Greenspan Says The Plunge Helped Market Decline May Help To Extend Expansion

Federal Reserve Chairman Alan Greenspan told Congress Wednesday the stock market’s sharp drop may well prove “a salutary event” and should help extend the economy’s 6-1/2-year expansion.

Are stocks still overpriced? “Things are less out of line, certainly, than they would have been,” he said as Wall Street’s rebound continued.

After months of warnings extending back to his December talk of “irrational exuberance,” Greenspan put a positive spin on Monday’s wrenching 554-point decline followed by Tuesday’s 337-point rebound in the Dow Jones industrial average.

“It is quite conceivable that a few years hence we will look back at this episode, as we now look back at the 1987 crash, as a salutary event,” he told Congress’ Joint Economic Committee.

In 1987, the 22.6 percent Black Monday crash - slightly more than triple Monday’s decline in percentage terms - neutralized inflationary excesses then building in the economy, he said.

Monday’s drop, provided markets settle down, “should help prolong our 6-1/2-year business expansion,” he said. By leaving investors less wealthy, the stock decline should dampen consumer spending, which has fueled unsustainably fast job growth that could lead to inflation.

Though U.S. economic growth is robust and inflation low, stocks fell because investors grew too optimistic about future profits, he said. Currency crises in Southeast Asia touched off the drop, but U.S. stocks “were primed to adjust” anyway, he said.

“If it was not developments in Southeast Asia, something else would have been the proximate cause for a re-evaluation,” he said.

The Asian currency turmoil that began in July also should have a “modest but not negligible” impact on the U.S. economy by muting export sales to the region, Greenspan said.

He said it was important for the United States and multinational lending agencies such as the International Monetary Fund to help the region.

The soothing tone of his remarks couldn’t have been more different from his Oct. 8 testimony warning the economy was on an “unsustainable track” and it would be “unrealistic” to expect stock market gains anywhere near those of the past two years.

Three weeks ago, the Dow lost 83 points the day Greenspan spoke. On Wednesday, it surged as much as 123 points before settling back and closing up 8 points at 7,507. Traders took his comments as suggesting Fed policy-makers won’t touch interest rates for the rest of the year.

“By saying economic growth is more likely to slow … he was implying that there is really no need to expect higher interest rates,” said economist Sung Won Sohn of Norwest Corp.

Two economic reports depicting mixed conditions supported that view. Orders to U.S. factories for big-ticket durable goods such as cars and computers fell 0.6 percent in September, the first drop in four months, the Commerce Department said.

The Federal Reserve, meanwhile, said most of its 12 district banks “characterized early autumn’s economic activity as moderate to strong.”

The survey of regional conditions through Oct. 20 said “labor shortages have intensified” for high-tech industries but prices remain stable.

Though Greenspan didn’t dwell on inflation, he made clear he hadn’t dropped his concern that labor shortages could fuel an acceleration in wage increases, which could produce faster consumer price inflation.

The pool of people who don’t have jobs and want them has fallen to the lowest level in years, he said, and “if that trend continues … something has to give.”

“It is terribly important for us to make sure that this recovery continues and continues in a solid way. I think the greatest threat to it at the moment … is the onset of inflation,” he said.