The Fabulous Destiny of Alan Greenspan
A DR Classique, first published December 3, 2001, in which your editor returns to one of his favorite topics…
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 doubled from 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 revised downward."
"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.
August 28, 2002
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."
Poor Ted Turner. We noticed his face on the cover of the International Herald Tribune yesterday as we rushed through the train station. He looked sadly comic, like Terry Thomas after a late night out. All we read was the headline: He’s not as rich as he used to be.
Not hard to figure out why. The poor man parlayed a few billboards into Turner Broadcasting into Warner Bros. into TIME Warner and Jane Fonda. Then Jane turned religious on him and then he got parlayed into AOL…
The AOL/Time Warner merger was both one of the most brilliant corporate moves of all time and one of the stupidest. It was all very well for the rubes, patsies and gilders to sacrifice themselves in the Great Internet Illusion, but what did TIME Warner think it was doing? The company had billions of dollars worth of real assets, and expertise that it took nearly a century to accumulate. What did it hope to gain by hitching itself to an internet portal?
But one of the many charms of the market gods is that they look for your weakness and provide a little moral instruction.
Greedy…lazy…megalomaniacal…hallucinatory… stupid…fearful…ignorant…arrogant, whatever your problem, the market gods have a solution. Yes, it will be costly and painful. But it almost always works; you may want to repeat your mistakes, but you won’t be able to afford them.
Right now, for example, (and remember, we’re just guessing) we suspect the gods are baiting naive investors. Stocks have gone up for the last few weeks. The International Herald Tribune and other sources of amusement have declared the bear market over. Grubman is out of a job and MicroStrategy is on the rebound.
There was even a report in yesterday’s news that durable orders jumped much more than expected in the month of July.
And so, the lumpeninvestoriat is encouraged. Things are looking up; buy the dips.
But what’s this? Intel announced that the 3rd quarter wouldn’t be so good after all. Hewlett-Packard said its sales were off. And Ciena, the Maryland fiber optics company, reported sales off 89% from last year…and a loss of $160 million in the last quarter.
So things are not exactly looking up in techland. What had been moving the market forward these past few weeks were the tech stocks – which rose twice as much as other stocks. Investors didn’t like hearing discouraging words from the tech sector yesterday; disappointed, they took the Dow down 94 points and knocked the Nasdaq down 43.
And what’s this? The price of gold is finally moving again, up $2.90 to $313. What’s moving the price of gold?
Big government deficits, for one thing. The Congressional Budget Office forecast a $157 billion deficit for the fiscal year ending Sept. 31.
And, of course, there was the Vice President of the U.S. in the news yesterday saying that Iraq constituted a "mortal threat" to America. In politics, as in markets, people always have a good reason for doing the wrong thing – whether it is launching an attack or taking on AOL. The gods set them up…and then destroy them.
If that is not the way the world works, that it is the way it ought to work.
*** Forget the market and the WAT (war against terror)…the entire world may be in danger. A Daily Reckoning reader tells me that the world may be getting better, but not in his neck of the woods:
"Perhaps if Mr. Bonner lived in a country that was being greatly affected by climate change TODAY, he’d recognize Bjorn Lomborg as just another crackpot, like the extremists on the other side of the debate (e.g. Brown and Ehrlich).
In Canada our northern ice pack is thawing, adversely affecting the wildlife and the natives that depend on it.
Our perma-frost is melting, causing multiple infrastructure problems – things like buildings, pipelines and roadways that normally depend on a solid base underneath are sinking!
We’re currently suffering through what is probably the worst drought in our recorded history, and our cattle and grain producers are asking that a ‘national disaster’ be declared. A country-wide relief program has had to be established to try and help the cattle ranchers.
Our fresh water is evaporating and not being replenished – yes, that very same fresh water that you Americans want to buy.
The water levels in the Great Lakes are so low that shipping channels are in danger – freighters commonly report brushing the bottom of the lakes. And the proposed solution of dredging deeper channels will simply increase the flow of water out of the lakes.
I’m advised by the weather forecasters that I shouldn’t go outside today (or yesterday, or tomorrow) because the heat and air pollution are too great for anybody’s health. When I do go outside, I must lather myself in sun block so I don’t get skin cancer because the ozone layer has a huge hole in it.
Other examples of climatic change from around the world are broadcast on television every day, most recently images of great floods in Central and Eastern Europe. Please recognize that these are not normal events – the climate is changing, world wide.
Proposals for reductions in greenhouse gases (and other environmental improvements) have been made, most recently in Kyoto. But the biggest stumbling block to implementing them is the refusal of the United States to ratify the program and start working to solve the problem.
GET WITH THE PROGRAM MR. BONNER! LOOK AROUND YOU! There may have been examples of environmental extremists predicting doom & gloom, but ignoring the very real problems that we see today is like cutting off your nose to spite your face.
I do enjoy reading the Daily Reckoning, and I shall continue to read it, but for Heavens sake, Mr. Bonner, how about using some common sense when you write."