Posted on 01/13/2006 1:17:20 PM PST by Travis McGee
The economy that Alan Greenspan is about to hand over is in a much less healthy state than is popularly assumed
DESPITE his rather appealing personal humility, the tributes lavished upon Alan Greenspan, the chairman of the Federal Reserve, become more exuberant by the day. Ahead of his retirement on January 31st, he has been widely and extravagantly acclaimed by economic commentators, politicians and investors. After all, during much of his 18½ years in office America enjoyed rapid growth with low inflation, and he successfully steered the economy around a series of financial hazards. In his final days of glory, it may therefore seem churlish to question his record. However, Mr Greenspan's departure could well mark a high point for America's economy, with a period of sluggish growth ahead. This is not so much because he is leaving, but because of what he is leaving behind: the biggest economic imbalances in American history.
One should not exaggerate Mr Greenspan's influence—both good and bad—over the economy. Like all central bankers he is constrained by huge uncertainties about how the economy works, and by the limits of what monetary policy can do (it can affect inflation, but it cannot increase the long-term rate of growth). He controls only short-term interest rates, not bond yields, taxes or regulation. Yet for all these constraints, Mr Greenspan has long been the world's most important economic policy maker—and during an exceptional period when globalisation and information technology have been transforming the world economy. His reign has coincided with the opening up to trade and global capital flows of China, India, the former Soviet Union and many other previously closed economies. And Mr Greenspan's policies have helped to support globalisation: the robust American demand and huge appetite for imports that he facilitated made it easier for these economies to emerge and embrace open markets. The benefits to poorer nations have been huge.
Advertisement So far as the American economy is concerned, however, the Fed's policies of the past decade look like having painful long-term costs. It is true that the economy has shown amazing resilience in the face of the bursting in 2000-01 of the biggest stockmarket bubble in history, of terrorist attacks and of a tripling of oil prices. Mr Greenspan's admirers attribute this to the Fed's enhanced credibility under his charge. Others point to flexible wages and prices, rapid immigration, a sounder banking system and globalisation as factors that have made the economy more resilient to shocks.
The economy's greater flexibility may indeed provide a shock-absorber. A spurt in productivity has also boosted growth. But the main reason why America's growth has remained strong in recent years has been a massive monetary stimulus. The Fed held real interest rates negative for several years, and even today real rates remain low. Thanks to globalisation, new technology and that vaunted flexibility, which have all helped to reduce the prices of many goods, cheap money has not spilled into traditional inflation, but into rising asset prices instead—first equities and now housing. The Economist has long criticised Mr Greenspan for not trying to restrain the stockmarket bubble in the late 1990s, and then, after it burst, for inflating a housing bubble by holding interest rates low for so long (see article). The problem is not the rising asset prices themselves but rather their effect on the economy. By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal saving rate, a growing burden of household debt and a huge current-account deficit.
Burning the furniture Ben Bernanke, Mr Greenspan's successor, likes to explain America's current-account deficit as the inevitable consequence of a saving glut in the rest of the world. Yet a large part of the blame lies with the Fed's own policies, which have allowed growth in domestic demand to outstrip supply for no less than ten years on the trot. Part of America's current prosperity is based not on genuine gains in income, nor on high productivity growth, but on borrowing from the future. The words of Ludwig von Mises, an Austrian economist of the early 20th century, nicely sum up the illusion: “It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises.”
As a result of weaker job creation than usual and sluggish real wage growth, American incomes have increased much more slowly than in previous recoveries. According to Morgan Stanley, over the past four years total private-sector labour compensation has risen by only 12% in real terms, compared with an average gain of 20% over the comparable period of the previous five expansions. Without strong gains in incomes, the growth in consumer spending has to a large extent been based on increases in house prices and credit. In recent months Mr Greenspan himself has given warnings that house prices may fall, and that this in turn could cause consumer spending to slow. In addition, he suggests that foreigners will eventually become less eager to finance the current-account deficit. Central banks in Asia and oil-producing countries have so far been happy to buy dollar assets in order to hold down their own currencies. However, there is a limit to their willingness to keep accumulating dollar reserves. Chinese officials last week offered hints that they are looking eventually to diversify China's foreign-exchange reserves. Over the next couple of years the dollar is likely to fall and bond yields rise as investors demand higher compensation for risk.
When house-price rises flatten off, and therefore the room for further equity withdrawal dries up, consumer spending will stumble. Given that consumer spending and residential construction have accounted for 90% of GDP growth in recent years, it is hard to see how this can occur without a sharp slowdown in the economy.
Handovers to a new Fed chairman are always tricky moments. They have often been followed by some sort of financial turmoil, such as the 1987 stockmarket crash, only two months after Mr Greenspan took over. This handover takes place with the economy in an unusually vulnerable state, thanks to its imbalances. The interest rates that Mr Bernanke will inherit will be close to neutral, neither restraining nor stimulating the economy. But America's domestic demand needs to grow more slowly in order to bring the saving rate and the current-account deficit back to sustainable levels. If demand fails to slow, he will need to push rates higher. This will be risky, given households' heavy debts. After 13 increases in interest rates, the tide of easy money is now flowing out, and many American households are going to be shockingly exposed. In the words of Warren Buffett, “It's only when the tide goes out that you can see who's swimming naked.”
How should Mr Bernanke respond to falling house prices and a sharp economic slowdown when they come? While he is even more opposed than Mr Greenspan to the idea of restraining asset-price bubbles, he seems just as keen to slash interest rates when bubbles burst to prevent a downturn. He is likely to continue the current asymmetric policy of never raising interest rates to curb rising asset prices, but always cutting rates after prices fall. This is dangerous as it encourages excessive risk taking and allows the imbalances to grow ever larger, making the eventual correction even worse. If the imbalances are to unwind, America needs to accept a period in which domestic demand grows more slowly than output.
The big question is whether the rest of the world will slow too. The good news is that growth is becoming more broadly based, as demand in the euro area and Japan has been picking up, and fears about an imminent hard landing in China have faded. America kept the world going during troubled times. But now it is time for others to take the lead.
LOL. "and therefore immigration" should say "and therefore IRRIGATION" Oops.
That's why I referred to the "phasing in the FRB in the 20th century". Better still, we might even say it was the Fed's phasing out the gold standard that did it.
In 1922 we still had gold money that looked like this. We had the Fed but still no monetary control to speak of, either de jure or de facto. The fed was still clueless into the 30's when the fit hit the shan and Rosevelt got elected and finally ended gold clauses in gov't contracts and made the dollar something people could actually use. That very day the stock market leaped ten percent and another the next day. Over all, evolution was still slow.
The final breakthrough was '72 with ditching the Breton-Wood's international gold standard. A gradual process was all that was possible I suppose given everyone's phobia for change, but looking back we see ourselves a lot better off with prices finally under control. Sure, a lot of other things got better too, but it's virtually impossible to imagine the other benefits if we still also had pre-Fed chaos.
Likewise, the Dow isn't adjusted for taxes and brokerage fees that Joe Q. Citizen would pay from year-to-year on his Dow holdings.
I think a chart that incorporated everything, including splits, dividends, and was plotted against gold would be very interesting.
more a learned the less I felt it was an important metric
I disagree. I would concur that it wasn't a metric if it diverged one way or the other over 100 years. But that isn't the case. Instead, you see an oscillation between the relative values of gold and the dow. Another confirmation that it is a useful metric is that the amplitude of the oscillation inceases with time. That is, you get higher highs and lower lows with each reversal in the market.
Personally, I'm expecting to see a Dow:gold ratio of 1 again.
So you really believe the government CPI numbers?
The optimal currency would hold its value from year to year with no deviation whatsover. The next best thing is one that oscillates about the constant value (as was the case until the Federal Reserve got involved). Of course, the lower the amount of the oscillation, the better. The worst currency you can have is one that is constantly losing its value. Ask the Germans or the Romans or the Argentinians how this worked out.
naked, starving, and crying
That was more a factor of lack of technology rather than the lack of a central bank.
Anyway, those "naked, starving, and crying" Americans didn't do too badly from 1790 to 1913. The conquered a continent, created a wonderful country based on individual Rights, and created countless inventions. Part of this reason what that until 1913, the advice of Washington, Jefferson, and other Founders, was heeded and we more or less had a currency backed by gold.
If we had a fiat paper currency from 1790 to 1913, then America would have just been another Mexico.
For a supposedly "conservative" website, there sure are a lot of folks here who support centralized planning as it relates to the currency. Why not let the market decide?
If you want to know the rules and regulations, go to the NYSE website and then read the FAQ part.
Prior to 1987, an 100 point slide would trigger a "stop". After that, it went to 200. I don't know what the exact figure is now and there have been NO "stop" set offs since '87. The markets were all shut down, BY AN ACT OF WAR, on 9/11. This lasted three days. No, you couldn't divest yourself of your holding for those three days, but neither could you have used your gold to buy anything either.
Keep on posting...you are only proving, beyond a shadow of a doubt, just how uneducated you are on this topic and many other. Your analogies are error filled and inane. Neither are your price quotes accurate.
An eight year old would be able to understand what I have been writing; you can't. Pardon me for assuming that even a very simplified post would be clear to you. LOL
Gee.don't take my word for anything. Instead, believe, completely, the FICTIONAL. completely unsubstantiated posts made by the tinfoilers. ;^)
Neither our economy nor our money was as stable as you claim. There were market BUBBLES, real estate BUBBLES, bank failures, native born BUM armies which roved throughout the land terrorizing people, farm failures, mortgage collapses, foreclosures, inflation, and on and on and on! Your alternate history flies in the face of facts.
Mexico actually had a silver based currency through most of the period mentioned above. Their flirtation with paper money is about the same age as ours. The US silver dollar was set up to be the same as the orgininal Mexican peso, which in turn was based on the Spanish 8 Real.
But my full statement was "the government essentially requires you to have a 401k if you have any hope of retiring".
Not quite the same thing, is it? What's the alternative - save after tax dollars that the government has already taken somewhere between 35 and 55 percent of? Hope Social Security survives?
I like all kinds of ways of measuring inflation-- each method has a different purpose. There's the CPI or the PPI from the BLS for gaging labor trends (don't even ask me about the ECI), there's the GDP deflator from the BEA for checking overall economic changes, I've even come to use various university data sets (here's a cool site).
--but to hell with all that! If you've really got some kind of inflation numbers that show price stability for "150 years" and then show price increases "about 6-10% today" then I'd really like to see them! Unless you're just making all this stuff up, in which case you really had me going for a minute there ;^).
That word "essentially" sure is slippery one. There really is (yet) no government savings law. Some people save and some don't. You may be saying that anyone who can but doesn't save will either starve live off others but that's hardly a 'requirement' (essential or otherwise) considering that this is the path chosen by many, if not most people.
For the self employed, there are several other financial implements one can use. For everyone, there are before tax dollars one can use as well. And whether someone uses before or after taxed monies, it's a very good idea to have funds put by; not only for one's retirement. Social Security was, in point of fact, NEVER supposed to cover, IN FULL, one's expenses in their old age. Anyone who thought that was the case, was/is just plain old stupid!
:-)
I've invested in the stock market and in metals. It just seems that when I buy gold that I am holding something of value of the least risk while a stock must be watched daily for volatility. Gold isn't a money maker in the long term, but right now it is. Stocks are as worthless as the computer I use to buy them. They are great money makers as trading cards, but they have zero value; they only have a price. Their price can disappear instantly. I know. I’ve had that happen a few times. Gold is something whose price does change but it never drops to nothing.
If companies would pay dividends and couldn't cancel stocks on nearly a whim maybe stocks would have continuous value. The idea that dividends should be put into investment into the company is silly as I invest for returns not for the hope that someone else will speculate on my stock and buy it.
The fact is few companies actually make profits to pay dividends. Most recorded profit is false as they play shell games with the books. A profitable company is one that makes enough profit to pay dividends and has enough to invest in their continued profit making endeavors. If a company has to put all they earn back into company, then how do the executives rationalize paying themselves the high salaries and bonuses that they do? I thought every nickel needs to go back into the company?
Our economy is quickly basing itself on the hourly service employees provide and not in the wealth that producing products provide. A company that makes a physical product has something of value. Service companies have no wealth. They only have the hourly effort an employee provides or the profit of moving someone else’s product around.
An example is the mouse that I am using right now: “Made in China” for Dell. Multiple departments at Dell are involved with it’s purchasing from China and selling and distributing it to me. The value is the mouse. The services to get it to me are bloated and unnecessary. China could just as easily shortcut the Dell supply chain and sell me the mouse nearly direct from them, and I could pay even less. Yet, there are probably 100+ people at Dell and other companies involved with Dell in supply me the mouse: A $1 product with $15 in overhead. That isn’t value or wealth and subject to collapse. Should China find a way to sell me the mouse, there are 100+ people that I don’t need anymore.
I was responding to this: In 1963 a decent suit cost around $35.00, same as an ounce of gold. Today a decent suit costs around 500 bucks, just about the same as an ounce of gold. Therefore in around 40 years gold has neither gained nor lost any purchasing power. That's what I meant by 'worth'.
Now, if you agree that this anecdote is true, and gold has kept the same value for the last 40 years, it shouldn't matter what you compare gold to or what time frame you consider. If you think an anecdote comparing gold to a single consumer product 40 years ago is a silly "fact" on which to base such a broad assertion, join the club.
That's exactly the point. Gold maintains its purchasing power over time. Fiat currencies do not.
Did you forget my post?
If you buy anything else, let's say a house, then gold isn't as good. In 1980 the median house was about $71,000 (about 90 ounces of gold) in 2005 the median house was about $253,000 (about 500 ounces of gold)
Gold hasn't maintained its purchasing power since 1980.
Fiat currencies do not.
If you can find where I said they did, you can slap me like I slapped lurker.
LOL!! Gold hasn't outperformed equities, except when it has.
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