WEEKLY INVESTMENT REVIEW

To: Account Executives
From: Andrew E. Beer, Chief Investment Strategist for the AFS Group
Date: March 20, 2000

The surge in oil prices has finally affected the Consumer Price Index, bringing that measure of inflation to 3.2% at an annual rate in February, the highest rate in three years. No doubt the members of the Federal Reserve are contemplating the significance of this evidence of inflation. The Hawks will use it as a good excuse to raise short term interest rates, probably by increasing the Federal Funds rate on Tuesday, March 21, when they next meet. The Doves, however, may well point out that the price of oil is very volatile, politically controlled by the OPEC cartel, and that several member nations of OPEC have recently suggested that they will soon raise production to moderate the rise in the price of oil or cause this price to decline. Many economists may point out that rising interest rates might not have much effect on consumption and hence the price of oil, unless interest rates were raised so significantly as to cause a deep recession.

Years ago, the late Chairman of Gulf & Western, Mr. Bluhdorn wrote a comprehensive editorial in the Wall Street Journal opining that OPEC was in violation of Antitrust Laws and suggested that it be prosecuted as a monopoly. Not much publicity was given to his observations and recommendations, perhaps because Administrations in Washington have believed more could be gained by alliances, trade and political savviness than by such difficult to enforce legalistic means.

Chairman of the Federal Reserve, Alan Greenspan, will probably cogitate about all these points of view. He will deliberate in the context of broad horizons envisioned hardly ever outside the meticulous ratiocinations of his elegantly corrugated brain. He will focus his attention on the reported realities of economic indices, of actual prices and volumes of goods and services, and the broad swath of interest rates throughout the panoply of fixed term securities and will himself to understand, to conclude, to find arguments to persuade the Hawks and the Doves on his Board, and resolve the competing opinions to some balance, to the optimal resolution.

Aware that there could be programmer induced residual errors in the mass of diverse data in the main computer serving the Federal Reserve, he has come to rely on the data of the marketplace rather than to depend on the hard-to-check reams of data spewed forth from the computers. And, while careful to give the impression that his cerebrations are only for the good of the country, he no doubt has to weigh the political implications of Federal Reserve Acts. Furthermore, he must be aware of the interpretations of his statements and the actions taken by the Federal Reserve by members of the two primary political parties in Congress knowing quite clearly that they could alter the legislated mandate and sanctions of independence of the Federal Reserve. He may well chafe in the chakra of his heart with self-abnegation for this honors and reverence and responsibility bestowed upon him, in the favored seating next to the President’s wife at the Inauguration of the current President who castigated the former President and his Administration for the recession, which, in truth, was more induced or condoned by the Federal Reserve in earlier inflation fighting, and which led to his being rewarded Judas-like, even though his sympathies may have lain more with the previous President and Administration. A concatenation of such cerebrations, or now that he has been ensconced for a fourth term, a symphony of emotion-tinged musings may be conjured in the penumbra of his subconscious, or in the periphery of his consciousness as he considers the brash impudence of investors in their actions last week to cause the well-known Averages to rebound smartly despite his cautioning that the Federal Reserve would have to raise interest rates until the wealth effect was no longer inflationary

Quite probably, Chairman Greenspan realizes that the budget surplus, enabling the U.S. Treasury to buy back long-term bonds, as he suggested would be the best way to use the surplus, would by late this year, make it quite difficult for the Federal Reserve to prevail in raising short-term rates while.long-term rates were declining. Already he must aver to himself, the evidence in the marketplace suggests that long-term interest rates are bottoming out and likely to decline over the ensuing months. His finely tuned sense of appropriateness must be compromised, perplexed, confounded and possibly frustrated by the prospect of the dwindling effectiveness of the Federal Reserve to continue to lower inflation by raising interest rates.

In fact, in the inspired gleanings of his radarscope of a mind, he must be reaching for more effective means of preempting wage inflation. He must be questioning whether the economic precedents which guide Federal Reserve policy may not be as pertinent this time; that a low unemployment rate which has not signaled inflation over the last five years may not this time lead to inflation driven by demand for higher wages. Possibly in the unexpressed intuitions of his fine mind he may be searching for other, more effective ways in present circumstances to forestall inflation rather than by increasing short-term interest rates which he undoubtedly recognizes contributes to interest cost inflation.

Perhaps Chairman Greenspan will reconsider other options which he and the Federal Reserve have passed over as too cumbersome or too indirect or not pervasive enough to be implemented in the past. Perhaps he will apply jawboning or moral suasion to gain the cooperation of other branches of government. Basking as he is in the reverence of most of the country, the Administration and Congress, as an elder statesman, as a national treasure, perhaps he will begin to use his personal charms, articulateness and influence privately or in his public appearances before Congress to suggest other measures which might contribute to hampering or ameliorating inflation. Such measures could conceivably be:

1. to change the Immigration Laws beneficially to allow more suitable workers from foreign countries to emigrate to the U.S. to increase the labor force during the prolonged period of low unemployment.
2. to encourage U.S. based businesses to expand their labor forces by enlisting foreign workers in intellectual tasks which are potentially those where productivity gains are feasible over the internet or via numerous methods of telecommunication.
3. to stimulate active negotiations with OPEC and non-OPEC oil producers through strategic alliances, trade and aid to alter and stabilize the price of oil, just as the Federal Reserve in the past has influenced interest rates.
   
   
4. to make a study of how productivity gains come about, particularly from the high technology advances of the new economy, and to suggest how Congress could legislate tax incentives or decreased regulations or other ways to enhance production as a way to more permanently prevent inflation while fostering faster growth of the economy and greater improvement in standards of living than ever before.
5. to suggest how the United States could guide, influence and actionize other friendly countries to employ similar methodology to reinvigorate the global marketplace and economy to enhance the chances for peace and prosperity and lessen the outrages of revolution, war, poverty and hunger and other ills throughout civilization.

When William McChesney Martin became the youngest Chairman of the Federal Reserve he defined the role of the Fed by analogy, to take the punch bowl away just as the party gets going. Ever since the Fed has tended to treat investors as juveniles. During the reign of Arthur Burns, an authority on Business Cycles, as Chairman, the Federal Reserve presided over a long down phase which undermined the most productive companies in the economy by depressing the stocks of the Nifty Fifty by 70-90% until their Bear Market lows at the end of the 1970s. Ever since the Federal Reserve has kept investors in the most dynamic productivity enhancing companies uncertain by frequent changes in policy. Under Paul Volker, the Federal Reserve three time unexpectedly raised interest rates during the early part of his administration, in 1978, 1979 and 1980 in deference to the advice of foreign Central bankers even though he and most of the other members of the Fed of that time felt it might be counterproductive to the interest of the U.S. during the period of low confidence of consumers and investors at that time. Eventually, nominal interest rates rose to almost 20% before inflation and interest rates began to decline.

Very probably it was the combination of political savvy and classical economics called Reaganomics that broke the back of inflation and eventually brought the end of the Cold War and led to the recent period of relative peace and prosperity much more than anything the Federal Reserve has done. When Ronald Reagan became President, there were no economists with a suitable plan for the political and economic malaise of the country. By cutting taxes and keeping the country economically and militarily strong while pointing out the dangers of burgeoning deficits, President Reagan curtailed the tax and spend policies of the predominant political party in Congress. Unable to persuade Congress to lower spending to reduce the deficit, he was roundly criticized, yet his pragmatic policies brought to a halt the inflationary burgeoning of spending so that eventually the growth of the economy could decrease the deficit and led to the recent budget surplus.

This paved the way for a healthier economy during the tenure of Chairman Greenspan. He deserves great credit for his personal influence in preventing the sharp decline of October 1987 from becoming a disaster, and has ably mediated between the Doves and the Hawks on the Federal Reserve. He has shown by his comments that he is open to innovative thinking. Perhaps he will lead the Fed to guide other branches of government as to how they can play a more important part in facilitating faster, less inflation prone growth `in the future than ever before.

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