WASHINGTON -- The Dow-Jones Industrial Average, which had been gingerly climbing upward last Tuesday afternoon, plunged the moment the Federal Reserve reduced short-term interest rates another one-quarter of a percentage point. That anomalous occurrence prompted worried financiers and economists to repeat the question they have asked all summer: Why has Chairman Alan Greenspan's monetary strategy failed?
Tuesday's drop in the Dow reflected the market's lack of confidence in Doctor Greenspan's medicine. The seventh reduction in the federal funds rate voted this summer by the Federal Open Market Committee (FOMC) might have pleased investors more had it been for 50 basis points instead of 25. Shortcomings by the central bank, however, are coming to be seen as qualitative rather than quantitative.
Erstwhile Greenspan champions are now admitting the hard truth. The FOMC's tactics are no more effective than were the Bank of Japan's repeated interest rate cuts a decade ago. To avoid an economic disaster, there is increasing belief that the Fed should start fighting deflation by targeting commodities. Gold? That is not a fashionable target, but a basket of commodities including gold might be.
Wayne Angell, chief economist at Bear Stearns and a former Federal Reserve governor, is a friend and admirer of Greenspan who believes that the American economy depends upon the longtime Fed chairman. Nevertheless, he is blunt about Greenspan. "I think he needs to be more forceful," Angell told me.
Angell explains how seven interest rate cuts totaling 300 basis points can have so little impact. With an anemic equities market, funds are being stuffed into the 21st century version of the mattress: interest-bearing, risk-free accounts. So, the heavy M-2 money supply figures that delight monetarists are no help in reviving the economy. In Angell's opinion, Greenspan is still running a tight money policy despite all the interest rate cuts.
That opinion is growing. Robert L. Bartley, editor of The Wall Street Journal, startled the financial community with what he wrote in his influential column last Monday. Bartley had not joined the chorus criticizing Greenspan and still hasn't. Nevertheless, he suggested that "perhaps something has gone awry." He perceives what Greenspan and Bush administration policymakers stubbornly refuse to recognize: the specter of deflation.
Bartley sees hope in recent easing of the dollar ("Perhaps (it) ... is the first sign that Chairman Greenspan is one step ahead of the deflationary demon."). Supply-side consultant Jude Wanniski, Bartley's former colleague, disagrees. Wanniski forecast the coming deflation in late 1996, and now he sees the slightly lower dollar against gold as a false dawn -- caused by increased state and local taxes resulting from reduced surpluses.
Indeed, if Democrats in Congress have their way in rolling back President Bush's tax cuts, the price of gold will be boosted the wrong way. A national tax increase would, Wanniski recently told his clients, produce "a decline in the demand for liquidity and a concomitant increase in the gold price. The deflation would be replaced by a contraction."
In April, Wanniski advised Treasury officials to watch deflation's impact on automobile sales. Thus, when the Ford Motor Co. announced Aug. 17 that it plans to curtail auto production this autumn, that sounded like the major prop of the American economy starting to collapse.
Angell long has feared an even more frightening prospect: deflation spreading to still-healthy real estate. A high-ranking administration official recently asked him what the chances are for that catastrophe. The reply: 15 percent.
That is much too probable. A real estate collapse would signal deep recession while the Republican administration and Democratic Senate engage in scholastic debate over federal bookkeeping practices and Bush makes unsubstantiated predictions of 3.2 percent growth next year. If the president would drop his resistance to Senate Republican Leader Trent Lott's proposed capital gains tax cut, the resulting liquidity would strike a major blow against deflation.
Without requiring congressional action, however, Greenspan could instantly cut through the gloom. To fulfill the hopes of his admirers Wayne Angell and Bob Bartley, he must shrug off the suffocating, secretive Federal Reserve apparatus (where seven out of 12 regional bank presidents apparently still see the inflationary bogey man around the corner). Alan Greenspan could still redeem his glittering reputation after two very bad years.