Spent Out Economy
Greenspan’s 50 basis point rate cut triggered an immense rally on Wall Street. The announcement took place just after noon, while fund managers and analysts were eating their customers’ lunches. Before the sun set on Wall Street investors were about $900 billion richer. On paper.
What more proof could we want that Alan Greenspan can work miracles…that he can create wealth out of thin air?
And yet, who knows, in a few more trading sessions that wealth may be wiped out…and more to boot.
The problem with humankind – to start this letter off with the proper profundity – is the same as the problem with the New Era itself. The New Era required a new, digital man to make it work – one who would respond rationally, logically, and unemotionally to whatever came his way. He would simply add things up – as a computer might…and come up with the right answer every time.
But we homo sapiens analogos don’t operate that way. Instead of ciphering the data, we try to make sense of things by comparing new information to other things we think we understand.
We don’t say, “the stack of wood was 2.235 meters high.” We say it is “as high as a pile of 15 tort lawyers…”
We don’t know precisely how thick each tort lawyer is…but it doesn’t matter. We only know things by analogy and metaphor…and can imagine how much nicer things would be if tort lawyers were stacked.
Human minds, except for those of Wall Street analysts, are flexible enough to absorb almost any new set of facts into the nuance of known metaphors. But the trouble is that the metaphors are never perfect.
In the popular imagination, Alan Greenspan is seen as the pilot at the controls of a vast airplane. He can lower the flaps or raise them – according to his wont. If the plane flies too high, or too low, it will be because of ‘pilot error’ – because Greenspan reacted too much or too little.
But the U.S. economy is not an airplane. The metaphor is inadequate. The economy is far more complex…infinitely complex, in fact. And in one critical respect, it is unlike any machine ever made: it anticipates the pilot’s moves – and resists them.
“A common characteristic of financial crises,” wrote Henry Kaufman in his recent book of memoires, “is that most market participants fail to anticipate them. If they did, the crisis wouldn’t materialize, for the majority of market participants would take countervailing actions that, collectively, would mute the developing turmoil. Only a few see the storm approaching. The vast majority – after contributing to the making of the crisis in the first place – are caught off guard when the tempest hits, and suffer the consequences accordingly.”
Alan Greenspan is reacting to what may or may not turn out to be a crisis. No one doubted that Greenspan would cut rates. The only question was when and by how much. And since everybody knew what the Fed chief would do – months, and even years, before he actually did it, they already had priced the Greenspan Put into their investment decisions. Those who believed Greenspan would lower rates – and that lower rates would make stocks go up again – were already fully invested. The rate cut had been discounted by the market months in advance, in other words. And since it had already been discounted – it will change nothing.
The only surprise in Greenspan’s move was the timing. He might have waited a few weeks for the next FOMC meeting.
The real surprise will come when the analogy proves misleading. Greenspan has opened the throttle and raised the flaps. But will the plane go up?
If liquidity were like jet fuel, the engine would roar and the plane would power higher. But it is not. It is more like pig food. Put it in a bucket and hold the bucket up to a pig’s snout – and you may be able to lead the animal where you want him to go. Then again, you may not.
There is a phenomenon in economics known as “spent out demand.” It is what happens after people have been on a spending spree.
“I don’t care how low you take mortgage rates and what kind of incentives you put on cars or how many rebates Best Buy offers,” comments Jim Paulsen of Well Capital Management. “Demand is saturated. The only solution is we use up those goods we have.”
Also saturated is the demand for credit. Consumers and investors were quite sure Greenspan would cut rates…or do whatever is necessary…to keep America prosperous. They saw no need to wait for him to prove it. They went ahead and acted on this belief – and thereby cut Mr. Greenspan off from his controls.
Confident of an era of permanent prosperity, protected by The Maestro himself, consumers cut savings rates from about 9% in 1991 down to nearly zero in the year 2,000. Household debt service rose to 13.7% – near an all-time record. Durable goods spending had been between 22% and 26% of GDP from ’50 to ’95. Last year, it hit 30% – “off the charts,” said Paulsen.
Looking at the 5 1/2 years from the beginning of ’95 to the middle of last year, GDP rose $2.7 trillion. But corporate and consumer debt rose $4.7 trillion. And total credit and debt creation rose $8.9 trillion.
The entire nation – anticipating the Greenspan Put – dared to spend and go into debt as never before in history.
Is there anyone in America who still needs a new gas- guzzling SUV or pick-up? Is there anyone who failed to refinance his house when the real, net cost of borrowed funds was a gain of 15% per year? Now that the net, real cost of borrowed funds is closer to a loss of 30% – will people rush to refinance, merely because Mr. Greenspan has cut the Fed Funds rate by half a percentage point?
People are saturated with confidence in the Fed chairman. They can only be disappointed.
More to come…
January 5, 2001
*** “Yesterday’s Rally Fizzles” announces the headline on TheStreet.com. After a spectacular run-up on Wednesday – following the Fed’s 50 basis point cut – neither the Dow nor the Nasdaq could follow through.
*** The Dow closed down 33 points – on huge volume. The Nasdaq lost ground too – down 49 points. The Internets fell 3%. Could investors just be pausing for breath before another big move to the upside? Or has the Greenspan Put been shot?
*** We’ll know soon enough. Ominously, while the Dow and Nasdaq at least held onto most of their gains from Wednesday, the dollar fell sharply against the euro. On Wednesday, the dollar registered its biggest increase against the euro ever. But 24 hours later, global investors must have realized that lower rates in the U.S. are not good for the foreign exchange value of the dollar. By the end of yesterday’s trading, the euro was back to 94.71 cents.
*** “Asian Investors Sense Alarm in Fed Move,” a Bloomberg headline informs us. “Why now and why 50 basis points,” asks Ng Cheong Lip, a Singapore fund manager, “Maybe the situation in the U.S. is really bad.”
*** The last time the Fed cut rates between meetings of the FOMC was during the Russian default crisis of Oct. ’98. Are there other big defaults coming?
*** The worry echoed around the world as investors waited for another shoe to drop. Could there be a size 12, EEE problem – like the Long Term Capital Management crisis – about to hit the trading floor? Might there be a major financial institution about to fail?
*** “What does Greenspan know that we don’t?” asked analyst Paul McCulley. “When stuff happens, the Fed eases,” McCulley notes, leaving investors to think that Greenspan is always ready to rush in and save the day with lower rates. And if you look at a chart of stock prices during Greenspan’s tenure you can see that each time stocks were threatened – the Fed dropped rates. Naturally, investors have come to expect help from the Fed at critical moments. More below…
*** “I consider Greenspan a menace to society,” writes William Fleckenstein. “Rather than talking about people managing their risks, he seemed to embrace the new era. My complaint with him is not yesterday’s ease, it’s the implication that he is bailing out the stock market and once again ‘writing a put for the stock market’.” (see: Rate Cut Rally, A Day Late And Maybe A Dollar Short)
*** A quick, gratuitous opinion: Greenspan’s rate cut has given investors a marvelous opportunity – to get out of overpriced stocks. Sell the rallies.
*** California’s largest utilities are on the verge of bankruptcy – but everyone knew that. And they’re not likely to be helped by 50 basis points. In fact, few people will get much out of it. Again, more below….
*** Curiously, breadth was decent yesterday – with 1590 stocks advancing on the NYSE and only 1366 declining. And only 7 stocks hit new lows, while 272 hit new highs.
*** The Financial Times reports that PC sales in December fell 2%; PC sales have gone down for the last 5 months.
*** Did I recommend a coal company to you last year? I should have. The FT also reports that coal has been in a bull market since July of ’99 – rising from $26.55 per ton to $42.45 recently (coal delivered in Northern Europe).
*** The January 8th cover of TIME magazine tells us “How to Survive the Slump.” But magazine covers are notorious laggards. If TIME editors are talking about ‘the slump’, it must be almost over.
*** “The last big winner from Time,” writes Caroline Baum a Bloomberg columist, “was its selection of Jeff Bezos as Man of the Year in December 1999. Bezos, the perennially perky CEO of Amazon.com Inc., an on-line retailer for whom profit is a motive, not a reality, was anointed at a time when Amazon’s stock was trading at $97, near its all-time high of $106.69 set on Dec. 10. Amazon is currently down 84 percent from its high at $17.56.”
She continues: “Examples of other classic magazine covers that provided good sell signals are:
– Time magazine’s ‘Interest Rate Anguish’ in 1982, ushering in one of the biggest bull markets in bond market history;
– Business Week’s ‘Trouble in the Government Bond Markets’ on May 28, 1984. In the following two years, 30-year bond yields were cut in half to 7 percent;
– Time’s Nov. 9, 1992, cover story, ‘Can GM Survive?’ GM stock returned 60.5 percent in the following 12 months;
– Time’s counter, ‘Detroit Shifting into High Gear,’ a December 1993 cover story, one month before GM went into reverse;
– The Economist’s March 6, 1999, cover story, ‘Drowning in Oil,’ predicting $5 crude. Crude oil was trading at about $13 at the time and marched relentlessly higher to $37.20 in September 2000.”
*** A careful reading of the TIME article shows that the editors have not lost their touch. “If you own stocks,” they write, “the worst is over. …Now grab some bargains on cars, mortgages and investments.” What a relief. I was afraid I would have to change my whole perspective. But no. Since TIME’s editors tell us the slump is over…we can be sure it is just beginning. What’s more, it will probably not be a slump at all – but a catastrophic financial collapse.
*** “As a small, but concrete, indication that the Winter of Woe is starting to bite,” writes Alex Green, “consider this: In Potomac, (Montgomery County) Md. as you know, net worth is (or was) extremely high. Yet, our local library is unable to keep the Wall Street Journal from being stolen. I’m guessing but the odds are that some poor sod …has stocks to check and A) can’t afford to subscribe to the paper but B) doesn’t want to stay in the reading room where people can see him cry.”
*** Yesterday evening, after work, I helped Maria, 15, with her math. The problems were simple – if a product sells for 11 francs and 20 centimes including sales tax…and 10 francs wholesale, what is the sales tax rate? But some people have a mind for math and some don’t. “Those sound like fun,” said Henry, 10, a bright, cheerful, figuring kind of look on his face. “Can I do some?” But Maria’s face was blank. “Sales Tax Rate? Hmmm…was that an American movie…or a song by Fiona Apple?”
*** Well, Benoit called the countess…and then paid her a visit. “She was very friendly,” he reported. “And she said she would happily sell the fireplaces. But the French Commission on Historic Monuments has seized the property. Even she no longer has the right to touch the stones.”
Tis a pity.