The Great Deluder
Mr. Greenspan, revealed…but will anyone take note?
For us, Mr. Greenspan is the great deluder of the American public, flatly deceiving it about the economy’s true situation and prospects. His speeches always convey the impression of extraordinary sophistication, but the reality is that elementary knowledge of macroeconomic aggregates or processes, such as saving or wealth creation, obviously eludes him. It keeps amazing us how little critical response he finds.
One reason for this generally silent complacency, we presume, is an overwhelming desire among economists not to upset the prevailing bullishness of public opinion. Bear in mind that Wall Street economists dominate economic discussion in the United States. Their main concern is the stock market.
But we also note a widespread lack of knowledge or interest in macroeconomic matters even of crucial importance. Nobody cares about savings, nobody cares about a credit expansion that has gone completely out of control and nobody seems to realize that the huge trade deficit has been the greatest profit-killer in the U.S. economy for years. Rather, it is hailed as an emblem of economic strength.
The other looming danger in addition to the trade deficit, is, of course, the immense risk it poses to the dollar and in its wake to the whole financial system, both having become heavily hooked on incessant, immense capital inflows. It seems to us that this horrendous danger, too, is in general not at all appreciated.
Pointing to higher U.S. real GDP growth in America than in Europe and Japan, the bullish American consensus has been hailing Mr. Greenspan’s aggressive monetary easing as a tremendous success. In our view, this comparison is heavily distorted by different calculations of inflation rates. Looking at the economic aggregates that truly matter for people and the economy, like employment, incomes, and production, the U.S. economy over the past three years has performed most miserably among the industrial nations.
Alan Greenspan: What Didn’t Go Wrong?
What went wrong in the first place? Actually, it seems easier to first identify some factors that have plainly not been among its causes. It is the first economic downturn in postwar history that has not been precipitated by rising inflation and monetary tightening.
As aggregate domestic demand eventually outpaced aggregate domestic supply during past booms, inflation rates used to accelerate. The Fed then pulled the brakes, invariably culminating in recession. Monetary easing, starting about a year later, then promptly triggered the subsequent V-shaped upturn. Within just two years following the recession, the economic losses suffered during the recession were more than offset by very steep economic recoveries.
Periods of recession implicitly reflected the liquidation of the borrowing and spending excesses that had accumulated during the prior boom. In this way, businesses came out of recessions with strong balance sheets and great gains in efficiency.
The thing to see is that the borrowing and spending excesses that accumulate in the course of the boom essentially disrupt the economy’s established pattern of demand, output, incomes, relative prices and profits. These distortions hamper economic growth directly over time, irrespective of the level of interest rates.
But manifestly, both the U.S. economy’s and the stock market’s sharp downturns in 2000 were not caused by tight money or credit. Nonfederal credit rocketed in the year’s second quarter when the two began their plunge at an annual rate of $1,315 billion. The increase during the year as a whole was $1,148 billion, after $1,098 billion the year before. For comparison, during recession year 1991, the total nonfederal credit rose $188 billion, after $410 billion in 1990 and $632 billion in 1988.
Assessing the U.S. economy’s prospects, we must be clear about the extraordinary causes of the downturn that started in mid-2000. In our view, the consumer borrowing and spending binge since 1997 is the U.S. economy’s decisive primary maladjustment, certainly the one that brought about the downturn in 2000. It was crucial in generating the variety of dislocations and imbalances that broke the economy’s vigor – the collapse of personal saving, the surge of the trade gap, the slump in business investment, the profit carnage, and exploding consumer and business debt loads.
In response, the Fed almost immediately began an unprecedented campaign of monetary easing. According to the American consensus economists, this campaign’s success over the last three years has been remarkable. As a result, according to the general mantra, the U.S. economy did not suffer an economic slump of the kind that followed the stock market’s crash in 1929. In one of his congressional testimonies, Mr. Greenspan actually emphasized that "imbalances in the economy had not festered in the past years."
Alan Greenspan: Not Loose Money Alone
But have the economic and financial maladjustments that precipitated the economy’s downturn in 2000 really been significantly remedied? To repeat the key point in this respect: Since this downturn was definitely not caused by tight money or credit, loose money alone cannot be the solution.
What Mr. Greenspan has succeeded in doing is cushioning the impact of the bursting stock market bubble on consumer spending, by rapid and drastic rate cuts that promptly fuelled a housing and bond bubble instead. The former created the soaring collateral values that facilitated sharply higher borrowing, while the latter served to slash borrowing costs.
For many observers, this was an ingenious new monetary policy. For sure, it prevented for the time being a sharper economic downturn. But it raises the last and most important question of all: Has Greenspan’s policy created the conditions that are requisite to put the U.S. economy on the road of lasting recovery?
The credit excesses of the late ’90s bubble economy implicitly disrupted its underlying structures of demand, output, relative prices and profits in many ways. The thing to realize is that these bubble-related maladjustments depress the economy of their own accord, as happened in the United States in 2000-01. In the same vein, restoring sustainable economic growth requires liquidation of the distortions that have accumulated in the economy and its financial system.
We see absolutely no evidence of this having happened. Instead, Mr. Greenspan has merely diverted these distortions, turning them into even greater maladjustments elsewhere in the economy.
In the view of the bullish consensus, Mr. Greenspan has done a brilliant job in preventing a deeper and longer recession than might have been expected. This assessment, of course, ignores the protracted employment and income disaster. In our view, America’s Great Deluder has done a miserable job: he has papered over existing maladjustments from the boom through even bigger, new bubbles and macroeconomic maladjustments, heralding much worse to come in the future.
The structural damage to the economy has become far too big to lend itself to a mild correction. The next downturn will not be pleasant.
for The Daily Reckoning
April 15, 2004
Editor’s note: Former Fed Chairman Paul Volcker once said: "Sometimes I think that the job of central bankers is to prove Kurt Richebächer wrong." A regular contributor to The Wall Street Journal, Strategic Investment and several other respected financial publications, Dr. Richebächer’s insightful analysis stems from the Austrian School of economics. France’s Le Figaro magazine has done a feature story on him as "the man who predicted the Asian crisis."
Dr. Richebächer is currently warning readers to beware the wiles of Alan Greenspan – for unchecked, they can sabotage your investments.
What fool would lend money for 30 years at 5% interest…when the present rate of inflation is 6% and rising?
The question showed up at yesterday’s market sessions like a drunken ex-husband at a wedding party. Everyone was sure it would lead to trouble, but no one wanted to say anything.
Yesterday’s big item was the rise in inflation. The International Herald Tribune felt the story was worth putting on the front page of today’s edition: inflation is back.
Consumer prices rose a half of a percent in March. This puts the annual rate at 6% – if March levels persist. That is a lot more than the 1.7% reported last year and nearly twice what economists expected. But it certainly wouldn’t impress anyone from Zimbabwe. Even in America, a few years from now, we’re likely to be nostalgic for it.
The rise in inflation levels should be good news. It means demand for goods is increasing so much, supplies can’t keep up. Or does it mean that supplies of money are increasing so much that supplies of goods can’t keep up?
Nobody seems to know.
Yesterday, investors couldn’t make up their minds. Business profits that are ‘better than expected,’ higher exports, more jobs…and now rising inflation rates – is this cause for celebration, or suicide?
The prevailing illusion is that Alan ‘Bubbles’ Greenspan has pulled it off. He came in with just what the market needed just when it needed it – more money and credit. (Some might say that he always comes with more money and credit, whether the market needs it or not.)
Interest rates at 1% (less than the inflation rate)….money supply (M3) ballooning by $1 trillion in a single year…hey, is it any wonder stocks rallied and real estate soared?
But for the longest time, it looked as though all Greenspan’s money could not buy the happiness of a thriving economy. Admittedly, many new jobs were created – but in China and India! And even a flood of new money failed to float prices higher. It was beginning to look to many economists as though there was something really wrong, after all.
What a relief the news from the last 10 days has been. Jobs, profits…and now inflation – what more evidence do we doubters need? Greenspan is a genius after all. What crackpot spoilsport can still deny it?
Ahem…we clear our throats…(as does our friend Dr. Kurt Richebächer, in today’s guest essay below…)
And what’s this? Now economists are speculating about when the Fed will raise rates – for how can they avoid it in the face of rising inflation!
Mortgage activity is suddenly slacking off; the Refinancing Index fell 30% last week. It requires either a surplus of faith or a shortage of brains to want to lend long-term at rates lower than the going rate of inflation
Good fortune is self-correcting…we point out again. Especially when it’s a fraud.
Over to Eric with more news from Manhattan…
Eric Fry, from the corner of Broad and Wall…
– "Texas Instruments’ Net Triples on Biggest Sales Gain in at Least a Decade," a Bloomberg News headline reported after the close of yesterday’s trading. A few moments later, the news agency owned by New York City’s billionaire mayor reported, "Apple’s Net Income More Than Triples to $46 Million as iPod Sales Surge."
– Unfortunately, investors did not have the benefit of this inspirational news while they were buying and selling stocks yesterday. Thus, the Dow Jones Industrial Average dipped 3 points to 10,378, while the Nasdaq Composite fell 5 points to 2,025.
– Share prices fell yesterday morning in reaction to a surprising spike in retail inflation. The Labor Department’s Consumer Price Index rose 0.5% in March, as energy prices jumped nearly 2%. As seasoned investors know, inflation is as welcome on Wall Street as a rapper at the Grand Old Opry…The collective mood becomes nervous and agitated. Yesterday’s frightening inflation news sparked a nervous liquidation of almost every asset, including the theoretically inflation-loving precious metals.
– In the bond market, the 10-year Treasury note fell 10/32 to push its yield up to 4.39% vs. 4.34% at Tuesday’s close. Meanwhile, the part-time monetary metals tumbled. Gold for June delivery fell $7.20 to end at $400.50 an ounce, and silver plummeted 45 cents to $7.00 an ounce.
– So it’s official! Inflation is back, just like Greenspan and Bernanke promised. You will recall, dear reader, that Fed Governor and Harvard graduate, Ben Bernanke, dazzled the world in November 2002 by declaring: "The U.S. Government has a technology called a printing press."
– The learned economist implied that day, in a speech entitled, "Deflation: Making Sure ‘It’ Doesn’t Happen Here," that the U.S. government would deploy its printing ‘technology’ as needed to combat deflation – a process that Bernanke whimsically referred to as a ‘helicopter drop’ of money.
– Six months later, two economists at the Federal Reserve Bank of Dallas expanded upon Bernanke’s metaphor by asserting, "The Fed could even implement what is essentially the classic textbook policy of dropping freshly printed money from a helicopter." Alas, since Bernanke’s infamous promise, the only helicopters to fly over your New York editor’s head were dumping Malathion instead of money.
– The half-percent hike in consumer prices in March suggests that Bernanke’s Black Hawks will remain grounded on the Treasury’s tarmac. So far this year, the CPI has risen at a hefty 5.1% annual clip.
– Of course, President Bush did most of the heavy lifting by borrowing billions of dollars to buy bombs, which were then dropped from helicopters and airplanes over Iraq. The Bush reflation effort was a bit more complex and a bit messier than Bernanke’s version, but the monetary results are similar.
– Rising bond issuance by the U.S. Treasury to pay for the Iraqi war effort and other indispensable government initiatives – along with a half-a-trillion dollar current account deficit – creates very fertile soil for the sorts of global monetary machinations that produce an inflationary result.
– We Americans borrow to buy what we could not otherwise afford. And we buy vastly more goods and services from foreigners than we sell to them. As a result of our wanton borrowing and spending, dollar bills pile up in foreign bank vaults like flotsam along a jetty.
– The overseas dollar-holders – finding that their vast stockpile of dollar bills greatly exceeds their day-to-day need for them – gaze about the globe for ways to swap dollars for something else…anything else. The foreign central banks often discover that their piles of excess dollar bills have only marginally more uses than a stack of arcade tokens at Neiman-Marcus. So the Japanese and Chinese central banks, for example, exchange their greenbacks for whatever they can get…and what they can always get in ample supply are U.S. Treasury securities.
– "The bank of Alan Greenspan has been laying on its oars, creating relatively few new dollars," observes James Grant, editor of Grant’s Interest Rate Observer. "For the past three months, the Fed’s assets and liabilities actually shrank…Compare the Fed’s indolence with foreigners’ enterprise. The foreigners – mainly the Japanese and Chinese central banks and finance ministries – have been accumulating monstrous volumes of dollars, which they routinely invest in Treasury and agency securities. In the past 12 months, foreign central banks purchased $262.2 billion of U.S. government securities, while the Fed added only $32.7 billion. The foreigners’ holdings today top $1.1 trillion…Over the past three months, the holdings of foreign central banks spurted at a compound annual rate of 48.3%."
– The convenient result of this Rube Goldberg monetary contraption is that the prevailing U.S. interest rates are much lower than they might otherwise be. The inconvenient result is that – eventually – inflation will be much higher than it might otherwise be.
– "Which leads us back to the question left dangling," Grant continues. "Does it make a difference which central bank pushes around the funds rate, the Fed or another? It matters in this fashion: Every central bank ‘prints,’ or creates, the money it spends. The Fed prints dollars; the Bank of Japan, yen. The Fed creates the dollars with which it buys Treasury bills; the BoJ creates the yen with which it buys dollars.
"The [monetary] system now prevailing is a system to push almost inconceivable volumes of Asian currency into circulation to the end of propping up the value of the dollar. Whatever comes of this transpacific fandango, we believe, it will continue to enrich patient holders of gold and silver."
– In other words, all of the money printing to which Grant refers is – or ought to be – inflationary, which is a good thing for patient holders of gold and silver…But patience is clearly the operative word.
Bill Bonner, back in Paris…
*** The dollar is up 5.6% against the euro so far this year. Gold tumbled $7 yesterday – almost to the level we said it might never see again in our lifetimes. By all measures, consumers are still spending more than they can afford. And stocks hesitate…not too far below their post-2000 highs.
We maintain, humbly – and not for the first time – that these trends are topping out. Not because we know anything…but because we do not. Whatever we choose to believe will be largely myth and guesswork. Better to believe, therefore, that what ought to happen will happen. Expecting what is widely expected…even though it ought not to happen…often proves correct, but rarely profitable.
*** Asked about the ‘recovery’ and its effects on his holdings, a UK growth fund manager gave the following reply:
"I’ve been doing this for six years and I’ve seen periods of underperformance in my fund that typically last about three months. There are lots of conflicting signals around at the moment and not much conviction about direction. But I believe the economic recovery is there and will begin to creep through during the year."
In six years, the poor dope thinks he’s seen it all. ‘Underperformance’ for three months at a time? Does Mr. Market have nothing more to teach these geniuses? Stay tuned…
*** "You should prepare to live to be 180 or so," said a friend to our daughter, Maria, at dinner the other night. "Too bad, because yours may be the last generation to die."
Immortality has been discussed in the English papers lately. People are looking forward to longer, healthier lives. "We shall play tennis until we’re 107," says Theodore Dalrymple in The TIMES.
That is the trouble with longevity, dear reader. You can’t merely have more time; you have to do something with it. The older you get, of course, the harder it is to find things to do that you haven’t already done. Already, at 55, we are bored with tennis. The thought of being able to play the game at 107 hardly gives us a reason to hang on.
Nature, in her wisdom, gives us fewer and fewer reasons to live…and more and more to die. We begin to ache and grouse. We can’t see as clearly or hear as well. We don’t get the same kick from booze that we used to; the vivid colors from the springtime of our lives turn a little brownish gray in autumn.
Nor can we remember why we got so excited about things. All of it – business, money, houses, cars, people – all seem a little small and dull against the immense majesty of the Great Eternal Unknown.