The True Greenspan Legacy

As Alan Greenspan’s reign as Fed Chairman gets closer to its end, people all over the press are either singing his praises or denouncing his practices. Today, Dr. Richebächer takes a look at the maestro’s policies and theories…

Reading so many ecstatic laudations on Fed Chairman Alan Greenspan, "the greatest of all central bankers," two other names and occurrences came to mind. The one was John Law and his tremendous wealth creation through rigorously inflating the share prices of the Mississippi Company. And the other was former Fed chief Paul Volcker and his recent article in the Washington Post titled "An Economy On Thin Ice," wherein he expressed his desperation about the economic and financial development in the United States. Though he never mentioned his successor’s name, it was all about him and his policies.

Just a few samples from Paul Volcker’s assessment:

Under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks – call them what you will. Altogether, the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it…

I don’t know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change.

The Greenspan Legacy: The Conventional Great Merits of Mr. Greenspan

What, after all, are the great merits of Mr. Greenspan, according to the conventional laudations? They are, actually, seen in two different fields: first, in the striking successes of his actual policies; and second, in notable contributions to both the theory and practice of monetary policy.

His policy successes seem, indeed, all too conspicuous: lower inflation rates than expected despite strong GDP growth; high gains in job growth; and low rates of unemployment. And yet only two mild recessions, of which the second one, in 2001, was so mild that it disappears when quarterly data are aggregated to a year.

His extraordinary successes are generally attributed to radically new practices in monetary policy. The Financial Times ran a full-page article under the big headline "Greenspan’s Record: An Activist Unafraid to Depart From the Rule."

To quote the paper presented by Alan S. Blinder and Ricardo Reis of Princeton University at the Federal Reserve Bank of Kansas City symposium on this point: "Federal Reserve policy under his chairmanship has been characterized by the exercise of pure, period-by-period discretion, with minimal strategic constraints of any kind, maximal tactical flexibility at all times and not much in the way of explanations."

It is true Maestro Greenspan disregarded any established rules in central banking. To escape the consequences of the equity bubble that he created in the late 1990s, he generated a whole variety of new bubbles that radically changed the U.S. economy’s growth pattern. What he achieved was the greatest inflation in asset prices in history, which became the economy’s new engine of growth. What about its inevitable aftermath?

The Greenspan Legacy: The Only Rule

If Alan Greenspan jettisoned all inherited rules, he nevertheless chose one predominant rule, actually, his only rule: a strictly asymmetric policy pattern. Every central bank has two policy levers at its disposal. The big lever is changing bank reserves, the banking system’s liquidity base. The little lever consists in altering its short-term interest rate.

Whenever monetary easing appeared opportune, Mr. Greenspan has acted rigorously with both levers. When it seemed to require some tightening, he always acted hesitantly and only with his little interest lever. He has never seriously tightened bank reserves. Though hard to believe, he has actually been easing the Fed’s reserve stance since last May.

This is most probably occurring because the continuous rampant credit expansion is increasing the banking system’s reserve requirements. Nevertheless, to keep the federal funds rate at its targeted level of 4%, the Fed has to provide the higher reserves.

What this means should be clear: The Fed is anxious to avoid any true monetary tightening in the apparent hope that the "measured" rate hikes will softly do the job over time, causing less pain. Most probably, though, this implies more rate hikes and more pain – later.

It was, as a matter of fact, precisely the same kind of experience that induced Volcker to abandon such strict funds rate targeting in October 1979 in favor of targeting bank reserves. It marked the fundamental divide in U.S. monetary policy from prior persistent monetary looseness and a strong inflation bias to genuine credit tightening, ushering in a secular decline in the inflation rates.

The Greenspan Fed has returned to dubious interest targeting, while explicitly restricting itself to "measured" – in other words, very slow – rate hikes. The true monetary ease shows in the continuance of the relentless credit deluge.

When Alan Greenspan took over as Fed chairman in 1987, outstanding U.S. debts totaled $10.57 trillion. According to the latest available data, they stand at $37.35 trillion. This is definitely Mr. Greenspan’s most conspicuous achievement.

To escape the aftermath of the equity bubble, the Fed created the housing and bond bubbles in 2001 and the following years. It is time, we think, to ponder the aftermath of these two asset and credit bubbles. The inverting yield curve is primarily threatening the huge existing carry-trade bubble in bonds. But the big housing bubble and the smaller car bubble too have plainly peaked. Rising interest rates and poor income growth are relentlessly taking their toll.

It should be immediately clear that the potential economic and financial aftermath of a bust of these bubbles will be many times worse than the potential aftermath of the earlier equity bubble. Spending and debt excesses have multiplied over the past four to five years to an extent that threatens the stability of the whole U.S. financial system.

Lately, Mr. Greenspan’s public speeches have insinuated that the high asset prices in the United States in recent years may, ironically, be due to the extraordinary success of his policies, by leading investors to demand lower risk premiums. Eventually, however, this reverses and asset prices fall reflecting "the all-too-evident alternation and infectious bouts of human euphoria and distress and the instability they engender."

The Greenspan Legacy: Complete Silence

Yet he emphasized that it is "simply not realistic" to expect the Fed to identify and safely deflate asset bubbles. The right response in his view is for all policymakers to keep markets as flexible and unregulated as possible. Flexible markets, he said, helped absorb recent shocks, such as stock-bubble collapse and the Sept. 11, 2001, terrorist attack.

We are not sure what shocked us more, this senseless, arrogant remark or the complete silence on the part of American economists. Exuberance, just by itself, is unable to inflate asset price levels. The indispensable primary condition is always credit excess, and Mr. Greenspan delivered that in unprecedented profligacy. By the nature of things, loose money and credit excess lead, and exuberance follows.

America’s reported economic recovery since 2001 has been its weakest by far in the whole postwar period. For the working population, there never was a recovery. They speak euphemistically of a shortfall of employment and income growth. It is better described as a fiasco for both.

Two acute dangers presently lurk in the U.S. economy and its financial system. One is the inverting yield curve threatening to pull the rug out from under the huge carry-trade bubble in bonds, and thereby from under the housing bubble. The other is the slump in consumer spending. Consumer borrowing is slowing, while employment and labor income growth are weakening again.

It seems that the carry-trade community is betting on prompt rate cuts by the Fed if something goes wrong in the economy or the financial system. We suspect that the Fed, grossly underestimating the enormous vulnerabilities in both sectors, will stick to its rate hikes. The interest "conundrum" is pretty much the only thing holding up this house of cards.

"Super-liquid markets" has become the common bullish catchphrase. It should be realized, however, that the existing liquidity deluge in the United States and some other countries has its sole source in the monstrous asset bubbles providing the collateral for virtually limitless borrowing. It needs a sharp distinction between earned liquidity from saving and borrowed liquidity accrued from asset bubbles. The latter kind of liquidity can vanish overnight.

The sharp surge in inflation rates is forcing the Fed to continual rate hikes. Doing so, it takes enormous risks with the existing bubbles. Bluntly put, it has lost control.


Dr. Kurt Richebächer
for The Daily Reckoning

Decemeber 14, 2005

The Fed has remained irrationally confident in the U.S economy – because they can’t afford from American consumers to see the truth – that the basis for this confidence is a shamelessly fraudulent farce of trumped-up statistics.

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."

Another rate hike by the Fed yesterday, its 13th since it began in 2004.

Everyone said it would raise rates another time. It did. The Dow rose 55 points. Why not? Fed officials said the economy is "solid."

Of all the many adjectives that could apply to the U.S. economy, "solid" probably describes it least well. It may be "dynamic" – we don’t know. It may be "flexible," "spectacular," or many other things. But solid it is not.

We have mentioned the reasons many times. We are getting as bored reciting them as you must be hearing about them. So, we move on.

We leave only the remark that an economy in which people earn less than they did the year before, spend more than ever, and save less than nothing is not solid. It is hollow. Or it is empty. Or is it soft…squishy…molasses-like.

If it is not solid, it is a liquid or a gas. In our guess, it is nothing more than a bubble floating in a world of pins.

"Yes, but American businesses are becoming more profitable than ever," say the Feds. "That’s why so many people want a piece of this economy…that’s why foreigners are willing to lend…and that’s why we don’t have to worry. The economy is in great shape."

At least in theory, American businesses are able to trim payroll costs – either by directly outsourcing to lower-cost areas, or benefiting indirectly from the globalization of the labor markets that has kept real U.S. hourly wages from rising for the last 30 years.

The problem is obvious. Unless U.S. businesses are able to sell overseas as well as buy overseas, their main market is still right here at home. How then can they sell more and more product to people who don’t earn more money? There is only one way: by expanding credit. The buyers have to go further and further into debt.

"Well, why can’t they just keep going into debt? After all, the value of their assets (presumably, value of the nation’s ever-more profitable businesses) is rising."

But rising asset values are a feint and a fraud. You can’t really sell off your house one room at a time in order to improve your lifestyle. Nor are companies that sell more products to more people who can’t afford them really worth more. At the end of the day, the apparent strength and solidity of the economy just evaporates.

Gold fell yesterday. It is in an upward trend, we guess, because it knows the economy, the dollar, and U.S. stocks and bonds are not nearly as "solid" as the feds say they are. Gold is really solid. People who want a little solidity in their lives hold gold. The more they sense that other things are not solid, the more they want to feel something solid in their pockets.

"You know, there is just something nice about gold coins," said my old friend Doug Casey, the other day. "I just like the feel of them. They just feel solid."

Doug told us that our technique of buying gold on dips will be hard to implement: "This market is taking off. It’s not going up and down like a yo-yo…giving you a chance to buy every time it goes down. Instead, it’s a like a train leaving the station. You’re either on board or you’re not."

The gold bull market has entered its second phase. In the last five years, the price doubled, but there were many chances to get into gold at good prices. We recommended it below $300. Each time it would go up, people would say, "well, that’s the end of that." And each time, gold would go down. Buyers were discouraged. Often, they waited to see if it would go down more before buying. Then, the price would take another step up.

Now, the market is taking bigger steps. The cautious buyer is finding it harder than ever to get into gold, because it doesn’t drop back far enough to hit his or her targets.

"It’s time to change the strategy," said Doug. "Look, the price could easily go to $1,000 an ounce next year. It won’t matter if you bought at $500 or $550. You’ll be way ahead of the game. I know I’m on board this train."

We’re going to ride it to glory, dear reader.

The last bull market in gold, in the 1970s, took the price up some 21 times from where it began. Then, gold gave way, and a bull market in stocks took the Dow up 11 times from where it started. This bull market in gold has only doubled the price. It has a long, long way to go.

More news from our currency counselor…


Chuck Butler, reporting from the EverBank trading desk in St. Louis:

"Yes, for 18 months now, the Fed has pretty much told us the accommodation of lower rates was being removed, and that the moves would be ‘measured.’ Yesterday, they broke from that routine, and removed the ‘accommodation’ word altogether!"


Bill Bonner, back in Bal’mer with more commentary…

*** "Are you depressed?" one reader asked us.

"They say people get more depressed during the holidays," he continued. "I received the following e-mail that might contain the root cause:

"According to the Congressional Budget Office, the federal government spent (PDF) nearly $2.5 trillion during the 2005 fiscal year. This means that, on average, the federal government spent nearly $6.8 billion each day, or $78,418 per second. The Census Bureau estimates (PDF) that in 2004 (the latest year for which data are available), median household income in the U.S. was $44,389.

"In short, the federal government spends almost twice as much money in only one second as a typical American household earns in an entire year."

Well, dear reader, if you weren’t depressed before, that little tidbit just might do it.

*** Last week, Jonathan Clements noted in the Wall Street Journal that:

"Over the last five years, total annual borrowing through student loans has soared 85%, easily outpacing the 41% rise in public-college costs and the

28% increase at private schools." So, kids are following the example their parents set: borrow like there’s no tomorrow. And they’re not only borrowing for school, they’re borrowing to buy beer and pizza, too. Perhaps that’s why McDonald’s decided recently to accept credit cards.

"Even amongst the most well-to-do, borrowing a lot of money at a very young age seems to be vogue…among kids graduating last year from private non-profit four year colleges, 73% had taken out loans, typically borrowing $19,400, according to the College Board. These kids of credit cards, too – 91% carry at least one card and have $2,864 average balances."

*** While many Americans are wading through their debt, making minimum payments or just wishing it away, one DR reader has decided he won’t let debt worries run his life:

"Against my conservative nature, I shelled out $1,000 for Sala’s report through Agora. On Monday 12/12/2005 morning at the opening of business, I placed limit orders on all stocks in Sala’s special report (limits at her highest recommended prices), purchasing $15,000 of her three India picks.

"I spent approximately $5,000 per symbol through my online brokerage account. The money to purchase these shares came out of my home equity line, and I’m already up over $300. With any luck, Sala’s stocks recommendations and a purchase of 2.5 pounds of Gold bullion earlier this week will eliminate my mortgage debt.

"By the way, I bought your two books on The Demise of the Dollar and Empire of Debt. I’m halfway through the first and it’s pretty damn good if I should say so myself. (Normally I’m bored silly by these finance books but you’ve got an amazing conversational style that takes the edge away, Addison.) It should become a staple for MBA grads.

"Please send my regards to Sala and pray for a tsunami of cash to hit India’s financial shores to buoy these shares to the crest of the mountainous wave! It will be a view to a kill, as the old Silicon Valley cliché goes."

*** And one more from the DR mailbag…

"For 50 years, I have been an investor wandering in the desert searching for useful financial advice," writes John Kiser, from Wichita, Kansas. "To pursue that analogy, Agora Financial is the long sought and unbelievable oasis.

"Your book tells it like it is. The humor is a delightful bonus. Every page is a wonderful surprise in humor, fact, political insight, and economic insight. Thanks."

Thank you, Mr. Kiser. We always appreciate a kind word – and an appreciation of our (sometimes twisted) sense of humor.

But more than that, we appreciate what he included along with his note: four letters that he recently sent to members of Congress and the Senate. Here is a brief snippet:

"I am a life long Republican, a 68 year-old retiring general surgeon, and an economic conservative. I believe that our country and its leadership have completely lost their way.

"A book entitled Empire of Debt should have recently been delivered to you. This book paints a horrible picture of our leadership. Unfortunately, I believe it is true. Please find time to read it. I am purchasing my copy of it for my family and many of my friends. I will help provide it for all who will read it in Washington."

*** How the days dwindle down when you get close to the end of the year! And what a change from Argentina! Maryland is covered in snow. It is beginning to look a lot like Christmas.

We are back in Baltimore for our annual opportunity to play Fezziwig at the company party. Last night, we went to a reception at the Nicaraguan Embassy in Washington. The cab driver filled us in on the latest real estate trends.

"Look over there. Those houses now sell for $400,000. They used to be boarded up. This was the ghetto, but I picked up a white woman the other day. She told me where she wanted to go. I asked her if she was sure we wanted to go to that address, because I knew that area of town…and I didn’t think she wanted to go there, But I thought it was a party or something. It turned out she bought a house up there. I tell you things change quickly around here. And now all these houses are selling for, I don’t know, $200,000…$300,000…$400,000."

We recalled that we once owned two houses in the area (a few blocks north of the Capital). That was back in the late ’70s, maybe the early ’80s. We paid $12,000 for each of them, but the area was infested with rats and drug addicts, and the city was cracking down. We were ordered to make repairs that we judged more expensive than the houses were worth. Besides, we figured it was too dangerous to work on the places ourselves. So, we gave them both to charity outfits.

The Daily Reckoning