How the Market Scares Itself
By every real-world sign, the latest being a plunge in global crude oil prices, there is no significant threat of inflation that would derail the American economic recovery. The consumer price index over the past three months has risen by an annual rate of a mere 1.9 percent. The index for medical care in this period has not moved up at all, a striking difference from the recent past.</br></br>The economy appears to be expanding moderately. A leading private organization, the business-oriented Conference Board, said this week that consumer confidence is at the highest point in nearly four years, promising a "sustained and reasonably vigorous economic expansion."</br></br>Yet, ironically, the stock and bond markets exhibit a bad case of frazzled nerves. The Dow Jones Industrial average closed yesterday at 3,626, off almost 9 percent, or 352 points in a two-month slide from a record 3,978 on Jan. 31. In the perverse spin Wall Street puts on good news, consumer confidence means growing future consumer purchases - and the markets interpret that confidence as a harbinger of inflationary pressures.</br></br>Interest rates, as measured by the yield on the 30-year Treasury bond, jumped to 7.11 percent at the close of business yesterday, the highest level in a year, reflecting a continuing erosion in the value of bonds. The markets not only fear further Federal Reserve Board moves to boost short-term interest rates but no longer have confidence in Chairman Alan Greenspan's assurances that his "preemptive" strike against short-term rates will assuage fears of future inflation, and thus keep long-term interest rates in check.</br></br>Logic doesn't necessarily govern financial markets. Participants are now caught up in the worry that they have set a self-fulfilling prophecy on track, and that having scared themselves to death, there is no way to escape the punishment. But there is much more to explain the collapse of stock and bond prices than the markets' psychosis about future inflation. Behind the slump there exists a phenomenon largely unknown to the public, the existence of huge (and unregulated) speculative funds that made tons of money for their investors - usually, individuals who can gamble amounts in excess of $1 million - during last year's boom.