When Greenspan talks to Congress it is important. It is a forum that he takes seriously. He presents his vision of the economy and agenda for the future. The latter is the most important. It is a political event in which he tries to pump up his authority and get people to trust him. And I'm not just talking about politicians, but powerful people in the banking and investment communities across the world. When I wrote my Stock Market Forecast for 2001 back in January I said that if the markets made new lows after he cut interest rates - which I expected - that the day would come when he appears before Congress and comes under vicious attack. If that were to happen he would then disappear from the public scene. Those attacks haven't happened. People believe the market has bottomed and that he is clever enough to painlessly stop the economic imbalances from unwinding.
When the stock market bubble popped and the Nasdaq swooned what you saw was the smart and big money display their convictions that technology stocks were overvalued in the face of a coming economic downturn. Since April we've "bottomed" and everyone still believes technology stocks are overvalued. They just don't think that matters. They have faith in Greenspan. If the markets make a new low before the year is over they will completely crash and the final bull marke conviction - that Greenspan is the investor's friend- will be destroyed. You'll see a crisis of confidence across the country over the men of power running the financial system. Greenspan will become the chief villian and the Scared Crow will be blown across the fields as Bush and the Treasury Secretary look on in worry. Let's hope things don't come to that, but with the odds of a second half recovery quickly dimming, it is looking more and more likely. The Fed has spent its bullets.
Let's take a closer look at Alan Greenspan's testimony yesterday. His words, followed by my editorial comments.
"By aggressively easing the stance of monetary policy, the Federal Reserve has moved to support demand and, we trust, help lay the groundwork for the economy to achieve maximum sustainable growth. Our accelerated action reflected the pronounced downshift in economic activity, which was accentuated by the especially prompt and synchronous adjustment of production by businesses utilizing the faster flow of information coming from the adoption of new technologies. A rapid and sizable easing was made possible by reasonably well-anchored inflation expectations, which helped to keep underlying inflation at a modest rate, and by the prospect that inflation would remain contained as resource utilization eased and energy prices backed down."
In simple terms Fed cuts rates to stimulate consumer demand. Traditionally Fed has cut rates during recessions to stimulate investment. Businesses expand and consumers follow. This time the Fed is trying to keep the consumer afloat and encourage him to go into debt to make up for lost wealth and wages while investment spending collapses. The hope is that the consumer can hang in there long enough for investment spending to pick up. This is a new theory of Greenspan's that has never before been tried by the Federal Reserve: we can just encourage people to go into debt during recessions so that consumer spending won't falter. The danger is that if this fails any recession will be prolonged even longer because people will be so bloated by debts that it will take them much longer to get back on their feet. If this happens then Greenspan's monetary policy will have been a disaster.
"In addition to the more accommodative stance of monetary policy, demand should be assisted going forward by the effects of the tax cut, by falling energy costs, by the spur to production once businesses work down their inventories to more comfortable levels, and, most important, by the inducement to resume increases in capital spending. That inducement should be provided by the continuation of cost-saving opportunities associated with rapid technological innovation."
Tax cut will help fuel consumer demand and so will falling energy prices. The last two sentences are rather amazing. He says that businesses will resume capital spending because of the opportunities of technology. Well, why would they do that now all of a sudden when there is a huge glut of technology goods out there?
"But the uncertainties surrounding the current economic situation are considerable, and, until we see more concrete evidence that the adjustments of inventories and capital spending are well along, the risks would seem to remain mostly tilted toward weakness in the economy."
There is no evidence at the moment that capital spending will increase.
"Despite the recent economic slowdown, the past decade has been extraordinary for the American economy. The synergies of key technologies markedly elevated prospective rates of return on high-tech investments, led to a surge in business capital spending, and significantly increased the growth rate of structural productivity. The capitalization of those higher expected returns lifted equity prices, which in turn contributed to a substantial pickup in household spending on a broad range of goods and services, especially on new homes and durable goods. This increase in spending by both households and businesses exceeded even the enhanced rise in real household incomes and business earnings. The evident attractiveness of investment opportunities in the United States induced substantial inflows of funds from abroad, raising the dollar's exchange rate while financing a growing portion of domestic spending."
A little history lesson. Greenspan explains how the bubble came into being: surge in high-tech investment spending brought higher stock prices(the stock market bubble) which increased consumer spending through debt - in Greenspanspeak this is spending which "exceeded even the enhanced rise in real household incomes and business earnings". The last line is the current account deficit: the flow of foreign money into the United States to finance corporate debt and the trade deficit. These are the economic imbalances in the economy which are prolonging this downturn. What Greenspan doesn't mention is the source of all of this which is his knee-jerk Scared Crow drop in interest rates back in 1998 to bail out banks which had given bad loans to third world nations. His policies created the stock market bubble and the unwinding of that bubble is what is causing the current downturn. His policies are the cause of the bear market and the hundreds of thousands of people who lost their jobs this year.
"Moreover, as I testified before this Committee last year, the economy as a whole was growing at an unsustainable pace, drawing further on an already diminished pool of available workers and relying increasingly on savings from abroad. Clearly, some moderation in the pace of spending was necessary and expected if the economy was to progress along a more balanced growth path."
In other words it was a bubble.
"The economic developments of the last couple of years have been a particular challenge for monetary policy. Once the financial crises of late 1998 that followed the Russian default eased, efforts to address Y2K problems and growing optimism--if not euphoria--about profit opportunities produced a surge in investment, particularly in high-tech equipment and software. The upswing outstripped what the nation could finance on a sustainable basis from domestic saving and funds attracted from abroad. "
Again the bubble. The lower interest rates produced the surge in investment and stock market which was unsustainable.
"But there are also downside risks to consumer spending over the next few quarters. Importantly, the same pressure on profits and the heightened sense of risk that have held down investment have also lowered equity prices and reduced household wealth despite the rise in home equity. We can expect the decline in stock market wealth that has occurred over the past year to restrain the growth of household spending relative to income, just as the previous increase gave an extra spur to household demand. Furthermore, while most survey measures suggest consumer sentiment has stabilized recently, softer job markets could induce a further deterioration in confidence and spending intentions."
The current danger. If consumer spending falters than Greenspan's current pet theory will be proven wrong and the US will enter a prolonged recession.
"A central bank can contain inflation over time under most conditions. But do we have the capability to eliminate booms and busts in economic activity? Can fiscal and monetary policy acting at their optimum eliminate the business cycle, as some of the more optimistic followers of J.M. Keynes seemed to believe several decades ago?"
Haha! Three year's ago Robert Rubin the Treasury Secretary said that he and Alan Greenspan had stopped the business cycle through their expert oversight of the economy. When asked Greenspan said that he agreed with that. Of course he ignores this hubris.
"The answer, in my judgment, is no, because there is no tool to change human nature. Too often people are prone to recurring bouts of optimism and pessimism that manifest themselves from time to time in the buildup or cessation of speculative excesses. As I have noted in recent years, our only realistic response to a speculative bubble is to lean against the economic pressures that may accompany a rise in asset prices, bubble or not, and address forcefully the consequences of a sharp deflation of asset prices should they occur. "
This is the most important paragraph in his testimony. Never before has Greenspan publicly acknowelged that we have had a stock market bubble. Even when he gave warnings about "irrational exuberance" he said that he wasn't smart enough to know if there was a bubble or not and that the smartest brains in the world are on Wall Street and to say there is a bubble means to say that they are wrong. Now the Scared Crow says there has been a bubble. And what is amazing is his statement that he leaned against the bubble to stop it from growing and in his last words he says that he is now addressing the consequences of its collapse. In other words he is trying to lower interest rates to bail out the stock market. If this creates more debt imbalances which cause prolonged suffering if the economy doesn't pick up than the real economy will pay the consequences for his attempt to make stock prices go higher. Let's hope his new theory works. If not you're looking at a lot of ruined lives and years of sub par economic growth. Do you trust him |
