflation pressures sooner than official data, Mr. Greenspan told House Banking in August 1994.
That's a stark contrast with his Senate Banking testimony late last month, during which Mr. Greenspan essentially contradicted the idea that commodity prices convey pertinent monetary information. During a Q&A; exchange, Sen. Robert Bennett, Utah Republican, pointed to commodity prices "going down everywhere at very significant lows," and related to Mr. Greenspan the straightforward reasoning of one Utah copper miner, who told him, "When copper is scarcer than money, the price of copper goes up. When money is scarcer than copper, the price of copper goes down."
Mr. Greenspan, though, would have none of that, telling Mr. Bennett: "I think that the demand for commodities is … more an indicator of industrial activity and its use than it is of financial liquidity. In fact, I rarely use commodity prices as a single useful indicator for broad inflation, which is really where the issue of liquidity rests." Besides, Mr. Greenspan added, "If liquidity were a crucial factor in determining commodity prices, then they should be buoyed at this stage — M2 has been going up at double digit annual rates in the last number of months."
Well, the proof is in the pudding. A simple statistical test of regression analysis shows nearly 80 percent of the decline of the Dow Jones commodity futures index is explained by the rise of the G-6 trade-weighted dollar. What's more, another test shows the Dow Jones spot commodity index is closely linked to the falling turnover ratio of M2 velocity. So if liquidity is ample, as Mr. Greenspan maintains, why then are both commodities and velocity falling?
It seems the last thing Mr. Greenspan wants at this point is to have his performance judged against a set of objective, market-based variables, which would be tantamount to holding the Fed and its chairman accountable for their actions. Thus, he can be expected to remain in denial that commodity deflation is a monetary phenomenon, while markets continue to extract a risk premium to account for the uncertainties imposed by Mr. Greenspan's seat-of-the-pants policy paradigm.

Lawrence Kudlow is CEO of Kudlow & Co. and is CNBC's economics commentator. David Gitlitz is managing director of Kudlow & Co.



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