We return, after many months away, to Alan Greenspan. And we find him, as usual, in his bath.
There, on this 202nd anniversary of the creation of modern central banking, the Maestro contemplates his achievements, appropriately…amid his bubbles.
The U.S. currency has become the world’s most treasured paper thanks largely to him. Or so he believes. It was he who kept inflation under check for so many years. And it was he who guided the U.S. economy so well that U.S. dollar assets became the envy of the entire world.
But his success is even greater than most mortals can imagine. Has he not been the first man in history to preside over a two-decade period in which fiat paper money has gained value against gold? In 1980, it took as many as 850 dollars to buy an ounce of gold. Twenty-two years later, that very same ounce changes hands at only $280.
Greenspan, former gold bug, and now a paper bug, smiles. He is happy with himself.
He recalls his speech from yesterday: "The dollar, despite many challenges to its status, remains the principal international currency," he had told the gathering of numismatics in New York. He had recalled the success central bankers have had recently in controlling inflation. This offers hope for the future of managed currencies [as opposed to those backed by gold or other real assets], he suggested. He spoke modestly.
But they knew what he meant. These coin collectors… they knew better than anyone that he, Alan Greenspan, the Maestro, had done what no man had ever done…he had made paper money rise in value against real money.
"One of the great inventions of mankind," he had called money. But it is fiat money – paper issued by governments with no precious metal backing – that was the real breakthrough. Paper money, like "pro-forma earnings," can be anything the government says it is. A valuable tool in self-delusion and deceit, paper money can also suddenly become worthless.
Of that Greenspan is well aware too. But that is what makes his achievements so…well, almost unbelievable. Any fool can make real money – such as gold coins – worth something. But it takes real talent to make paper more valuable than gold.
"I bet several people in the audience had had their houses robbed in the last year," Alan thought to himself. "The thieves probably turned up their noses at their gold coins. Instead, they took cell phones and laptop computers."
Even the coin dealers don’t want gold anymore…
My old friend, Jim Blanchard, began the Blanchard Company more than a quarter of a century ago. Jim went to his grave a couple of years ago still trusting in gold and believing it would come back. But on January 1st, 2002, his company sent clients the following remarkable message:
"Effective as of January 1, 2002, Blanchard and Company is changing its business practices and policies in order to limit its exposure to falling gold prices, and recommends to its clients that they do the same. As of that date Blanchard will not maintain inventories of gold bullion or gold bullion products, nor will it market gold to, or solicit gold sales to, Blanchard clients."
"Gold is no longer a hedge against inflation, devaluation of the dollar or falling stock prices," continues the mailing from Jim’s old company. "It is no longer a store of value. The very idea of gold’s intrinsic value – value that is not dependent upon the actions or promises of any government – is publicly questioned by senior central bankers, and by the heads of major financial institutions."
Greenspan had made a joke of it just yesterday in his speech. Gold has been so thoroughly discredited that if paper money ever fails, he mused…we’d have to go back to exchanging sea shells or oxen.
"In that unlikely event, I trust," he recalls his words, "the discount window of the Federal Reserve Bank of New York will have an adequate inventory of oxen: Heh, heh…"
But on this, the 202nd anniversary of the Bank of France, perhaps it would be a good idea to look at what other central bankers have actually done. We won’t try to prove anything. We merely present the story, without prejudice. You, dear reader, may draw your own conclusions:
My house in France was owned, prior to the Revolution, by a family of minor nobility. When the sans-culottes began cutting off heads, the aristocrats fled…leaving their property, along with the considerable lands of the church, to be taken over by the revolutionary government. Against these properties the government issued interest-bearing bonds, called "assignats." Then, the properties were sold off – at auction. Our house was purchased by a local family, the Ducelliers, who paid for it in assignats and held onto to it for the next 204 years.
Exchanging the assignats for real property turned out to be a spectacularly successful trade in 1791. As the government sold off the real estate that backed up the assignats, the notes became a managed currency…and quickly collapsed in value. By 1795, inflation was running at 13,000% per year. It didn’t help that the British were forging the notes and flooding the market with them – in a deliberate attempt to destroy the French economy.
The idea of selling off the church property originated with Maurice de Talleyrand, a man who was not only an aristocrat, but a bishop. He was the ultimate mover and shaker of the late 18th century…a man whom Napoleon aptly described as "a sh** in a silk stocking."
The revolutionary terror came to an end in France with Napoleon’s coup d’etat in 1799. Even before Napoleon’s seizure of power, the assignat had already been tossed on the scrap heap of monetary history. It was replaced by the gold Franc, released in April of 1796. April was known as "Germinal" in the revolutionary calendar, still in use at the time. Thus, the new currency was known as the "Franc Germinal."
Napoleon created the Bank of France in 1800; it was given the right to issue paper money…with the stipulation that every note be backed by gold, and that every holder have the right to redeem his notes for gold whenever he wanted. The Franc Germinal lasted until 1921. But these gold coins and gold-backed currency – issued by the Bank of France – helped France sustain more than a century of growth and prosperity. Much of the wealth and beauty you see in France today…the broad avenues of Paris, the grand country houses, the beautiful apartment buildings, railroads, the canals – was created during that period.
A lot of mischief was done to the Bank of France and the Franc in the 20th century. Socialists came to power throughout Europe in the ’30s. Until the victory of the "Popular Front" in France in 1936, the Bank of France had been a private company, operating under a government charter. But in two legislative acts in 1936 and 1945, it became wholly owned by the French government. The gold backing was removed soon after. France, once again, had a managed currency.
What happened next? Hardly a dozen years after the Bank of France was nationalized in 1945, inflation had gotten so bad that Charles De Gaulle found it necessary to knock two zeros off the currency. On the first of January, 1958, he introduced the "new" franc…or the "heavy" franc. Each new franc replaced 100 old ones. Anyone foolish enough to have stuffed "old" francs into his mattress found that his savings had lost 99% of their value in the prior 13 years.
Mr. Greenspan is no doubt far smarter than the heads of the Bank of France in the postwar years. And no doubt the central banking profession has made great strides. With the aid of computers and internet connections, teams of economists working at the Fed can now estimate GDP in the year 2010…to the penny.
Will the estimates be right? Or, more broadly, will the Fed be able to maintain the dollar’s value in the next quarter century as they have in the last?
We don’t know, dear reader. But we enjoyed looking at a chart showing what had happened to France’s many different managed notes. From the WWII era, for example, you can find notes of 50 "American" old francs.
They are worth about half of one single new franc. A 1,000 "English Marianne de Dulac" note from 1945 fetches 10 new francs. Five hundred "Victor Hugo" old franc notes are worth 5 francs each. The 5,000-franc "Land and Sea" note will get you a 50-franc bill. My favorite is the 10,000-franc note from 1945 celebrating "French Genius." Thanks to the genius of the folks managing France’s money, it is now worth just 100 new francs… or, about 15.2 euros…enough money for a simple lunch.
And so…I will go to lunch today, spend 10,000 old francs…and celebrate the genius of central bankers everywhere.
January 18, 2002 — France
Intel and Cisco are up more than 70% from their lows. Earnings drop, but they "exceed expectations." Said a wire service headline of Nortel’s quarterly results: its "16 cent loss matched goal." Tech stocks are once again trading at preposterous prices.
Merrill Lynch’s chief U.S. strategist, Richard Bernstein, reduced his recommended exposure to stocks from 60% to 50%. "[T]there is a thin line between a liquidity-driven market that anticipates improving fundamentals and a bubble. The equity market may have stepped over that line," he wrote.
Since WWII, stocks have usually risen along with the money supply. That’s another reason why most economists are sure the economy is picking up. Then again, money supply usually tracks the economy; as commercial transactions increase, so does the supply of money. But what if the money supply increases without a corresponding increase in real economic output? Then, as Bernstein suggests, the result is not improving fundamentals, but a bubble.
All bubbles must pop, of course. But Alan Greenspan is neither worried about bubbles nor excess liquidity. He credits himself with having turned the dollar into the world’s dominant currency. Central bankers’ success in "containing inflation during the past two decades raises hopes that fiat money can be managed in a responsible way," Greenspan said in a speech at the New York Fed, delivered one day prior to the 202nd anniversary of the creation of one of the world’s first central banks – the Bank of France, established on this day in 1800 by Napoleon Bonaparte. What might Alan Greenspan learn from the history of the Banque de France? We’ll see…below… In the meantime, here’s Eric’s report from Wall Street, 2002…
– Mr. Market bounded out of bed yesterday morning and decided that he’d had enough of doom and gloom. "Gosh darn it!" he thought, "It’s time for some boom!"
– And with that, Wednesday’s disappointment became yesterday’s delight. Stocks soared from the opening bell, although not enough to recover the prior day’s losses…nor enough to lift the major averages back into the plus column for 2002.
– The Dow recouped 138 of the 212 points it lost the day before to finish at 9,850.04, while the Nasdaq jumped more than 2%, to 1,985.82.
– Helping to spark the rally, Citigroup and Yahoo both wowed their investor-fans with crowd-pleasing earnings reports. And General Electric, that bluest of blue chips, announced another of its monotonously impressive quarterly results. All three stocks advanced yesterday, helping to lead the market higher.
– Meanwhile, the Enron saga continues to wend its way through the headlines. I have to admit, I was somewhat dismayed by Bill’s cynical essay about Enron on Tuesday – dismayed that I had not written it myself.
– Bill was particularly on point when he observed that some (not all) of the victims were accomplices to their own victimization by virtue of their willingness – nay, eagerness – to be seduced. But there’s more than enough complicity to go around.
– Take Arthur Andersen, for example. In the latest twist, the accounting firm’s CEO, Joseph F. Bererdino, took a page straight out of "Poor Crisis Management 101" by firing lead auditor-cum-paper-shredder, David Duncan.
– Does anyone in America really believe that Duncan is singularly responsible for the shredding episode, or for the long string of questionable accounting maneuvers at Andersen that created the very files that needed to be so urgently shredded?
– More than likely, Duncan is the Lee Harvey Oswald of accounting. A "patsy," I believe, is the word that Oswald used to describe his role in JFK’s assassination.
– But having been fired by Andersen, Duncan is now completely free to turn State’s evidence against his former colleagues. This should be interesting.
– And it might not be a bullish event for the stock market. Uncovering the rot permeating parts of the American corporate edifice can be a little troubling…even for bulls.
– Most investors like to think that the financial reports they never read are honest. After all, an honestly overvalued stock has to be better than a dishonestly overvalued one, doesn’t it?
– Short seller and DR "Blue Team" member David Tice knows a thing or two about companies who practice dishonest accounting. David’s very timely article in the January 3 issue of Strategic Investment observes, "It’s tough for dreary old balance sheets to hold investors’ attention in the era of the upbeat press releases and the CNBC interview. Investors should realize, however, that accounting games are played by scores of companies, not only a handful of high-profile disasters."
– Or, as former Securities and Exchange Commission chairman Arthur Levitt put it bluntly in a speech three years ago, "Too many corporate managers, auditors and analysts are participants in a game of nods and winks."
– "[But] the accounting profession," says professional investor Donald Smith of the creatively named Donald Smith & Co., "isn’t the only thing wrong with the system. The integrity issues extended to the investment bankers going public with companies with no assets, no earnings, nothing but hope…the quality of Wall Street research has really gone down, certainly the integrity of its research."
– "One of the problems with the market," he continues, "is that no one knows what earnings are anymore. We now have reported earnings and reported earnings after extraordinary items. We have operating earnings. We have companies’ definitions of pro forma earnings…It’s a mess. Ultimately, a lot of individual investors are going to say, ‘I don’t understand this’ and ‘I can’t trust the numbers’…After Enron etc., I think people are going to say, ‘This is a game I can’t play…’"
– It’s easy to wag a finger at wrongdoing, of course; much harder to follow the path of righteousness by becoming part of the solution, as Enron whistle-blower Sherron Watkins attempted to do. Concerning the blunt, critical letter she sent to Enron CEO, Kenneth Lay, one observer remarked to the New York Times, "I would say I have a newfound respect for this person. Because it’s not easy to stand up and point out things that are wrong in corporate America. It’s much easier to let it go." Not to mention that it often pays better.
– Perhaps the Enron disaster will kick off a bull market in honest corporate accounting. Making an example of those responsible for the mess is as good a way as any to get the ball rolling
Back in Paris…
*** Let’s say you’re getting a little nervous about the dollar…what should you do? My friend, David Galland, sent this suggestion:
"I have some breaking news from Everbank World Markets that I thought might interest you (and your readers). Namely, our currency team has come up with a great new FDIC-insured* Index CD – it’s called the European Opportunity CD.
"It’s made up of a blend of currencies from Hungary, the Czech Republic and Poland – countries that are on the fast track to joining the EuroZone in the next round. – currently the 3 month version has an APY of 7.75%, and the 6 month has an APY of 7.25%.
"We don’t expect these rates to last much more than another month or so, which is why I’m sending this message out to you now. In fact, the European Opportunity CD is so new, it’s still not on www.everbank.com, but will be within the next 10 days.
*** What else is happening? Guess which country had the world’s top performing market last year? Well, I don’t know either, but Zimbabwean stocks rose 160% last year. Who says you need a free economy to make money in stocks? Who says you need a healthy economy? Zimbabwe is neither free nor healthy. Go figure.
*** "On average, secular bear markets have lasted about 10 years," said Felix Zulauf at Barron’s Roundtable. "I’m not sure we’ll have three down years in a row. Most likely I see a decisive setback, and a sharp rally thereafter. This is going to be a year for traders, not for investors. The S&P could be up 10% at a maximum, but it could be down 50% over the next 3 years…"
*** You can bet either way, of course. But the smart money is probably short.