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Predictable
The Fed refrained from raising interest rates at its December 20 meeting.
Maybe Mr. Greenspan wanted to avoid being cartooned as the Grinch. This holiday honor was instead bestowed on Messrs. Gingrich and Dole, while Mr. Clinton appeared as the Me Too Tax Cut Santa ("Saturday Night Live" had the president giving every middle class American a garage door opener, and a first time homebuyers' certificate for É five dollars).
More likely, the December pause reflects Mr. Greenspan's desire to move gradually, so as not to cause unnecessary disruption in markets and the economy.
It's often said that the Fed pauses so it can assess the effect of its past moves, but this is true only to a limited degree: the lag time from rate rise to economic slowdown is somewhere between six and eighteen months, way too long for 60-day pauses to provide useful insight.
There are two recent examples of the kind of disruption which Feds in general can cause. One came last winter when our Fed had just got started, and the second one -- just last week -- was caused by omission, and by a different Fed.
The Fed's first tightening move was on February 5, a slight, .25% rise in the Fed funds rate. Sixty days later, bond and mortgage yields had risen two percent, and financially savvy Americans learned more about the term "derivative" than they ever wanted to know. A mere turn in direction from easy to tight, in insignificant magnitude, caused the worst bond market wreck in 35 years.
Imagine a tidy bachelor, one much like Mr. Greenspan, who keeps a very clean apartment in a big city. In the wee hours one night, the gentleman wakes hungry, and goes to the kitchen for a snack. He flips on the light switch, and É ROACHES! É scurrying for cover.
In February there was no sign of extreme speculation in the markets. A single, gentle move from the Fed, and the speculators were in plain sight, and disorderly retreat. If the Fed had moved harshly, rather than in the measured, patient, and disciplined .25, .25, .25, .50, .50, .75 of the last ten months, it might have caused a disaster.
As it is, the aftershocks are still coming. Orange County, California will be a symbol of overconfident folly for a long time. Bankers Trust, a good, dignified outfit, has just paid a humiliating fine, and had to settle with customers and regulators over its derivative misbehavior.
Then, last week, events in Mexico delivered a warning to those who think the American Fed is too tough.
In most disorderly fashion, Mexico devalued the peso. It began as a government effort to let the peso slide perhaps 10%, and a week later ended in an uncontrolled 40% plunge. Its stock market suffered an equivalent fall, and the purchasing power of Mexican wages fell the same amount.
Until last week, this was the resurgent Mexico, which had promised the world and its own citizens that its currency would hold stable value. Foreign investment had poured in, and domestic capital no longer escaped to safe currencies.
Why this disaster? The overheating economy encouraged a flood of imports, and a huge trade imbalance. As pesos left Mexico to pay for the imports, more foreign capital had to be imported in offset. These flows can be maintained for a while, so long as confidence lasts, but the day comes when nobody wants any more pesos.
The normal financial prescription for this condition might include a small devaluation of currency, making imports more expensive, and exports more competitive, but it absolutely requires a ferocious move to raise rates by the central bank.
The Mexican government forced its central bank to flinch, and relied entirely on devaluing the peso. When central banks tighten persistently, or hard, a recession follows. Mr. Zedillo's new government apparently thought that it did not have the political strength to cause a much-needed recession.
America has that strength.
If you are worried about the changing of the Congressional guard, a limping (if not yet lame) presidential duck, and social and financial instability, give thanks for faith in the Fed. Everybody knows that the Fed may be too early, too late, too hard, or too easy, but we have the courage to wish them luck, and get on with it. Neither the White House nor Congress is trying to stop them.
There is normal grousing, but the benefits of a low inflation, high productivity economy are clear. Maintaining those conditions requires periodic pain. Mexico will get its recession the hard, inflationary, and destabilizing way: in the absence of government, cruel markets will do it.
More predictions. The Fed will resume its rate increases, and a mild recession will start before the next round of New Year's predictions are due. A little later (but for different reasons), the duck will defer nomination to Mr. Gore.
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