Fed boss tries to soften US economy's landing

Wall Street widely expects the US Federal Reserve to cut interest rates today. The question is: by how much?

Will it be 0.5%, the amount the US central bank shaved off the rate five times already this year, or will is be 0.25%?

Whatever the Fed's decision, analysts are resigned to the fact that America is heading towards recession if it is not already there.

In the US, the National Bureau of Economic Research has warned that a recession may have already started, with unemployment rising and industrial production falling.

The news from the corporate front in America and elsewhere has been grim, with one company after another issuing profit warnings and slashing staff.

Bayer, Europe's second-biggest chemicals group, today was the latest corporate giant to warn of lower profits for the second quarter due to slower global economic growth and a sharp drop in earnings from its Kogenate biotech product.

Yesterday, Merrill Lynch, the US powerhouse of investment banking, said that second-quarter profits would fall by almost half.

Merrill has axed 3,800 jobs this year and more job losses can be expected as profits decline.

The signs of recession are all there, and this bust has been a long time coming.

The American economy has been growing for the past nine years, in the longest expansion in US history.

An explosion in the hi-tech investment in the early and mid-1990s, led some to believe that a "new economy" had dawned and that the business cycle had been banished, despite the historical evidence that bust follows boom.

Alan Greenspan, the delphic chairman of the US Federal Reserve who is credited with the long American boom, was a sceptic of the new economy fad.

In 1996, he issued his famous warning against "irrational exuberance" as the stockmarket climbed vertiginously. And then nothing. There was no follow-through to that warning.

The Fed did not raise interest rates to burst the bubble. At the time, there seemed to be no reason to do so as inflation was dormant.

In retrospect, Mr Greenspan would have been wise to back up his words with action and brave the accusation of taking away the punch bowl just as the party got going.

But the Fed's unenviable job is precisely that of party pooper and to make sure that revellers don't get carried away.

Other signs of excess in the US economy at that time were a number of huge mergers, a tell-tale sign that the party was revving out of control.

In the financial sector, Citibank gobbled up a succession of brokerage houses to metamorphose into Citigroup, and claim the No.1 spot in American banking.

In media, AOL bought Time Warner, already a huge media empire in its own right.

While these mergers possessed a certain logic on paper, these gigantic combinations also attested to an unhealthy euphoria.

Over-optimism led to over-expansion. The US telecoms industry has laid down so much optic fibre in anticipation of a broadband revolution that there is now a glut of these cables.

Similarly, the European telecoms are now deep in hoc to the banks as they bid fabulous amounts of money for new generation wireless services.

Yet the likes of BT are now wondering whether there will be enough consumer demand for these new-fangled services.

The bubble burst in March last year, when the dot.coms started to fold through lack of money.

In January, the Fed made the first of five rate reductions, but it looks as if Mr Greenspan was too tardy.

By cutting rates, the Fed is making money cheap for companies and consumers to borrow in an effort to keep the American economy afloat.

But the spending binge of the past decade has to work itself out and easy credit can do little until that process comes to an end.

If it is going to be a hard landing for the American economy, then it will be bumpy ride for the rest of the world as well.

As Mr Greenspan said earlier this year, when asked whether the Fed could avoid boom and bust: "Do we have the capability to eliminate booms and busts? The answer is no, because there is no tool to change human nature to predict human behaviour with great confidence."

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06.07.2001: Riding the boom


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