RAISE RATES NOW, KILL BEAR TOMORROW
Enough of this procrastination. The Federal Reserve should have raised interest rates last week. Simply signaling that it…
Enough of this procrastination. The Federal Reserve should have raised interest rates last week. Simply signaling that it is leaning toward raising them in the future is not enough.
There are as yet no signs of serious inflation in consumer or producer prices, but there is clearly inflation in stock prices.
This is reflected not only in the p/e ratio of the stock market, but in the prices some companies are paying for the assets of other companies — the $115 billion merger between Sprint and MCI Worldcom announced last week being only the latest example.
The stock price inflation is being driven, in large part, by the retirement of corporate equities through mergers, acquisitions and buybacks. According to Paul Kasriel, chief U.S. economist at Northern Trust Corp., a record $305 billion of corporate stock was retired in the 12 months ended June 30.
This stock retirement contributed to stock price inflation in two ways. First, it reduced the supply of stock while the demand from investors was constant or even rising. Second, it inflated earnings per share, encouraging a misperception on the part of many investors about how well companies are doing.
Companies have been borrowing heavily to finance the mergers, acquisitions and buybacks, and the Fed has been aiding and abetting them by keeping interest rates low and by keeping the growth rate of the money supply high. The M3 annual growth rate topped 10% at the beginning of the year, and is still high at 8%.
The Fed should be raising the cost of this borrowing to reduce these often unproductive activities (particularly the stock buybacks).
Yes, it would probably cause a decent correction in the market, but would no doubt be prophylactic medicine, preventing a more painful correction — even a bear market — in the future.
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