The Fabulous Destiny of Alan Greenspan
A Daily Reckoning Classique originally broadcast on December 3, 2002, which proves the ol’ French adage: plus ça change, plus c’est la même chose – the more things change, the more they stay the same.
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.
Alan Greenspan: Serene at 11,722
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 slipped the attention 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.
Alan Greenspan: Sharply revised Downward
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.
Alan Greenspan: Irrationally Exuberant
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."
Shares rise, as Buffett put it, first for the right reasons, and then for the wrong ones. Shares were cheap in ’82…the Dow rose 550% over the next 14 years. Then, by the time Greenspan warned of "irrational exuberance", shares were no longer cheap. But by then, no one cared. Benjamin Graham’s giant "voting machine" of Wall Street cast its ballots for slick shares with go-go technology and can-do management. Shares 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.
The Daily Reckoning
December 3, 2004
No word from Bill this morning. We looked for him in London and Paris and even Baltimore too, but to no avail.
No matter, we move swiftly on…
This morning, we found the latest payroll data waiting for us when we tuned into CNBC. 112,000 new jobs were added, says the Labor Department, about half the number economists had predicted, and the slowest gain in five months.
Stocks shrugged and then rallied, but bond traders rejoiced. The yield on the 10-year note is nearly 16 points lower this morning. Gold is also strong, and is up over $5. With only 26 minutes of trading remaining in the metal pits, our favorite yellow metal looks like it might close the week above $455.
Here’s more news from Eric, with an unofficial survey on the state of the nation’s housing market!
Eric Fry, reporting from New York City…
"It goes like this: the housing market is in a bubble of sorts, but one that accelerating inflation will gently deflate. In other words, most of us homeowners will barely notice the demise of the bubble because the NOMINAL value of our houses will not drop. Indeed, they might even continue rising."
Back in Baltimore:
*** Our old friend, Martin Spring, sends these impressions from his recent trip to Japan:
"Our visit to Japan proved to be a stimulating experience… in more ways than one.
"As we lay on the tatami in Japanese traditional accommodation in Hakone, a typhoon swept over us. Two days later our hotel bedroom in Tokyo on the 28th floor vibrated from the spreading shock waves of the worst earthquake to hit the country in ten years. More than a hundred people died in the two natural disasters, with even one of the "bullet" trains we used to travel around the country being derailed for the first time in their 40-year history.
"However, our abiding impression of Japan is not of disasters, but of a nation that remains immensely strong, socially and economically.
"The social breakdown that is slowly destroying the quality of life in Britain and elsewhere in Europe is completely absent. The ‘old-fashioned’ virtues, such as respect for others, willingness to work hard for long hours, and loyalty to family, group and nation, remain pre-eminent.
"Because the woes of its financial system are paraded endlessly in global financial media, it’s easy to forget how strong this economy remains. Japanese enjoy incomes significantly higher than the citizens of Western Europe, and their prosperity is ‘in your face’ when you visit their vibrant cities. Although their quality of life has some well-known deficiencies, such as tiny homes, it also boasts favorable features, such as excellent educational, medical and public services, while the range and quality of the goods on display in its stores is a wonder to behold.
"Dazzled by China’s current emergence as a major economic power, it’s easy to forget that the Japanese economy is three times its size. And, being both far more advanced technologically and managerially, and conveniently located in the region, it seems certain to be a major beneficiary – perhaps the biggest – of China’s future growth. However, in contrast to China, which is a huge country whose government is a nasty dictatorship lacking legitimacy, Japan is a stable democracy with sophisticated institutions.
"Although Japan’s growth rate in recent years has been even poorer than Europe’s, I have the impression that enough things are going right for it to do rather better over the coming decade. It would be foolish to underestimate the continuing dynamism of this industrial juggernaut and to ignore the investment opportunities there. [Ed. Note: Martin Spring isn’t the only one who thinks Japan holds a plethora of investment opportunities…in today’s issue of The Daily Pfenning, our very our currency counselor, Chuck Butler, urges his readers to put their money in one of the currencies from the "tremendous tri Japan, Thailand or Singapore."
*** A Daily Reckoning reader writes:
I must be a bit of a freak; I have managed for several months to live comfortably (though certainly not frivolously) on the combined income from a small pension and my Social Security, which total $1775/month. I own a very nice, small condo with a mortgage balance of just over $31,000 and a current market value of about $180,000. I’ve handled my stock investments rather poorly, and have less than $40,000 left in various funds. My credit cards are paid up to date, though Christmas may put a bit of a dent in that.
I eat out very rarely, and don’t entertain at home, but I have good friends whom I cherish, to say nothing of my two adult children and four grandchildren. I have more to read than I have time for, and lately have been spending a lot of time sorting and getting rid of the mountains of paper that clutter the place.
I am in the process of retiring from my career in real estate sales (which I have let go defunct this year anyway) and will save quite a bit from dues and other fees I won’t pay any more.
The only reason I can give for being perfectly happy on so little money is that I was born in 1937 and grew up with very little. When I was five years old, my parents started giving me a weekly allowance, of which 10 cents was for Sunday school, 10 cents for War Bonds, and 5 cents to spend or save. We didn’t have a lot of "stuff" at our house – probably because first there was no money and then there was nothing much available to buy. My kids have more income but thank goodness they also live simply.
I’m not sure why I decided to bore you with all this, except perhaps to let you know that there still are a few of us who live frugally and enjoy it.