Greenspan lifts stocks worldwide

WASHINGTON -- With a couple of carefully chosen comments, Federal Reserve Board Chairman Alan Greenspan has -- once again -- turned around financial markets worldwide.

Stocks surged Tuesday on markets from Tokyo to Frankfurt to New York, reversing a six-week slump, after Greenspan suggested on Friday that Fed officials may cut interest rates if the world's economic troubles further slow growth in the United States.

The United States has been the engine of growth in a world of declining demand. By suggesting the Fed's focus has shifted from controlling inflation to sustaining growth, Greenspan reassured investors he intends to keep the engine well-oiled.

"He didn't say he was going to lower rates, but he raised the possibility," said Paul Kasriel, chief economist at the Northern Trust Co. in Chicago. "Alan was saying, `I'm not going to sit by and let Asia sink the U.S. economy and the U.S. stock market.'"

That was good enough for investors, who pushed U.S. stocks higher. The Dow Jones industrial average rose 381 points, the biggest point gain ever, to close Tuesday at 8,020.78. The Standard & Poor's 500 index rose 50 points to close at 1023.46. Both indexes rose about 5 percent. The Nasdaq Composite Index rose 94 points, or 6 percent, to close at 1,660.86.

Bonds declined as investors switched their focus -- and money -- to stocks. The Treasury's benchmark 30-year bond fell more than a full point, pushing up its yield more than 7 basis points to 5.36 percent.

As recently as July 21, Greenspan told Congress that Fed officials were concerned that inflation was the biggest danger to the U.S. economic expansion, now in its 90th month -- and knocking at the door of the longest on record during peacetime, 92 months during the 1980s.

His concern about inflation helped send stocks swooning. The Dow and the S&P 500 each fell about 18 percent from the day before Greenspan's July congressional testimony through Friday's close.

On Friday, however, the Fed chairman said he and his colleagues are now just as worried that U.S. growth could be slowed by global economic woes.

"It's just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress," Greenspan said at the University of California at Berkeley. His comments suggested that he and his Fed colleagues now see a rate cut and not a rate increase as their next move if clear signs emerge that the U.S. economy is in trouble.

"It's not the idea of a rate cut so much," said James Glassman, economist at Chase Securities in New York. "It's a psychological boost. Here's a central banker who has a strong economy, but has an eye on what's going on overseas. It's a signal that the policy leadership is mindful of what's going on."

Stock prices reflect investors' expectations about future corporate income, which should be higher if borrowing costs fall. Companies will pay less for loans, as will their customers, stimulating demand.

"If rates fall, profits should go up. It's as simple as that," said Bruce Steinberg, chief economist at Merrill Lynch in New York.

What's not clear is whether the economy has weakened enough to spark assistance from the Fed. With the jobless rate at 4.5 percent, companies are having trouble finding and keeping workers and are being forced to raise wages to attract the best candidates. Average hourly earnings rose 0.5 percent in August, a healthy increase even if boosted somewhat by General Motors workers returning from their monthlong strike.

Home sales are close to record levels -- as mortgage rates decline -- suggesting demand for home furnishings and appliances will stay strong in the months ahead.

In addition, borrowing by U.S. consumers grew at a faster-than- expected pace in July as auto and other personal loans surged, the Fed reported Tuesday. Borrowing rose by $5.3 billion for the month to $1.266 trillion after rising a revised $8.8 billion during June.

Economists watch the Fed's consumer credit statistics because it helps them gauge changes in consumer spending, which accounts for two-thirds of overall economic activity.

Whether Fed policy-makers actually cut rates "is up for grabs," said Diane Swonk, deputy chief economist at First Chicago. "They've got strong U.S. growth in the face of a crumbling world situation," she said. "The Fed is now reactive. They can't be pre-emptive anymore."

In fact, it could be ironic if stocks continue to rally, analysts said. "The more the market rebounds in the short term, the longer the Fed is going to delay easing," said Steinberg.

Still, if they find it to be necessary, Greenspan and his colleagues have some room to cut the overnight bank lending rate, which the Fed's held at 5.50 percent for more than 17 months.

"Normally at this stage of the business cycle the Fed would not have the luxury of lowering interest rates because it would be battling inflation. This time, inflation is benign," said Kasriel.

Consumer prices rose just 1.7 percent over the past year. And with commodity prices falling -- the Commodity Research Bureau index fell to its lowest since 1977 on Aug. 28 -- analysts said inflation is not a concern. "Deflation is much more of a threat than inflation today," said Brian Wesbury, chief economist at Griffin, Kubik, Stephens and Thompson in Chicago.

Deflation, though, would be bad news for corporate profits, too. Given that, many analysts are skeptical Tuesday's rally will last. Although Greenspan has a proven ability to move markets in the short run, absent action his influence wanes.

While the Fed chairman sent stocks tumbling when he mused about "irrational exuberance" in December 1996, the Dow has risen 26 percent since then.

"It's not clear what he said will propel us back to where we were" in July, Kasriel said. "What Greenspan has done is moderated the overshoot on stocks on the downside. What he may be doing is more putting a bottom under things."

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