People love to take pot shots at the economy of the United States.  There is always someone either overseas or domestically who believes our economy is on the brink of disaster, because of problems with the balance of payments, ballooning national debt or whatever the topic of the day, week or month happens to be.  The amazing thing about our economy is that it has endured some pretty tough times in its relatively short history.  It has survived several wars, multiple recessions, depressions, inflation, deflation and even stagflation.  Currently we are emerging from a difficult period of economic slowdown.  There is some talk going around that the economy is slipping back into a recessionary mode, but no compelling arguments are evident and most likely those concerns will soon fade.

One of the strengths of the United States is our system of checks and balances.  Most people think of our political system when they read about checks and balances.   Our founding fathers had the wisdom and foresight to spread the power among various branches of government to protect us from ourselves.  In doing so they set the stage for political bickering and behind the scenes maneuvering.  It may take forever to get things done, but the system eventually does work. 

The system of checks and balances I am referring to however, is between the Federal Reserve System and the stock market.  This system of checks and balances also has its fair share of controversy.  Back in the Jimmy Carter Presidency our economy was really in tough shape.  We had rising oil prices and a total lack of confidence in business and political leadership.  Mr. Carter was in serious trouble with the economy and he was looking for someone to save him and the country.  That someone turned out to be Paul Volcker.  Not only was he an imposing figure at 6'9" tall, but he also possessed an impressive resume and a willingness to make the tough decision. 

Prior to Volcker's appointment the Chairman of the Federal Reserve had been largely a rubber stamp type of appointment.  All presidents wanted a chairman who was going to be a "team player" and work toward implementing the President's agenda.  With Volcker, Carter got an entirely different package, an independent who had the ear of business and banking leaders and who put the interests of the economy above the President's agenda.  Beginning with Volcker, the economic checks and balances really began to function. 

The purpose of the Federal Reserve System is to manage the money supply in our economy and by doing so they also manage the economy.  They largely control the money supply through the manipulation of interest rates and reserve requirements in the banking industry.  The stock market as we have seen has a mind of its own.  The stock market is merely an extension of investor sentiment about the economy and contrary to popular belief the stock market does not reflect the health of the economy.  It merely represents investor perceptions of the health of the economy.  Is that a big difference?  You bet it is. 
When the stock market was going wild in 1998 and 1999, was it an accurate representation of the state of the economy?  Was the economy increasing at a 25% rate like the stock market was? Nope.  It was chugging along at healthy robust pace above the historical averages but by no means was it even close to the growth rates of the market.  Historically, the performance of the stock market tends to overemphasize the actual performance of the economy. 

An earlier point needs to be emphasized here.  The Fed's main responsibility is to keep the economy stable.  Its job is not to manage the stock market.  Doing so would make it clear not only in the US but also to our economic partners abroad that the stock market is setting economic policy.  If that were the case we would have an economic disaster on our hands in no time.  In the short term it would certainly keep the investment community happy and give all of us a huge helping of relief.  However, in the long run it would prove to be our undoing. 

Our economy is like a huge oil tanker, it takes time to change its course and it possesses incredible momentum.  The stock market as we have seen can turn on a dime and right now it seems to be going around in circles.  If we start managing the economy to satisfy the market forces we essentially end up with the tail wagging the dog. 

Both the stock market and the Federal Reserve are looking at the same economic data, but they are drawing separate conclusions.  In his testimony on July 17 of this year before the Committee on Financial Services, Chairman Greenspan in his dry, deliberate manner described an economy that has confronted significant challenges but is projected to grow at a solid rate that will be higher than the anticipated rate earlier in the year.   Translated that means we have seen the worse and we are returning back to normal economic conditions.  Like his predecessor, Chairman Greenspan is maintaining his independence and keeping an eye on the economy and not the antics of the "talking heads" on CNBC. 

The investment community clearly has a different opinion as evidenced by the severe downturn we are experiencing.  To look at the stock market over the last 30 months, one would think we were on the brink of economic disaster.  Fortunately for us it does not set economic policy.

Now it could be that the Fed is wrong and the stock markets are right and the economy really is in bad shape.  It is also possible that Greenspan and his economic advisors are interpreting the economic data incorrectly, and the emotional investor community is actually right.  I am clearly on the side of the economists who are managing the economy.  The institutions, whose nests are feathered when the market is booming, would prefer to have the markets running the economy.  If you remember nothing else, remember that it is the US economy that we are putting our faith in for the long haul and not the stock market.  Our economy is fine.  It is growing and once corporate profits begin to improve the stock market will come around as it has done so many times in the past.
 
 

© 2002 Mark Neil