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James Turk: ''Fear Index'' still rates gold as a buy
By Gretchen Morgenson
The New York Times
Thursday, July 1, 2004
http://www.nytimes.com/2004/07/01/business/01place.html
Inflation and market interest rates are far ahead of
Alan Greenspan's federal funds rate, which he raised
yesterday to 1.25 percent. Now the nation will see
how well Mr. Greenspan, the Federal Reserve
chairman, plays the game of catch-up.
Fears that Mr. Greenspan has opened wide the
door to inflation in the United States by keeping
interest rates too low for too long prompted a
selloff in the bond market recently. That has pushed
short- and long-term rates far above the federal funds
rate and produced the worst quarter for bond
investors in almost 25 years.
Since falling to 3.68 percent in March, yields on
10-year Treasury securities have risen nearly a point,
to 4.58 percent yesterday. Yields on two-year
Treasuries have risen to 2.69 percent from 1.46 in
March.
When inflation outruns a central banker, price
increases on goods and services not only take
hold, they tend to feed on themselves, rising ever
higher. Inflation is exceedingly difficult to bring
under control once it has gained a foothold.
So it came as a surprise to some economists and
portfolio managers that Fed policy makers thumbed
their nose at inflation worries in the statement
accompanying the rate increase. "Although
incoming inflation data are somewhat elevated, a
portion of the increase in recent months appears
to have been due to transitory factors," the policy
makers said.
That is not the opinion of Alan W. Kral, portfolio
manager at Trevor Stewart Burton & Jacobsen in
New York. "We believe that inflation has returned,"
Mr. Kral said. "And the cause of it has been an
overexpansive monetary policy for almost 10
years."
As a result, many say that Mr. Greenspan has
two battles to fight: one against inflation and one
against the view that he has been far too
accommodating in keeping interest rates low.
"I believe the Fed is behind the curve because
the economy continues to be strong and the
inflation rate is creeping up and will continue to
creep up," said Henry Kaufman, an economist in
New York. Its plan to raise interest rates gradually
may be good for the economy, he said, "but is
not designed to put the system back into balance
in terms of constraining inflation itself."
For weeks, the Fed has broadcast its intention
to raise interest rates glacially, so yesterday's
move surprised no one. Some economists said
the Fed's approach was appropriate given the
economic indicators. "There are good reasons
for this gradual approach in 2004," said Sung
Won Sohn, chief economist at Wells Fargo
Co. in Minneapolis. "With the declining price
of oil, economic fundamentals, including
productivity and global competition, will keep
inflation in check."
In the statement accompanying the interest
rate increase, the central bank acknowledged
that the economy showed strength, and it ended
by saying that it would "respond to changes in
economic prospects as needed to fulfill its
obligation to maintain price stability."
But many view the Fed's extremely measured
approach to curbing inflation, which is running
at a rate of 2.9 percent so far this year, as a
mistake. Paul Kasriel, director of economic
research at the Northern Trust Co. in Chicago,
said such a tack allowed for too much
inflationary pressure to build before meaningful
brakes were finally applied.
Mr. Kasriel points to the past for evidence of what
can happen when the Fed begins to raise rates
well after inflation has taken hold. He identified two
other periods during which the Fed began to
increase rates when the Fed funds rate was in
negative territory, adjusted for inflation, as it is
now. Each time -- in March 1971 and July
1980 -- inflation soon took off with a vengeance.
"Everyone recognizes that holding the Fed funds
rate below the inflation rate is a recipe for
accelerating inflation because it creates an
incentive for people to go out and buy things and
finance them at relatively low rates," Mr. Kasriel
said. "That act tends to drive the prices of those
goods and services even faster. That was the
predicament the Fed got itself into in the 1970s
and spent a long time remedying. Now the Fed
is in the early stages of squandering some of the
gains that chairman Volcker made in eliminating
inflation during the '80s."
Mr. Kasriel said he thought the Fed would be
forced to abandon its measured approach to
interest rate increases early next year when
inflation pressures become undeniable.
The stock market barely reacted to the rate
increase; the Dow Jones industrial average closed
the day up 22.05 points. Bonds rallied, pushing
yields on the 10-year Treasury down to 4.58 from
4.69 on Tuesday.
Richard Bernstein, chief United States strategist
at Merrill Lynch, said he was surprised that
investors seemed so optimistic about the Fed's
move because corporate profits were no longer
rising. A study of history, Mr. Bernstein added,
indicates that financial disruptions have followed
periods when the Fed raised rates while
corporate profits slowed.
There have been only three times during Mr.
Greenspan's tenure when rates rose while profits
weakened, Mr. Bernstein said, and each ended
badly. The first was followed by the recession of
1990-91; another such period preceded the
financial crises of the summer of 1998; and
finally, a period of rising rates and falling profits
culminated in the collapse of the stock market
bubble in 2000.
"Every time that profits growth has peaked out,
people say it doesn't matter, and every time the
Fed has started raising rates people say it doesn't
matter," Mr. Bernstein said. "But every time it has
mattered. The combination played a major role in
terms of getting investors to be more risk-averse.
So to me it is a little remarkable that people are
so sanguine about this."
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