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.
dope
Hey - you are the one paying $56 for a Chinese meal.
At least you are vaguely in touch with the gold price
Watch the Chrissy Mathews show. It's actually been very very watchable. He's been covering Iran's nukes for the last two days
Thanks and ping and read the posts below
And you may have a scintilla of a sense of humor which you have not yet demonstrated.
I just bought my first 1/10 oz Eagle yesterday! I bought it just to feel it and see it and show it. (I don't leave the big ones around!)
In my new novel, small gold coins are going into circulation just as you mentioned. The coins are minted at Indian casinos, where they are happy to take gold in trade from gamblers. The casinos become freewheeling money and gold changing centers, where the devaluing paper money is changed for gold coins.
And yes, that Chinese restaurant would be MORE than happy to take a couple of 1/10 OZ gold pieces in return for a magnificent private room dinner for 10. They would use a calculator and figure the value of the gold in several currencies as fast as you could run a credit card.
You are my friend so keep your eye on US debt and keep your eye on gold. Gold is real money. Play your paper and plastic (credit card) games but gold is real money
You have a good memory and are so correct. Don't forget the complicity of the MSM who purposefully ignored positive economic developments until after the election.
Anyone who does not look at the chart at #35 and not take it like a bucket of cold water in the face is in a coma.
I think I have an extra not in 51.
By printing more money and dropping it from helicopters.
Shhhh! Better not let the sheeple know. Maybe we better stop releasing M-3 data.
This is not the same country it was 20 years ago.
Then we were a creditor nation. Now we are a debtor name.
Then we produced things. Now we consume them.
And so on.
Point one: Our currency has not been debased, but the value storage medum has changed from gold to GDP. It is not a big change as the only requirement is that a currency be backed with some form of value storage.
Point Two: If we printed more currency than our GDP would allow, we would experience inflation, less and we would experience deflation. Printing more money than we have in value storage, (generally for the benefit of government programs) would be a debasement of our currency. Simply trading one value storage medium for another is not debasement.
Point three: Since the Humphrey-Hawkins act has been permanently placed in the freezer for the future, the Federal Reserve, under the leadership of Paul Volcker and Alan Greenspan, have busied themselves with only one primary objective: To tabilize prices. THAT IS THE ROLE OF THE CENTRAL BANK, IN THIS COUNTRY AS WELL AS OTHERS. To adjust money and credit supply to match the available value of value stored in our GDP.
Point Four: Gold will never again be the backing for currencies. There just isn't enough gold to go around and the value can be easily manipulated by large holders of the metal. It is worth less industrially as it has been replaced by other metals that are more available and easier to use in industrial applications.
Point five: Credit is money. There is actually a very small amount of paper and coin currency in circulatiom. Most transactions are handled through credit cards and loans. I have heard that less than 5% of the transactions in the US involve specie and I suspect it is less than that.
Point six: The Economist is, in some ways, a holdover from the time when most economists, because most of their funding came from the Feds, were substantially left wing and many of them were socialist. This has started to change because of the successes of the "Supply-siders" (Classical economists). The Economist has been warning the world of the impending death of the American economy since the Reagan administration and they have been consistently wrong. I cancelled my subscription because I felt that they had become agenda driven or had become ossified due their presence in and their outlook for the EU and thier particular regard for the socialist policies that the EU has pursued.
Many of their insights into the American economy have not been dead wrong, but 180% wrong. And I refuse to pay for that level of expertise, no matter how prestigious the publication.
Bull. I have been living on Lewis Farrakan's earth orbiting cylinder, quite happily I might add.
BTW, did you remember to stop by the store and buy some gold about six months ago?
Chinese people and Indian casinos are working at a true instinctual level. Of course they know the value of gold and gold coins
You have a great scenario there for your novel. Where Injuns become gold to cash brokers
superlative
I'm feeling good tonite because Chrissy is defending Alito and has been talking Iran/nukes
THANKS CHRIS MATTHEWS AND I MEAN THAT
Thank you
Disclaimer: Opinions posted on Free Republic are those of the individual posters and do not necessarily represent the opinion of Free Republic or its management. All materials posted herein are protected by copyright law and the exemption for fair use of copyrighted works.