Alan Greenspan has been renominated to head the Federal Reserve Board, and that is mixed news for the municipal bond market. Control of the money supply and the fight against inflation will continue, but the economy will still be constrained, and federal, state, and city budget deficits will continue to plague bond issuers.
Depending on where you sit, this outlook can be good or bad.
Bond issuers can find comfort that bond yields are unlikely to increase, for the economic recovery is apt to be less than robust. But bond issuers cannot become ecstatic about borrowing costs, because Mr. Greenspan will keep real interest rates high as he insists on gradual money supply growth to restrain wholesale and consumer prices.
Then, too, governments at all levels want a stronger economy to produce the revenues they need to balance their budgets and to convince lenders they are creditworthy. Last week, the National League of Cities reported that more than one in every four cities in the United States face severe budget gaps because of the recession and spiraling costs. For bond investors, the survey was a warning.
In naming Mr. Greenspan, President Bush had no alternative, for there were no candidates of equal stature. If he had nominated someone more willing to stimulate the economy, the fixed-income markets would decline and interest rates would climb. Financial markets would view such a new nominee as a political choice, selected to engineer economic recovery in time for the presidential election in 1992. Given the low chances of any Democratic hopeful next year, Mr. Bush can afford Mr. Greenspan and the Federal Reserve's long-term campaign against inflation if he wants them.
Since Mr. Greenspan took the helm at the Fed, growth in the money supply has averaged a little more than 4%, its lowest rate in 30 years. This degree of tight monetary control is accomplishing its work (the producer price index during the first six months of 1991 rose at an annual rate of only 1.5%), but there is a real risk that the Fed may push the economy back into a recession.
If that seems likely to happen, Mr. Greenspan must be wise enough to relax the Fed's grip on money supply enough to keep from choking off the recovery. With all levels of government suffering from overindebtedness, the Federal Reserve must not permit the economy to slow down, for renewed recession would mean disaster. Bond issuers and bond investors would suffer from downgradings and threats of bankruptcy, and citizens would suffer from decreased services and higher taxes.
Parlous times, to be sure, Mr. Greenspan.
