A former Federal Reserve governor was quoted yesterday as predicting a fall in US share prices and saying a Dow Jones index of 6,000 to 7,000 points would be a realistic level.
Lawrence Lindsey told the German newspaper Euro am Sonntag corporate earnings could not possibly continue to outpace gross domestic product growth as they had done throughout the 1990s.
"I expect a slowdown in earnings this year. That means that share prices will fall," said Lindsey, now with the conservative American Enterprise Institute.
Lindsey predicted medium-term and long-term interest rates would increase as a result of "enormous" global demand for capital which was needed for refinancing and recapitalisation rather than investment.
Asked what consequences the interest rate increases would have, Lindsay said:
"That depends of course on how rapidly and how low share prices fall. But I am convinced that the consequences will be all the more harmless the sooner the bubble bursts. I think a Dow of 6,000 to 7,000 points represents a realistic level." The Dow Jones industrial average ended above 10,000 for the first time last Monday as Wall Street shrugged off tensions in Yugoslavia and focused on upbeat corporate stories.
Lindsey said that if the Dow fell by 3,000 or 4,000 points the paper assets of US households would shrink by about $4 trillion and consumption would weaken commensurately.
"I expect this would reduce economic growth by about two percentage points."
Given that the dollar would depreciate in response, a decline in key interest rates would be unlikely, Lindsey said, adding that he could instead imagine fiscal policy becoming more accommodative.
Lindsey also said he was "quite depressed" about Europe's prospects as it had not yet comprehensively reformed its welfare system or liberalised its markets.
"They should cut taxes, free labour markets of restrictions, curb the power of the unions. There are no really free markets in Europe and the cake is being dividend up among a few," Lindsey said.
He also said the euro area states would transform the new single currency into a "political currency".
