Thanks Peter for the welcome back. I think I saw some things about undeveloped Asian countries that might be interesting generally to the thread, but current historic action on Wall Street and Main Street claim much of my attention now, as I suspect it does for most people on the thread.
There is so much that screams to be said about what is happening to the technology economy, technology companies, the U.S. and global economies in general, that a few observations about these goings-on are in order. This is especially the case since so much garbage is streaming from the mouths of countless pundits, including the ex-Maestro himself, Greenspan. Ramifications are vast for what is happening now for investors, and I want everyone on the tread not to be confused by events. We may not see the future perfectly either, but at least we ought to be able to add some reason to the nonsense that most people are blathering. Please bear with me while I try to get things started with my assessment of what’s going on and what will happen next.
The NASDAQ dropped 64% off its peak of last year, having achieved that infamous result faster than any major index in at least the last 100 years. Its recent plunge is faster than the start of the 1929 crash leading to the Great Depression, much faster than the embarrassing action of the Nikkei over the last decade, and worse by any measure than the adolescent NASDAQ of 1973-1974 (which by virtue of its youth alone at the time could be somewhat excused for excessive volatility). The oft-feared 1987 market crash pales compared to the wealth wrongly taken off the NASDAQ table over the last year. While Congressmen debate with Greenspan the importance of paying down the federal debt rather than “spending” the budget surplus on a tax cut, nobody in Washington seems to notice that enough wealth has been taken out of the NASDAQ IN ONE YEAR to pay off the entire federal debt, with enough left over to still fund the tax cut. I heard on the radio yesterday that wealth has evaporated from all U.S. stock markets to pay down the entire federal debt twice over. The U.S. stock markets lost 70% of GDP, probably the largest market loss ever in the U.S. in both absolute and percentage terms.
Should the NASDAQ sink another 7% from its high and it will have passed the Nikkei for pathetic peak-to-trough performance. As I said, the NASDAQ already has blown away the youthful 1973-1974 NASDAQ, which I think retrenched only 57% from its peak. The dreadful 1929 crash took years to grind 87% off the 1929 high, a rate much slower than what we have been experiencing.
The reason I am harping on history is that all those other crashes have something in common, which is very important to understand. The Great Depression, the 1973-1974 bear market in the NASDAQ, and the 1990’s Nikkei were all victims’ of massive errors in monetary, fiscal or other important government policies, most notably trade but also regulatory. The 1929 stock market crash happened for many of the same reasons that the 2000 NASDAQ crashed, but the real damage that followed in the early 1930’s was a direct result of counterproductive monetary policy, fiscal and trade policy. Hoover’s instincts were wrong and FDR was anti-business, with money wrongly tightened, the fiscal budget tightened not loosened, and the country allowed to follow a populist path into isolationism (to protect American jobs) rather than continue a free trade policy.
Similarly, 1973-1974 was awash with the beginnings of inflation resulting from an overly simulative fiscal policy based on the false premise that America could afford Guns (the Vietnam war) and Butter (the Great Society) simultaneously. We printed money, got jerked around on oil in 1973, responding with price controls incredibly by a Republican administration, all which pushed the superlative 1960’s economy in the doldrums for the 1970’s.
By broad agreement of most knowledgeable observers of the Japanese economy during the 1990s, the Japanese wallow in their own failed government monetary, fiscal, regulatory and trade policies. The collapse of the high-flying Japanese stock and real estate markets of the 1980s may have been the inevitable spark, but extent of the damage was the exclusive domain of government policy failures in regard to the handling of real estate write-offs, excessive bank loans, lack of corporate transparency, poor choice for stimulative fiscal policies (crony public works projects) and a persistence toward protectionist, anti-consumer trader policies. Their failing economy and matching stock market performance simply reflect poor governmental monetary, fiscal and trade policy.
In stark contrast, the 1987 stock market crash in the U.S. did not live up to popular pundits’ expectations at the time of a follow-on depression, or at least a recession, starting in 1988. Greenspan may have triggered the crash with an unnecessary rate increase, but he corrected that mistake by flooding the economy with money. Subsequently, we had to endure a slight recession, in the early 1990’s, to wring out excesses caused by excessive simulation, but he prevented the big recession considered inevitable at the time.
In mid-1998, the Asian crisis was growing out of control. The U.S. stock market was reacting in anticipation of a broad economic slowdown in the U.S. – which never happened, again thanks to Greenspan. Recall October 8, 1998 when he announced a reduction in fed interest rates, and gave the impression that he, backed by the entire U.S. financial system, drew a line in the sand against the crisis infecting the U.S. Most of the world’s business leaders believed him, as did the U.S. stock market as it reversed on the 8th of October and galloped rapidly to new all time highs. An earlier Mexican debt crisis was met with equal resolve by Rubin and Greenspan, preventing it from starting anything like the Asian crisis.
I conclude from all of this history that the economic business cycle is live and well, and remains unpredictable, and it will always impact stock prices. BUT, outsized market movements ALWAYS are a result of mistakes with monetary, fiscal, trade or other government policies. Given the speed of the slowdown and the market’s already historic reaction, it follows the current crash already must be classified as one where historic policy mistakes were made by our government. What mistakes were made? There are three possibilities that stick out. First, the U.S. suffered from lack of sufficient oil, or refineries, to keep prices and availability at normal levels. OPEC had a hand in this (where they relearned the economic lesson that gouging always leads to near-permanent depression of demand that in turn clobbers subsequent oil revenues.) California exemplifies the failure of near-sighted regulatory policies, with unintended negative side-effects. Second, the Federal tax receipts have leapt to more than 20% of GDP, a level that skims excessively from a normally efficient economy. Politicians and the Clinton Whitehouse should have realized that a surplus growing much faster than even they could spend was a danger sign for the economy. Greenspan, who should have known better, encouraged the misguided notion that paying off the public debt was first priority. Third, monetary policy was flagrantly tight at least during all of 2000, if not for the entire period of 1999 through the present.
The oil crisis that emerged in 2000 was beyond our government’s immediate control, given that the Clinton administration obviously failed to implement an adequate energy policy in recent years.
The political pandering surrounding the need for a sizeable tax cut is characteristic of how Congress functions, and exemplifies yet again why tax cuts are an inappropriate fiscal tool for stimulating a receding economy. Tax cut policy should be anticipatory and understanding of the weight excessive taxes places on the economy, but it is disingenuous to expect tax cuts can be a timely tool for providing needed fiscal stimulus. It is interesting to note, that the historic imbalance in the recent federal budget was largely a result of consistent encouragement by Greenspan. He was a broken record constantly claiming that a rapid pay-down of the federal deficit conferred benefits to the economy that far outweigh the costs, mainly in the form of reduced long-term interest rates and its consequent benefit to industry of reduced and stable cost of capital. He seemed to ignore entirely the burden on the economy implied by ever-increasing surpluses, and the fact that many holders of the U.S. debt are foreigners (meaning that the pay-down implies a huge transfer of liquidity out of the U.S.)
Monetary policy is unique in that it can turn on a dime, and does not require consensus building by politicians on both sides of the isle. Thus, of all the many ways government can screw up the economy, an adverse monetary policy always will be viewed as the straw that breaks the camel’s back. Greenspan was indeed late to the monetary loosening party, which he should have jumped all over by December of last year at the latest, and he should not now be taking baby steps, Japanese style. He let the patient get too sick, and now he should intervene forcefully. His errors last year, first in raising, then in not dropping interest rates soon enough, not to mention the inexcusable fiscal preferences he pushed on Congress and the Clinton Whitehouse, makes him most responsible for this historic debacle. He will be labeled as the man responsible for destroyed more wealth than any man in history. (The race is on to write the best-selling sequel to “Maestro”, the book in which Greenspan was popularized as the smartest and best central banker ever. By summer the books will start to appear that vilify, rather than glorify, him. I personally ran into one author last night who plans to roast him ASAP, and of course make a name for himself in the process.)
This leads to what Greenspan is really thinking about these matters. If history is any guide, his appearance of conservative calm – of a man pleased that the economy is wringing out inventory excesses and the stock market is returning to proper levels – is dead wrong. Certainly he understands exactly his role in history and the enormity of the situation he helped create, and must be personally as close to panic as he has ever been. I believe he is loosening money faster, much faster, than anything implied by the interest rates he controls. For example, the Fed has a policy of being the lender of last resort to needy banks. I suspect that policy is in the process of being temporarily suspended. I suspect that all the Fed governors are jawboning banks to lend generously. There is probably a number of other, behind-closed-door policies that the Fed is changing to make certain that money floods the economy and, knowingly, seeps into the stock market.
In other words, the Fed is NOT going to let this slowdown get much more serious than it is. Although a rate reduction of at least 100 basis points is called for immediately, a 50 basis point reduction is more likely today so as not to show panic, and not to create oscillations hard to dampen afterward. Whether the rate is 50 points now with more to follow, or 100 basis points now probably with more to follow, the Fed is adding liquidity to the economy NOW. And the Fed will continue to fan the economic flames until there is evidence that the slowdown is over. This means the Fed will overshoot to the high side, and end up in a couple years creating the very problem is sought to avoid in 1999 and 2000, inflationary pressures. However, a little inflation is vastly better than a deflationary depression, toward which he unintentionally tipped the world.
One of the things all this means is that the great conundrum, that has troubled me for years, is solved. I always wondered how a stock market, consistently dumber than a doornail, always gets it right by anticipating upturns in the economy. Stock prices always signal an upturn in the economy, not the other way around. The fact is that the more the economy falters, the more expensive stocks appear, almost irrespective of how far they have fallen. Near-sighted pundits with their short-sighted institutional clients can never anticipate an upturn in the economy. How is the possible that somehow the herd always gets it right?
The answer is that they never do. What actually happens is that share count declines in a U.S. economic slump, due to bankruptcies, buybacks, takeovers by foreign companies, mergers and acquisitions, stagnated IPOs, and a huge buildup in short interest. When, and if, monetary policy adds significant liquidity to the economy, first it accelerates the drying up of shares through debt-financed consolidations, then liquidity begins to leek into the stock market. As more money flows into a stock market with fewer shares, we get the classic combination of more money chasing fewer goods, resulting in stock price inflation. While we normally react negatively to the word “inflation”, in the context of the stock market it is a good thing, because it corresponds to a sustainable rally.
Thus, basic economics, not the keen advice of trend-following pundits, is the ONLY catalyst that will correct the market plunge. There is not a single useful observation about the economic pricing of the current market that has anything whatsoever to do with the market bottom. The bottom will form when and only when the reduced shares are balanced against increases in money flow resulting from the Fed’s action. If I am correct that Greenspan is fanning early flames maximally, the turning point should be soon indeed.
There, I got that off my mind. Let’s see what Greenspan decides to do.
Allen |
