Economy and the Blame Game

Republican’s blame Clinton, Democrat’s blame Bush for the spawn of the recession and the fact is our economic downward spiral did not result from either past or current executive leadership or partisan party politics. This article serves to place the blame where the blame belongs and in this case the buck stops with Alan Greenspan who began in June of 1999 to plant the seeds and continued to nourish through May of 2000 an environment conducive to a protracted recession.

Increasing or decreasing interest rates do not always have the same effect on the economy and can contribute to expansion, investment and savings or contraction, layoffs and recession depending on the correlation between the cost of financing and the expected rate of return. The economic environment in June of 1999 when the Federal Open Market Committee (F.O.M.C.) began to raise interest rates was overheating, the stock markets were in a state of speculation and subsequently pricing securities well beyond rational market valuations. An increase in the interest rate at that time would serve to return the economy in general and stocks in particular to a sustainable rate of growth.

HISTORICAL PARAMETERS

1.) An increase or decrease in the interest rate does not historically begin to have any measurable effect upon the economy for some six months to a year from the date interest rates are expanded or contracted. The actual time in which an interest rate increase or decrease begins to have an effect upon the economy is largely a function of short term financing maturity dates. This occurs because as short-term notes mature (one year and less) new financing rates become applicable. In mid 1999 the state of the economy indicated that increasing interest rates would equate into declining revenues, net income, earnings per share and consumer spending and serve to temper the overheated economy.

2.) New technology, product life cycles, and expanding markets are essential elements required to maintain economic growth. Research and develop in a quest to discover new technology is a net user not provider of funds. As new products or processes emerge additional capitalization is required to ramp up production facilities to meet demand and the initial costs of production, inefficiencies and supply and demand all exact a premium upon the consumer. Learning curves, economies of scale, increasing demand and overall production efficiencies eventually lead to declining per unit costs that translate into end user declining price. As the market matures saturation and competition ensue and new features are added to maintain market share but, eventually there are no new features to add given the current realm of knowledge and new technology must once again emerge if growth is to be maintained.

Source: www.mortgage-x.com/general/mortgage_indexes.asp

As indicated by the above graft, late June 1999 the Federal Open Monetary Committee (F.O.M.C.), Alan Greenspan and his compatriots began raising interest rates and continued through May 2000. Over the course of this period the prime rate went from 7.75% to 9.5% an increase of 1.75%

The above graph indicates that the stock market began to decline early March 2000 some 8 months from early June 1999 when the F.O.M.C. increased the interest rate. To reiterate, an increase in the interest rate will begin to have an effect upon the economy six months to one year from the date of implementation.

This graph combines the first two graphs. In this graph the interest rate has been inverted so that the increasing interest rate is represented by the declining black line and transposed for comparative purposes. As a lagging indicator the various composite indexes adjust radically to reflect the historical performance of the prior quarter as corporations issue financial reports all other movements between reporting dates are the result of expectation and speculation. The interest rate graph has also been skewed 9 months to the left to correspond with corporate financial pre-announcements because the stock market reacts to increasing or decreasing revenues, net income and earnings per share and subsequently the prospects for growth or contraction as corporations report earnings.

There are 3 potential dates that represent the beginning of corporate financial pre-announcements that fall within the six months to one year time period, where a change in interest rates would begin having an impact upon the stock market. The potential dates are January 1st, April 1st, and July 1st. January 1st eliminates itself because the composite stock index is rising in conflict with expectation, is biased by holiday spending patterns, presidential election euphoria and optimism. This leaves April 1st. and July 1st. as potential points where the increasing prime rate and the composite index would intersect. April 1st. was chosen as the date of intersection because this date is not influenced by extraordinary events (holiday spending and election). It should be noted that the relationship between increasing interest rates and the declining market remains viable regardless of the point of intersection selected. Nor does the choice of a particular index (NYSE, NASDAQ or S&P) disrupt the relationship, between increasing interest rates, declining corporate profits and subsequently declines in the composite index and employment. The NASDAQ composite index was chosen because it represents emerging new technology that must be sustained for growth in the overall economy to continue.

CONCLUSION

I would agree that the stock market in 1999 was running out of control with wild speculation and pricing stocks beyond rational valuations with dreams of grandeur and that curtailment was both required and appropriate. The F.O.M.C. first contributed to the problem in the beginning of 1999 when the interest rate was decreased and the economy was already overheated. In defense of the F.O.M.C., corrective action was taken late June of 1999 (rate increase) in an effort to return the markets to rational valuations and sustainable growth. The recession was nourished when the interest rate was raised month after month beyond 3/4% without allowing the economy to adjust (6 months to 1 year later) to determine the effect of prior policy and the need for future adjustments. The interest rate increases occurred at a time when new technology not yet profitable was emerging at an astounding pace and the interest rate increases made financing already unprofitable operation impossible by further deteriorating the corporate bottom line and subsequently contributed to a corporate shift from expansion to survival in general and specifically declines in employment, consumer spending, consumer confidence and capitalization. So if you need to blame someone place the blame where it belongs with “Alan Greenspan”.