Greenspan's Star May Be Dimming; Alan Greenspan Once Was Hailed as a Visionary Fiscal Planner Whose Words Alone Could Move Markets. but a Stagnant U.S. Economy Has Critics Second-Guessing Him

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Byline: Jamie Dettmer, INSIGHT

The hints have been easy to pick up and Alan Greenspan, chairman of the Federal Reserve Board, has done nothing in the last few weeks to dispel the idea that when the central bank's policymakers meet next they will cut interest rates once again the 13th time since the start of 2001. In fact, quite the opposite. Participating by satellite with a bankers' conference staged in Berlin, Greenspan said some kind of "insurance" may have to be taken out against a new downturn.

But is it a done deal or has Greenspan been talking up the possibility of a rate cut to help drive down long-term interest rates in the financial markets and reduce the cost of borrowing, hoping to jawbone economic growth? We'll soon find out, but some Wall Street analysts point out that all the hints about a further reduction in interest rates already have helped keep down the cost of borrowing, sustaining a mortgage-refinancing boom and encouraging corporations to take on debt to buy new factory equipment.

Either way the Fed appears to have decided that it has little choice but to pursue a strategy of keeping interest rates artificially low for an extended period, hoping in that way to kickstart the economy and keep it out of the doldrums.

Greenspan and the Fed's governors seem more anxious about the possibility of deflation, which can paralyze an economy by causing wages to fall and debts to become effectively larger than inflation hence their readiness to pursue an expansionary monetary policy. But will the strategy work and is the Fed at risk of prompting a nasty bout of inflation a little further down the road by being overexercised about the dangers of deflation?

As everyone knows, if all the economists in the world were laid end to end they still would not reach a conclusion. So it is not surprising that some economists worry that the Fed is taking a big risk. They argue that the inflationary dragon is stirring in its lair, fed by the massive double dose of expansionary fiscal and monetary policies that the Fed and the Bush administration are pursuing. In fact, some analysts are concerned that Greenspan is making a major miscalculation by fomenting a housing-price bubble that could have huge consequences if and when it bursts.

"In the second half of 2002, the average American home buyer has made a 7 percent down payment and is putting 40 percent of household income toward mortgage payments. This is unsustainable and will end just as badly or even worse than the tech bubble did," according to Michael Preiss of Finance Asia.com. Preiss says that "instead of starting several of his recent speeches asserting that there is no U.S. housing bubble (to avoid rattling American consumers), Greenspan should have addressed bank-lending standards to home buyers." He believes the Fed chairman needs to tighten bank-lending standards for home loans and to be more cautious about encouraging consumers to burden themselves with a mountain of debt to boost temporary demand.

Others maintain the Fed is wrong to be exercised about the risk of deflation. Greg McBride, a financial analyst for Bankrate.com, says that aside from April's modest drop in consumer prices "there is a lack of evidence suggesting deflation at the consumer level." He added in a recent assessment of the dangers of deflation: "Through the first four months of 2003, consumer prices were climbing more than twice as fast as was the case one year ago."

Much of the second-guessing of Greenspan is a fairly recent phenomenon. Back in the 1990s when the economy was booming his pronouncements were accepted as invariably right and his actions as brilliant. The BBC noted in a 2001 biography of the Fed chairman that "Greenspan has played a crucial role in keeping the U.S. economy on an even keel." The biography continued, ironically in hindsight: "If he can manage to avoid a painful economic crash, his place in history will be assured. …