I, Greenspan... Part Duh

Bill Bonner asked me to write today’s letter.

“How did an Ayn Rand devotee become the world’s most respected central planning bureaucrat?” he asked. “How can you hope to overcome the business cycle and command the entire world’s economic tides?” he wanted to know.

Good questions. So earnest. So innocent. So silly.

And why not answer? Nobody reads this pathetic little electronic rag anyway. That is, nobody who counts. Nobody with real power, that is. And if anyone ever asks me…I’ll deny I ever heard of it.

Besides, I’ve been dying to explain…

Do you think I really failed to see the bubble in U.S. stock prices? You would have had to be blind, deaf and dumb not to notice.

Do you think I really believe in this New Era nonsense…or the productivity miracle? Do you really think that I don’t know what happens when I flood the world with cash…and take real short-term interest rates down near zero?

But what was I supposed to do? I couldn’t exactly come out and say – “it’s a bubble!” Investors would have panicked.

Once stock prices got to bubble levels, I had to think of a reason why they might stay there…that was where that New Era and productivity razz-ma-tazz came from. People wanted an explanation and I gave it to them.

Do you think I learned nothing in all that time I spent with Ayn Rand – that miserable, self-absorbed old tart? Reading her books was painful enough – but can you imagine having to spend time with her? I tell you frankly, I got so sick of those ego-centric gab fests, in those pitiful little apartments of lower Manhattan…I thought I would go mad.

Rand had made herself into a minor cult figure. But what did it gain her? A following of marginalized nuts and kooks with bad taste, bad habits, and apartments cluttered with science fiction paperbacks.

What I wanted was power, love, money – the same things we all want. And I could never get them with the Randites.

Instead, if you want power, you have to go to where the power is. Ceasar could have lived comfortably in any of the Romanized towns around the Mediterranean. Hitler could have had a pleasant life eating schnitzel and brautwurst in Austria. And Bill Clinton could have stayed in Hope, Arkansas. He could have married a local girl, worked as a courthouse lawyer, and become a colorful subject for a grotesque southern novel.

Power in America is in two places. The political power is in Washington. And financial power is in New York. But the real power is where the two come together – in the Federal Reserve system.

You have to remember, that the purpose of the Fed – as with any cartel – is to make sure the member banks make money. But, the Fed gets its authority from Washington…it has to pay for this privilege somehow.

The Fed was chartered to protect the currency and ensure the stability of the banking system. But its real mission – now – is to keep the economy expanding. Why? Because that gets politicians re-elected. Not only that, it keeps the money flowing to Washington. Give people the impression that they are better off…and they won’t fuss about taxes.

The Fed was founded in 1913. At that time, Washington only took about 5% of the nation’s income and the dollar was solid. Since then, Washington’s percentage of GDP has increased by nearly 600%. Meanwhile, the dollar has fallen 95%.

Do you really think that was an accident? C’mon…give us central bankers some credit. Inflation pushed people into higher and higher tax brackets. Plus, it gave people the impression that they were getting richer – just what Washington wanted.

Of course, if the inflation rate goes too high…then, people begin to complain and you have to take action. Thank God, Volcker was on watch back in the late ’70s, and not me.

But here’s the important thing. Even when you have control of short term rates…and some control over the money supply…you can never completely master the markets. They’re too big, too many players, too much money. If you allow too much inflation, you spook the bond markets…and the bond vigilantes mount up. Investors dump bonds…driving up long term interest rates…which has an effect opposite to what you’re trying to accomplish. That’s already happening a little bit. I’ve cut rates 5 times in the last 5 months – no one ever cut rates as aggressively as I have – and still mortgage rates are higher today than they were at the end of last year.

Could inflation go higher? Could the dollar fall? Mightn’t the bond buyers get nervous and drive up long-term rates even higher?

Yes, of course. It’s a risk. But it’s a risk I have to take. You don’t get power by being careful. And you don’t do either the Fed or the politicians, or yourself, any favors by carefully protecting the dollar.

The goal here – as with all government programs – is to produce the desired benefits…while pushing the costs onto someone else. That’s how politics works. You promise something…and you force someone else to pay for it. You rob one rich Peter voter…and spread the loot among the poor Pauls.

Why do you think liberals always favor the poor? Why do you think every politician talks about programs for the disadvantaged, the sick, the unemployed? Why do they not give money to the rich…at least, not openly? You think they are just big-hearted, generous souls right? Ha ha. Look, you have to do the math.

Politics favors the poor for two reasons – there are more of them…and they’re cheaper. How many rich votes can you buy with a $100 handout?

Does that sound cynical? Well, sorry. But you have to look at the situation, shall I say, objectively.

In the long run, giving money to poor people hurts the poor more than the rich – but who cares about the long run? In the long run, said Keynes, we’re all dead.

And now let me tell you another secret – how I became the most successful central banker ever. Keynes also figured out how to use fiscal policy to keep the economy expanding – beyond its natural cycle. The idea was for the government to spend like crazy when the economy was weak – to stimulate it. The government would run deficits during the down cycles…and then make up for them by running surpluses in good times.

But guess what? The politicians forgot to run surpluses in the good times. Why? Because they really don’t care about the long term or about fiscal responsibility. What they care about is promising voters new programs…and keeping the economy expanding. So, the debts mounted up, but people felt like they were getting something for nothing and so it worked for a long time.

And now, thanks to the economy that I helped create, government is looking at big surpluses. Well, don’t count on it. Washington wants to appear to run surpluses – this allows the politicians to decide where to spend the money. But no one in Washington has any interest in actually running a surplus. Count on it. The surpluses – to the extent they were ever real (which they weren’t) – will disappear before our very eyes.

Well, what I figured out was that you could use monetary policy in roughly the same way. The theory is that you’re supposed to loosen up on the rates – lower them – in a downturn. And then, when times are good, you gradually increase rates to ‘cool things down.’ But the trick is, you forget to raise them as much as you should. You always favor rates that are lower than they ought to be. Because you want to encourage more business expansion – and the illusion of prosperity – than would otherwise be justified.

Let me ask you a question: could you imagine me raising rates 5 times in 5 months to head off a bubble? Not a chance. I would be torn apart by the furies in Washington, the media, and Wall Street.

Of course, there will be a price to pay for this too. Nothing comes without a price. Investors who really believe this New Era nonsense will lose a lot of money. They think they can get 15% per year on their investments forever. It isn’t going to happen. That doesn’t mean stocks have to crash. In fact, I think I can keep them at present levels for many years – perhaps like the period between 1966 and 1973. Easy money can perform wonders – for a while. But instead of 15% for the next 10 years, investors are likely to get zero percent for the next 15 years. Who knows?

Probably bonds and the dollar will come down too…and a lot of people will be hurt. But it could take years. And it might not even be noticeable. Who knows or cares that the dollar today is worth only 5 cents in 1913 terms?

And eventually, the system of managed currencies will collapse. Every central banker is doing what I am doing – deliberately destroying the currency to insure the appearance of prosperity. Sooner or later, people will catch on. They will try to switch from one currency to the other – but all the paper currencies will be weak and untrustworthy. Most likely, they will turn to gold. It’s the only thing that we can’t manipulate.

But that is probably years ahead. And it’s a problem for someone else.

Alan Greenspan,
Public Servant
Paris, France
May 29, 2001

Market Watch

To remind you, this section of the Daily Reckoning is written by Eric Fry, editor of Grantsinvestor.com. Eric is also the guest host on CNN-FN this week, 9:30 – 11 E.S.T. My notes and letter follow, as usual.

From Eric:

*** The U.S. financial markets took the day off yesterday in observance of Memorial Day. The stock market ought to have its own Memorial Day to remember those stocks that have fallen in the pursuit of capitalism.

*** Nasdaq Stock Market delistings have tripled so far this year. Names like Drkoop.com Inc., EToys Inc. and Pets.com Inc. litter the battlefield. Through the end of April, the Nasdaq’s ranks thinned by 147 companies – more than three times the 46 companies delisted in the same period last year.

*** But as the NASDAQ stocks did not trade yesterday, neither were any additional companies delisted. No casualties reported. All present and accounted for.

*** European stock markets, although open for business yesterday, might as well have been closed. About the only noticeable trend was that the stocks of exporting companies moved a little bit higher, the thinking being that as the euro weakens against the dollar, any company selling its goods for greenbacks will enjoy rising profitability.

*** The shares of French cosmetics company L’Oreal and Dutch consumer electronics maker Philips both advanced about 2% yesterday.

*** The slow US economy is opening up travel bargains in Europe as well as at home, according to the Wall Street Journal. “For vacationers, there’s one pleasant side-effect to the soft economy: Summer travel is on sale, cheap.”

*** Even in the hoity-toity Hamptons to which wealthy Manhattanites flock every summer, rental rates for the summer season are softer than last year’s. Thrifty multimillionaires, here is your chance. A beach house that cost about $80,000 to rent for “the season” last year might only cost about $70,000 this year.

*** Even as consumer debt levels soar, the retail sales trend is an Icarus cascading into the sea. It is becoming painfully obvious that employment levels, not debt levels, power retail sales. That is, because unemployment is rising, retail sales are falling.

*** Not only do the unemployed avoid shopping malls, they also avoid opening mail from their creditors. “The quarterly bad loan write-off rate rose to 5.6%,” Moody’s states, “and the rate at which cardholders repay their credit card debt fell to 14.9%. That was the first time since 1996 that [these] measures of US consumer credit quality have posted such a broad-based decline.”

*** Yet, it is these consumers that Mr. Greenspan depends upon to pull the economy out of its slump. “Heavily leveraged consumers are in no position to take up the economic slack,” grantsinvestor.com’s Andy Kashdan observes. “Exuberance has returned to Wall Street in recent months and the mood on Main Street appears to be brightening as well. But lest this revived party mood completely obscure some of the imbalances that have built up over the last few years, we offer a friendly reminder: consumers are still leveraged to the hilt.”

*** Citing graphs provided by the International Strategy & Investment Group, Kashdan points out that mortgage debt, consumer installment debt and interest payments as a percentage of disposable personal income are all at record high levels. “At some point, creditors might actually want some of that money back,” he notes dryly.

*** Aware of these trends, most lenders are becoming a little more cautious about extending credit to consumers. Upon examining the May “Senior Loan Officer Opinion Survey on Bank Lending Practices,” Charlie Peabody stated, “The banking industry continued to move toward a position of ‘tightening’ in its standards for credit card loans and mortgage loans. Bankers are growing concerned about ‘the recent run-up in consumer delinquency rates.'”

*** Peabody continues, “The simplest measure of the banking industry’s liquidity (the loan-to-deposit ratio) has deteriorated to its worst level since data started being kept in 1934.”

*** Still, somehow Wall Street’s faith in Greenspan remains unshakable. Most investors, when gazing across the Valley of Dire Economic News, still believe that they see the land of milk and honey and Dow 36,000.

And a few notes from Bill:

*** “Don’t Fight the Fed!” Do a search of the financial media and those 4 words – in exactly that sequence – are likely to occur more often than any others. It is as if that is all we know and all we need to know. Is it really that simple, dear reader? I don’t think so. More below…

*** “I see the funds rate coming down at least another 100 basis points to 3% and possibly a little bit lower than that by year end,” said Morgan Stanley’s chief economic strategist, Stephen Roach. “But the Fed won’t get the bang for the basis points that it got in past periods of cyclical retrenchment…”

*** Why not? “Unlike in ’98,” Roach explains, “when America was the engine that pulled the world out, this time the engine is off the tracks.”

*** What will it take to put it back on the rails? “All the President’s tax advisers and all the Federal Reserve’s actions can’t put the economy back together again,” writes Stephen Gottdiener to Barron’s. “The stock market will seek new lows and so will the economy.”

*** All of a sudden global warming has reached Paris. It is hot – with temperatures reaching up into the 80s. It must be a little like American cities before air conditioning and the flight to the suburbs. Windows are open. You can see your neighbors dressing and smell what they are having for dinner.

*** Edward, 7, is scheduled to go on a class trip on Wednesday. He’ll spend two nights away – in Normandy . That is, if he goes. He’s never spent a night away from his mother. And I don’t know who’s more concerned – Edward (our youngest child) – or his maman. Stay tuned.