Once upon a time, folks would gather around the broad tape to see the weekly changes in the money supply, from which they would try to divine the actions of the Federal Reserve. Later, the focus was all on the Fed Funds target, with CNBC trying to judge from the thickness of Alan Greenspan’s briefcase whether there would be a move in that target coming out of a meeting.
You can see in the right side of the lower panel of the chart that we don’t fiddle with such concerns today. The game is to predict the next path of whatever acronym-based policy has in place at the time. Now, it’s QE.
I posted an editorial cartoon on research puzzle pieces yesterday from Tom Toles, which showed Doctor Greenspan with a needle, bringing the stock market back to life. I posed a question as to when the cartoon was penned.
It was clipped from a paper dated November 28, 1998. Surprised? The Russians ran into some difficulty in the late summer of that year, devaluing the ruble and defaulting on its ruble-denominated debt. Global markets went into a tizzy and Long-Term Capital Management, a darling of the investment world, headed for a spectacular fall from grace.
In September, the New York Fed brokered a deal to bail out LTCM, with the big banks putting forth a few billion dollars to try to right the ship. (Bear Stearns didn’t participate, which didn’t help it a few years hence.) Days later the Fed rolled into action, with the first of three rate cuts (shown by the vertical line in the chart). The official statements (9/29, 10/15, and 11/17) referenced prospective economic activity, but can best be summarized as follows: “financial market conditions.”
It’s important to set the scene. The stock market, which was up massively since the early 1980s, had fallen around 18% from its July high in the immediate aftermath of the Russian moves, but had rallied back to being down a bit more than 10% by the time of the first rate cut.
How about the economy? Real GDP was 4-5%, we were at or near full employment (just over 4%), and CPI was a bit more than 1.5%. You could not describe it in any sense as an economy at risk.
Roger Lowenstein’s account of LTCM’s rise and fall (When Genius Failed) gives the key to the Fed’s actions. Wall Street “was overinvested in the same trades” as LTCM, compounding the problem, and Greenspan’s actions were “a signal that he would cut and keep cutting until liquidity to the system was restored.” By the time of the Toles cartoon, the stock market had recovered all of its lost ground. It would then vault to astounding valuation levels before beginning a lost decade.
This morning, in an opinion piece in the New York Times, Martin Feldstein said that the Fed is “unwittingly encouraging private investors and institutions to continue to take risks.” The title of this posting corrects that statement, in that there has been nothing unwitting about it.
The situation begs for a good cartoon. (Chart: Bloomberg terminal.)