Danger Time for America

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.

"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."

--TexanToTheCore, 2006

"If recession should threaten serious consequences for business (as is not indicated at present) there is little doubt that the Federal Reserve System would take steps to ease the money market and so check the movement."

--Harvard Economic Society, October 19, 1929

Keep on chugging that Koolaid, TTTC. The more you drink, the better it tastes.

But now, economic reality is a knock-knock-knocking on the door. See anything interesting about this chart? BTW, the current lucky number is 20, on its way (fast!) to the historical range of 3 to 5.

Travis, I know whereof I speak; unlike you. Just because you write fiction books, doesn't mean that your tinfolil covered posts should be taken as anything other than the FICTION you get printed.

For starters, the stock market crash of 1929, was due, in large part, to buying on margin and the fact that yes, it was herd mentality and a BUBBLE. Yes, that's the simple dumbed down version, but I fear that that's about all you are capable of understanding.

The markets WERE making a comeback, but Joe Kennedy and his syndicate went in and SOLD, SOLD, SOLD! So Morgan's money and his group couldn't effectively pull a sustainable market back. Actually, they DID help and the market rallied a bit.

The worst of that DEPRESSION didn't hit full force, until '33.

Now, throw in the DUST BOWL, the world wide depression, and world wide strikes, and you have something that is absolutely NOT in evidence today.

And as far as all of the rules, regulations, and in place safeties, HELL YES, Travis, I know faaaaaaaaaaaaaaaaaar more about them than you EVER will! All you're doing, is posting emotional, tinfoiled cover codswallop!

Obviously, you enjoy writing scenarios to scare yourself and your readership. Some people get a kick out of that, I guess, but once you start taking yourself seriously, as do the gullible and ill educated, then it's time for someone to take you do several pegs and post the nonfiction, FACTUAL truth.

I'll say it again...IT IS IMPOSSIBLE, TODAY, FOR THERE TO BE A CRASH, EXACTLY LIKE THE ONE IN 1929 !

And your goldbuggery claims, your juvenile hyperbolic bloviation, can't make what I say not true!

Hey Mase and Todd...the doom&gloomers are at it again. LOL

Yes I was an adult in 1987, not that it has anything to do with my question.

Now, here's another one for you. How long does the 'cooling off' period last? Is it three days like a handgun purchase? What if people don't 'cool off' they way they're supposed to?

Perhaps my question is a bit too simple for you, but I think it's a fair one. If you can't buy or sell something, then does it really have any value?

I mean what good is 5000 shares of Acme Inc if I can't sell it?

You're falling prey to a rather elementary flaw in logic my friend. You assume that because something hasn't happened that it can never happen. That's a serious error.

Now I'm no gold bug, although in the interest of full disclosure I've got a couple of ounces of the stuff in 1/10th rounds stashed in my safe along 100 or so ounces of silver in 1 oz rounds. It's not a fortune, but it's there for a SHTF scenario.

I am invested in the market. I've got 401ks, the Mrs. has a 403b, and we've got a 529 and a mutual fund set up for Lurker Jr. That doesn't mean I don't think there can never, ever, under any circumstances be a repeat of something like the '29 scenario.

I know it could never be exactly the same as '29, but to say that there can never, ever, be a substantial loss of market capitalization due to some unknown external action is a bit of hubris I don't care to engage in.

So, please explain to me all about these 'cooling off full stops', and please answer the questions about what happens if people don't 'cool off' in the manner or time frame you expect them to.

Thanks in advance.

It looks to me like he or she is 'in the business' somehow and is trying to convince us that the market can never crash.

I'll agree with np that this is a most unlikely scenario. There are lots of new laws and regs there that are supposed to protect the average schmuck like me who's trying to save something for retirement and to educate my son.

But that doesn't mean I'm in the crowd who says it can never, ever, ever, under any circumstances happen again. People who say things like that are whistling past the historical graveyard IMO. Besides, they just look plain silly.

I am very interested in an answer to my question about these 'cooling off' periods. I mean if I own something but I'm not allowed to sell it, nor is anyone else allowed to buy it; then how can anyone possibly say it has monetary value?

Oh well. I'm down here in the OEM Bunker till about 0800 local so I can hang around a while for the answer. It's a quiet night so far (damn I shouldn't have said that; now buildings will begin to spontaneously burst into flame and I'll have to wake people up and send them out...)so I've got time.

How's the book coming? You're leaving me hanging.

Fortunately I just got a shipment from B & N so I can dig into Ayoobs "Stree Fire II" and a book I got on long range shooting. It's been a while since I had access to a 1000 yard range so I figure reading up can't hurt.

I was just going to make some popcorn and watch you two go at it, but I did have that nagging little question I wanted answered.

Take care,

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.

I think the claim for debasement is in relation to the GDP, not gold. It's hard to make claims about debasement vs. gold because, as you point out, we're not on gold. The money supply has increased far faster than the GDP. I believe it's something like 4.5X for the money supply since 1980 and only 2X for the the GDP. The growth in M3 took off at a much higher rate in about 1990.

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.

Yep. And that's exactly what many claim has happened. Again look at M3 and GDP. Of course Greenspan and the Fed have now announced they will stop reporting M3. Convenient! (Can you imagine the uproar if Bush stopped reporting casualties from Iraq, or Federal spending) As for inflation I think I heard on the news that it's the highest it's been in 15 years, but it's all food and fuel, and the core rate is lower. Again, many knowledgable people believe the rates are not very accurate measures and are openly formulated to understate reality.

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.

Really? I guess I was imagining the "soft landing" that Greenspan tried to provide after the stock bubble burst, the emergency bailout of the Mexican Peso in 1995, the emergency bialout of Southeast Asia in the late 1990s, the Y2K cash infusion, the excess cash used to pump the economy post 9/11 and the Long Term Capital bail out. I guess I was also imagining the agreement to help "dollarize" the economy of Urugay, innumerable debt swaps with third world countries, etc.

Watch what they DO not what they SAY. All these bail outs, helping hands and interventions used the same tool: more money was created. That's why the M3 took off in 1990 and never came back.

As for "stable prices" don't make me laugh. Stable prices are what England had for over a hundred years on the classic gold standard. We were not too far off in the 1900s either. Since the Fed was created our money has lost 95% of it's purchasing power. Constant and unending inflation, even at so-called "moderate" rates destroys the value of money just as surely as the reverse mechanism, compound interest, can create wealth over long periods of time.

Point Four: Gold will never again be the backing for currencies.

Very possibly true. That doesn't mean the basis of international money might be something other than the dollar. The position of reserve currency, which the dollar took over from gold first at Bretton Woods, and finally when Nixon 'closed the gold window'. At some point major economic players, who are not in love with the USA, may find a different backing for their fiat currencies. Peg the value to the Euro, create a new IMF uber-dollar, etc.

There just isn't enough gold to go around and the value can be easily manipulated by large holders of the metal.

The first point isn't that important. Any amount of a material could be used to anchor a curreny. A dollar used to be 1/20th an oz of gold. It could just as easliy be 1/200th or 1/2000th. The system would work the same. (I assume paper money would still be the means of exchange for most people most of the time)

It is worth less industrially as it has been replaced by other metals that are more available and easier to use in industrial applications.

That seems like an argument FOR it's use as a reserve currency, no? Or not really on topic.

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.

I think better formulation is "money is created as debt". It is the mechanism of banks making loans, which they account as assetts, that create money. Again the question is "what limits their ability". The real answer today is NOT the GDP as you claim (please find a Fed citation that explains what the GDP:M2 or M3 ratio is that they are maintaining. Were this the case we would not have to have such arcaine things as meetings of the various fed committees to set interest rates. We'd just measure the GDP and go.

I am trying to make this as simple as I can.

Selling, in a panic, is just like a buying panic. The "cooling off" periods DO work. When the herd instinct begins, the stops last for a short period of time. Then, trading is resumed. If the panic is still there, the shut down is resumed. The ONLY way an investor loses money/the stock or bond or option or future becomes "worthless", is if the company/commodity becomes worthless. Just because you can't see your whatever, at the moment fear grips your intestines, doesn't makes it "worthless".

The reason that anything even remotely similar to the Crash of '29 can't happen again, is because of various rules and regulations that have been put into place during the almost 80 years hence. And that's NOT just on the markets, but on banks as well. Also, the same world conditions do NOT now exist.

My question about Black Monday, in '87, is EXTREMELY relevant! That was the closest to a PANIC, that the American markets had come to since '29. And after '87, even more regulations were put into place.

People, on FR, who talk about things they have little to NO idea of, but pretend to be "expert" in, may sway others; but, those who know the topic, see right through their posts. Anyone, ANYONE, who claims that 2006 is the same as 1929, is either lying through their teeth, or has no knowledge of factual history...perhaps both.

I listed a few factually correct historical divergences between then and now. There are more, but please take a look at a few of my earlier posts.

Gold and silver are commodities and like any other commodity, their value is constantly in flux. If you think that having some gold and silver on hand, just in case the world explodes into a world wide depression, it helps you sleep at night, okay........... Some people stocked up for the Y2K "HORROR" scenario too. :-)

Nobody should EVER have more money invested in the market, than they can lose without being terribly harmed. THERE ARE NO SURE THINGS!

Collecting/investing in coins was a one way street...up, up, ands UP; until 1990.

Taken as a whole, the stock market, even including all of the PANICS, RESESSIONS, and DEPRESSIONS ( of which there were many, until recent history ), has been solidly in favor of the investor. And yes, it has outpaced the value of gold; no matter what FR's goldbuggers post. But yes, the market goes up and the market comes down; so does the price of gold. Heck, so does real estate. So does any commodity you care to talk about...with the exception of diamonds; which is a "loaded"/controlled commodity.

Unlike some on this thread, I am "falling prey" to nothing! I know history, I know the rules and regulations set in place, that control "WALL STREET" ( the generic Wall Street, meaning all markets in this country ), and I don't wear tinfoil, nor do I fall for it, when it's posted. The serious errors have been committed by others; not by me.

And FWIW, the Crash of 1929 wasn't when things were really "BAD"! The markets actually did rebound, but to world conditions ( Depressions world wide !) and the machinations of some ( Joe Kennedy and his cohort of short sellers, idiotic schemes instituted by FDR, natural disasters, etc. ), the worst of times came in at 1933.

You want to worry yourself to death? Be my guest. Here's a scenario that could eclipse our GREAT DEPRESSION........

OBL isn't dead, neither are all of the terrorists we have killed or have holed up, every single Muslim in the world bands together and flies planes into every major and minor city in the world, blows up all train and bus transport, bombs the highways of every nation, poisons American, Canadian, Mexican, German, French, English, Scandinavian, Russian, middle European drinking water and burns all the crops and canneries and you name it. Or whatever else may make you go all numb and tingly to worry about. Have fun and pleasant dreams..........

Whoa take a breath there pard...

I just asked a little question and you get all CAPITAL LETTERS on me. BTW, you never did answer me.

How long do these 'cooling off' periods last and what happens if people don't 'cool off' in the manner they're expected to?

What if I really need to divest of these 'securities' during the 'cooling off' period? What if I really need the cash and can't sell my shares?

BTW, I keep the gold and silver around the house because I like the way they look, and because an ounce of gold is worth exactly the same thing today that it was worth in 1963. You can't say that about stocks and bonds.

I wouldn't go out and put all my cash into gold and silver any more than I would put all my cash into the stock market. It isn't prudent.

Now, if you can answer me in less than a paragraph without mentioning 1987 or 1929 then please do so. If you can't, then don't bother. A one sentence question shouldn't require a term paper with lots of capital letters in response.

I won't be sleeping for many hours yet, but I thank you for the good wishes.

Read Travis' books...they're fiction and he could use the money.

I assure you, I am NOT "whistling past the grave yard", nor will I EVER make a dime off you, in any way, shape, manner, or form. Get out of the market, stay in it...no skin off my nose.

Anyone who claims that there is a "pattern" and that 2006 will be a repeat of 1929, is the one who is handing out dross and telling you it is gold! There is no way that that is about to happen. Can the markets collapse at some future point in time? Anything is possible. Can there EVER be a repeat of '29? ONLY IF YOU BUILD AND THEN USE A FUNCTIONAL TIME MACHINE!

Banks used to regularly fail. Do you keep all of your money under your mattress, or in a box buried in your yard?

When our money was backed by gold and silver, there were MORE PANICS, RECESSION, DEPRESSION, BANK FAILURES, BUSINESS FAILURES, BANKRUPCIES, AND POOR than there have been, since it hasn't been. Just think about that.

You want to know who looks REALLY silly? Those who post utter garbage here and claim that it is absolutely within the realm of immediate possibility; that's who!

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The stock markets have so many regulations and safeties in place now, that it's IMPOSSIBLE to have another sustainable "crash".