The Fabulous Destiny Of Alan Greenspan
This week marks an important anniversary.
“How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions, as they have in Japan over the past decade?” asked the Fed chairman, when he was still mortal. The occasion was a black-tie dinner at the American Enterprise Institute in December – five years ago.
“We as central bankers,” Greenspan continued, “need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. But we should not underestimate or become complacent about the complexity of the interactions of the asset markets and the economy. Thus, evaluating shifts in balance sheets generally, and in asset prices particularly, must be an integral part of the development of monetary policy.”
Mortals make mistakes. But Greenspan was right on target in ’96. It was later, after he became a demi-god, the “Maestro,” that the Fed chief erred.
In 1996, the bear market of ’73-74 and the crash of ’87 were still functioning as caution signs. Greenspan spoke on the evening of the 5th. On the morning of the 6th, markets reacted. Investors in Tokyo panicked…giving the Nikkei Dow a 3% loss for the day, its biggest drop of the year. Hong Kong fell almost 3%. Frankfurt 4%. London 2%. But by the time the sun rose in New York, where the Fed chairman was better known, investors had decided not to care. After a steep drop in the first half-hour, as overnight sell orders were executed, the market began a rebound and never looked back. By the spring of the year 2,000, the Dow had almost doubledfrom the level that had so concerned the Fed chairman.
But while the maestro was alarmed at Dow 6,437 he was serene at Dow 11,722. Fatal to Greenspan’s judgment was a combination of bad information, bad theory and a human nature that – though unchanged for many millennia – seems to have avoided the notice of central bankers.
Greenspan’s theory was that by carefully controlling the cost of credit and the money supply he could avoid serious economic downturns. You have suffered enough discussion of this issue here in the Daily Reckoning, dear reader. For today’s purpose, we will just point out that Mr. Greenspan has everything he needs to get the economy back on track, except the essentials. He cannot make telecom debt worth what people paid for it. He can’t restock consumers’ savings accounts. He can’t make Enron a good business. He can’t erase excess capacity, nor make investment losses disappear.
In addition to the bad theory, Mr. Greenspan had bad information. The “information age” brought more information to more people – including to central bankers…but the more information people had, the more opportunity they had to choose the misinformation that suited their purposes.
Since the late ’90s, however, many of the figures used to justify the New Economy have been revised, downward. “The government previously decided that neither corporate profits nor productivity improvements were nearly as good as they appeared to be in 1999 and 2000,” reports Floyd Norris in the New York Times. “And now the industrial production numbers have been sharply reviseddownward.”
“The new numbers show industrial production was dramatically overestimated, particularly in the high- technology area,” Norris quotes John Vail, the chief strategist of Fuji Futures, a financial futures firm in Chicago.
What was true for the nation’s financial performance was also true for that of individual companies. Companies engineered their financial reports to give investors the information they wanted to hear – that they earned one penny more per share than anticipated. But what they were often doing was exactly what Alan Greenspan worried about – impairing balance sheets in order to produce growth and earnings numbers that delighted Wall Street. Curiously, during what was supposed to be the greatest economic boom in history, the financial condition of many major companies – such as Enron and IBM – actually deteriorated.
But by 1998, Alan Greenspan no longer noticed; he had become irrationally exuberant himself. Markets make opinions, as they say on Wall Street. The Fed chairman’s opinion soon caught up with the bull market in equities. As Benjamin Graham wrote of the ’49-’66 bull market: “It created a natural satisfaction on Wall Street with such fine achievements and a quite illogical and dangerous conviction that equally marvelous results could be expected for common stocks in the future.”
Stocks rise, as Buffett put it, first for the right reasons and then for the wrong ones. Stocks were cheap in ’82…the Dow rose 550% over the next 14 years. Then, by the time Greenspan warned of “irrational exuberance”, stocks were no longer cheap. But by then no one cared. Benjamin Graham’s giant “voting machine” of Wall Street cast its ballots for slick stocks with go-go technology and can-do management. Stocks rose further; and people became more and more sure that they would continue to rise.
“Greenspan will never allow the economy to fall into recession,” said analysts. “The Fed will always step in to avoid a really bad bear market,” said investors. Over the long term, there was no longer any risk from owning shares, they said. And even Alan Greenspan seemed to believe it. If the Fed chairman believed it, who could doubt it was true? And the more true it seemed, the more exuberant people became.
“What happened in the 1990s,” says Robert Shiller, author of the book “Irrational Exuberance,” is that people really believed that we were going into a new era and were willing to take risks rational people would not take…people did not feel they had to save. They spent heavily because they thought the future was riskless.”
But risk – like value – has a way of mounting up, even while it seems to disappear. The more infallible Alan Greenspan appeared…the more “unduly escalated” asset values became. Having warned of a modest “irrational exuberance,” the maestro created a greater one.
December 3, 2001
P.S. The most exuberant phase is passed. But neither investors nor consumers could be said to be acting “rationally”. Consumers are still spending as if there were no recession. And investors are still buying stocks – as if they were bargains.
“People are habitually guided by the rear-view mirror,” explains Warren Buffett, “and, for the most part, by the vistas immediately behind them.”
The Enron bankruptcy dominates the financial news. One of the biggest bankruptcies in history, Enron declared $53 billion worth of liabilities on its Sept. 30th statement.
Few readers will recall, but here at the Daily Reckoning we have long memories for foolishness. We cherish absurdity the way bag ladies cherish paper bags…they are our most precious asset, and the receptacle of every scrap of discarded insight we come upon.
At the end of the 20th century, Enron was one of the hottest companies on Wall Street. Why? Because the company had managed to transform the energy business into an “information” business. Instead of actually delivering useful BTUs Enron hyped itself up for its capacity to distribute information about energy. In the end, the company provided neither heat, nor light – but a sparkle of hype and misinformation.
Thus did Enron become a New Economy company…and thus did it have access to billions of dollars worth of investors’ cash. At its peak Enron shares traded for $82, giving the firm a $62 billion market cap. Last week, shares changed hands at just 30 cents.
Enron practiced the art of what Dr. Kurt Richebacher calls “late, degenerate capitalism” with the flair of a Dali and the talent of a Pollack. So recklessly were its finances engineered, that at the time of its bankruptcy it was widely believed that it no longer knew neither how much money it actually had nor what business it was supposed to be in.
Could other companies be in similar straits? Yes, they could. Christopher Byron mentions three candidates in his review of the Enron debacle: Sara Lee, Deere, and IBM.
But let’s hear from Eric.
Eric Fry, reporting from New York:
– Nothing much worries investors these days. A recent Financial Times story says it all, by making the following twin observations: The U.S. economy shrank faster in the three months following September 2001 than in any quarter since the 1990-91 recession. Yet, over the last seven weeks, the stock market logged one of its best-ever performances of the past 20 years. Falling economy, rising stock market…makes sense to me.
– “For only the sixth time in 17 years,” the Financial Times points out, “the Nasdaq Composite Index has soared more than 28 percent in seven weeks. And for only the fifth time in 20 years, the Standard & Poor’s 500 Composite index is up more than 15 per cent in seven weeks.”
– The FT explained this apparent contradiction by proclaiming, “[S]igns of a possible early recovery [continue] to mount.” Maybe so, but signs of a severe slowdown continue to mount as well.
– “I still believe the world economy is weakening,” says Morgan Stanley’s Barton Biggs, “that any V-shaped [recovery] will be later rather than sooner, and that all the King’s Horses and all the King’s Men can’t put the American consumer back together again.”
– Most investors can’t be bothered with Biggs’ somber outlook. Instead, any tidbit of good economic news makes headlines as a certain sign of the “economic recovery.” Bad news is brushed aside as “lagging information.” There is, of course, a more cynical interpretation: the good news of the last few weeks is nothing more than a bounce.
– In other words, the economy may be having a “big inning,” but it is still losing the ball game.
– Last week, for example, the Commerce Department reported a 12.8% rise in durable goods orders for the month of October, “led by increased bookings for weapons, ships, jet fighters and cars.”
– But on the very same day, the Labor Department reported a disconcertingly large rise in new claims for unemployment benefits. First-time claims rose 54,000 to 488,000. The number of people continuing to draw benefits jumped to 4 million – the highest number in 19 years.
– The robust durable goods report seemed to suggest that the economy is recovering, while the grim labor statistics seemed to suggest that it is not. Which one is right? In short, they both are. That’s because the TREND for both durable goods orders and employment is identical – both have been falling steeply and inexorably for months. Investors can sometimes do themselves a favor by focusing on the trend, rather than the occasional counter-trend bounce.
– The latest durable goods report is an obvious one-off. Durable goods orders had been sliding for months, before collapsing completely in September. The October bounce, therefore, is no more than that – a bounce. The two months taken together, and averaged, would amount to a steep falloff from the August total.
– What’s more, the durable goods rebound was led by big- ticket items like jet fighters and ships – the kind of things that very few ordinary people buy and park in their front yards. If durable goods orders are to continue growing, we’ll need to see rising orders for washing machines and refrigerators, as well as jet fighters.
– It’s hard to envision a durable bounce in durable goods orders until employment stabilizes. And that’s not happening.
– “Jobs continue to vanish at a record pace, with more people collecting unemployment insurance than any time since the 1982-83 recession,” writes Floyd Norris of the New York Times. “That number has risen more than 70percent over the last year, a rate of growth not seen since the brutal 1973-75 downturn. Help-wanted advertising has fallen to a 37-year low. But many Americans seem to be reacting to such statistics the way they react to reports of starving children in some Third World countries: it’s too bad, but it really doesn’t affect them. Their jobs are safe, they believe, and so is their future.”
– If only it were that easy. “The V remains a pipe dream,” scoffs Stephen Roach, the equally bearish colleague of Barton Biggs over at Morgan Stanley. “One of these days, I’m going to run out of reasons to be bearish. Yet, I obviously haven’t run out of grist for the mill…There’s a fair amount of artificial churning currently going on in the U.S. economy – forces that are both pulling demand forward, but also setting the stage for a prompt fallback in economic activity in 2002.”
– Stay tuned.
Back in Paris:
*** “The U.S. Economy Shrinks Fast,” says the BBC.
*** Last week was not a great week for financial news. It began with the official recognition that the U.S. economy is in recession…and ended with the official recognition that the downturn is almost 3 times as bad as they said it was on Monday. Revised figures show GDP declining at a 1.1% annual rate in the third quarter.
*** But the Fed keeps pumping – broad money (M3) rose at an annual rate of 20% over the last 10 weeks.
*** And the dollar! The greenback fell 2% against the euro last week.
*** Things were no better in Japan. That country is in its 3rd recession in the last 10 years. Unemployment is rising. Stocks are falling. And last week, Japan’s sovereign debt was downgraded.