part II.
Alan Greenspan became Chairman of the Federal Reserve Board in 1987. Within a few months the stock market crashed. He made emergency loan swaps and injected money into the banking system. The market quickly bottomed and made new highs. He was hailed as a genius. But as Greenspan later told Bob Woodward, he didn't really know why the market crashed or why it had bottomed. He was scared that a similar disaster could happen again.
Two years later Ronald Reagan deregulated the savings and loan industry. Savings and loan banks, mainly in Arkansas, Louisiana, and Texas, started to make junk loans that paid high interest in real estate ventures. Real estate prices climbed, but excess office buildings and homes were built.
I lived in San Antonio at the time. You saw newly built empty shopping centers and office complexes everywhere. There wasn't enough people for the real estate, but the junk loans were making con artists fortunes over night. Ask Bill Clinton. Ask Jeb and Neil Bush. It was a great scam. And of course it went bust.
The whole savings and loan industry in the South was about to go under. Greenspan knew that banks are the real engines of growth. He encouraged Congress to pass a $20 billion dollar bailout package to rescue the banks that had made stupid loans. They did it. $20 billion dollars was transferred from the pockets of American taxpayers and into the hands of savings and loans crooks. Fortune hailed it as another successful bailout. Greenspan had bailed out the real estate market just like he had bailed out the stock market.
Banks loved it. They could make high interest bearing risky investments and get free insurance.
Clinton came into office.
Mexico was about to default on loans given to it by Morgan Stanley and Chase Manhattan bank. Billions of dollars were at stake. Greenspan said that the banks had to be protected. Clinton passed a $50 billion bailout package for Mexico and advertised it as an aid package to help their economy. None of the money went to Mexico. It all went straight to the accounts of Morgan Stanley and Chase Manhattan bank. $50 billion was transferred from the pockets of American taxpayers and placed into the coffers of Wall Street banks. The Mexican economy picked up. Greenspan, Clinton, and Rubin were praised for engineering a successful bailout. Of course it is the banks that create economic growth and wealth.
The banks loved it. They could make even more high interest bearing risky investments and get free insurance
And more loans they made. To Russia. To Korea. To Latin America. To Taiwan. To Signapore.
But something happened. Russia was in a depression. Latin America and Asia ran into recessions. The loans could no longer be paid. The collection agencies of the international bankers - the IMF and the World Bank - ordered these countries to raise taxes and cut spending - to pay off the loans.
Wealthy currency speculators like George Soros knew that these front organizations were creating an unstable situation. Soros shorted sold the Thailand currency. It collapsed. Currencies throughout Asia and Latin America followed. Russia defaulted on its loans. An American hedge fund, Long Term Capital Management, overexposed in third world bonds was about to implode.
It was October of 1998. Greenspan morphed into the scared crow, jumping to bail out any large investor or bank that he deemed to be "too big to fail." He talked Warren Buffet and a consortium of private investors in buying the LTCM fund and bailing it out. For the third world he had another plan. He would bail them out by pumping increasing the demand in the US economy and letting them import more goods into the country. He lowered interest rates.
American GDP growth picked up through the end of 1998 and through the first quarter of 2000. Consumer demand grew and consumers bought more and more foreign goods that helped keep Latin America and Asia stay afloat. The money flowed into foreign countries who then turned around and used it to pay off loans owed to banks in New York, London, and Tokyo.
But there was one problem. The US economy was being hyperstimulated. He had cut rates too much. So much money was flowing into the banking system that there weren't enough prudent investments for it to go in to. That extra money flowed into what was left over - the investments with the highest potential for gains, but also the most extreme risk: technology and internut stocks. The Economist Magazine and The Financial Times called it asset inflation. Lawrence Kudlow and George Gilder called it a "new economy."
The stock market went up and up. The scared crow was hailed for engineering another successful bailout. Commentators waxed that Greenspan and Rubin were so adept at managing financial crisis that they had made the business cycle obsolete.
Greenspan knew cutting interest rates could be risky, but told people that it was safe because we were in a "new economy" in which inflation was no longer a threat thanks to the increases in productivity brought upon by technology.
No one knew if the theory was true or not, but Wall Street quickly accepted it. It was a good selling point for those tech stocks and as long as they went up people believed. But in the end it was a theory used by Greenspan out of necessity. He had to cut rates to bail out the banks and he used the theory to head off any possible criticisms.
But there were doubts. A study done inside the Federal Reserve showed that low inflation was caused not by technology, but by a large trade deficit. The truth was that inflation was low because cheap third world goods were flowing into the United States. That not only kept prices down, but kept U.S. wages down too.
As the miracle of tech productivity, this too had doubters and their doubts were confirmed this past summer when the government revised the productivity numbers of the 1990's down. In the end it turned out that the productivity gains of the 1990's were no more higher or unusual than the gains seen in any other decade.
There had never been a "new economy." The whole notion had been a lie used by Greenspan to provide an intellectual cover for his interest rate cuts and as promotional material for U.S. corporations and Wall Street. It was the greatest hoax of the 20th century.
The reality was that the economy boomed in the late 1990's because of an investment and debt bubble brought upon by the Federal Reserve. Foreign goods and foreign investment dollars flowed into the U.S. Corporations, in a race to make their stock prices go up, piled up debt to goose earnings. Consumers, who saw their stocks go up and thought they were in a new era of prosperity, broke out their credit cards and took on debt. The U.S. current account deficit exploded as the country became the biggest debtor country in world history.
Economies that become this imbalanced never have a happy ending.
Anyone who took Economics 101 and can remember the concept of moral hazard could see what happened.
In economic terms a moral hazard is formed when someone is repeatedly bailed out of investment mistakes. Once someone believes that they are insured from loss they will only take on riskier and riskier investments. The mistakes get bigger and bigger and the bail outs get larger. Eventually the bill becomes too big to pay and the system collapses on itself. 1929 America and 1990 Japan serve as examples while Enron and Argentina are contemporary warnings that tell us what the current system of moral hazard can produce.
Bailouts do not solve economic problems. They only post pone them and insure that the next economic crisis is worse than the last one. In the meantime they transfer wealth from the masses and hand them over to those who made the risky investments and give them a chance to get out.
This is essentially what happened. The stock market is a good example. In March, 2000 insiders began to heavily sell just as the market turned down. Each time the Fed cut rates in 2001 and the market rallied they sold even more shares. When the small investor bought the rallies he was often buying from these insiders. When the market dropped he got stuck holding the bag.
The whole process of bailout transferred the risk from the international bankers, hedge funds, and so called "venture" capitalists and placed it into the hands of the small stock investor who kept buying more. Ironically, it was the small player who kept the faith in the Scared Crow and believed CNBC and the analysts when they said buy. Those who believed the most in the "new economy" ended up losing the most money.
Most economic downturns have come after the Federal Reserve sees signs of inflation and then raises interest rates. This one came because the Federal Reserve helped spawn an investment and debt bubble. We noted the first signs of recession in the 3rd quarter of 2000 when corporate investment spending went negative. Since then corporate investment spending has been in collapse. The economy will not pick up meaningfully until corporations begin to invest and expand again.
In every month of this recession U.S. consumer spending has either risen or maintained itself. However, the income for the average consumer has dropped during this time. They've been able to increase spending by refinancing their mortgage and by using credit cards. In short they've taken on more debt.
I do think that the recession will come to an end in the final 6 months of this year. It will bottom out. However, unlike most economists I do not think the economy will grow much. GDP Growth will remain under 2% or under 1%, which is more likely.
All economists are basing their prediction for higher growth on interest rate cuts. But we've had interest rate cuts for over a year and they have made no difference.
You have to ask yourself where is this growth going to come from?
It won't come from the world economy, which Greenspan tried to bail out with the U.S. economy and ultimately failed. The world economy is in a recession and U.S. exports are now dropping faster than imports.
A government fiscal package is a spit in the ocean and so are tax cuts, most of which are going to corporations who are using the extra money to increase their earnings per share.
Consumers can't do it by themselves. They've carried the burden so far and can't continue to pile on more and more debt forever.
The most important engine for growth is corporate investment spending. When corporations expand they buy more technology and hire more workers. The problem here though is that corporations already overinvested themsevles in the internet, computer, and telecom bust. What is worse they took on so much debt that they now have reason to be cautious about taking on anymore.
Corporate and consumer balance sheets need to be brought in line. This is a process that can only be solved through time. Interest rate cuts are not a quick remedy. Greenspan mortgaged the present to provide the bailouts of the past. Until these debts are worked off any economic recovery will be extremely sluggish.
My final outlook is this. The economy will bottom in 2001. The stock market will too, if it hasn't already. But the coming recoveries will be very weak and will disappoint the current bullish progenitors. The U.S. stock market will ultimately enter a trading range as it works off the excesses of the 1999 tech bubble. The U.S. economy is in the same situation.
The recovery will be weak enough that most people won't even notice it. They'll think it is still in a recession. Beliefs will be readjusted. Expectations for a return to booming bubble growth will be eliminated. Faith in the power of bail out will disappear.
In the end this process will be good for the country. Just as the war on terrorism helped to eliminate some misguided fantasies about foreign policy and brought upon a realization of the limited power of globalization, this economic bust will cause people to abandon the policies of bailout. There is a reason that the Old Testament Jews made charging interest a sin called usury. It doesn't create wealth. It only transfers it from the productive to those who hold the power of owning a vault.
The writers of the law in the Old Testament discovered that their economy went through cycles of growth and bust, which they blamed on speculative orgies and out of control debt. They believed that money lenders profited from the destruction and took steps to make sure their influence did not get out of control. Every fifty years the Levites decreed a "Year of Jubilee" in which every man had his posessions returned to him. All loans were forgiven and money lenders had to return collateral that they confiscated from people. The authors of the book of Leviticus deemed this to be stolen money and associated the charging of interest with highway robbery.
That is extreme thinking by today's standards, but the whole point for you is that these people understood that orgies of debt and speculation can ruin economies and their story shows that they understood that there is a linkage between out of control banking power and the appearance of ruinous economic calamities. To translate that to the 1990's, debt exploded and a financial bubble appeared because Alan Greenspan hyperinflated the money supply in order to bail out investors "too big to fail." In turn the power of international bankers grew because entire regions of the world become debt slaves to them and their front organizations.
When bankers become too powerful and destructive they destroy entire countries for profit. Witness Argentina. Argentina was burdened by billions of dollars of debt owed to international banks that it couldn't pay. It slipped into a recession. The IMF collection agency ordered Argentina to raise its taxes, cut spending, and hand over the pensions of all state employees to the IMF as a loan payment. When Argentina refused the IMF pulled out its loans and let the entire country collapse. Argentina now stands as a warning sign to the rest of the world for what happens to countries who try to brush off IMF dictates.
After the cold war ended the fraternity of international finance tried to set up a world empire tied together by the flow of U.S. dollars and loans throughout the world. In 1998 that system began to collapse. Greenspan leveraged the U.S. economy to try to bail it out and ended up creating a big boom and horrible bust that was worse then the crisis he was trying to fix.
It was impossible for Argentina to rescue itself by trying to pretend that it could pay its obligations. Its leadership decided that it had one choice. It had to declare itself bankrupt and completely reorganize itself.
The only protection a people have between itself and a debt disaster or abuses by international finance is their nation state. President Putin realized this. When he became President his country was saddled by international debt and a depression. He declared his nation bankrupt and reorganized the debt. He then stimulated his economy by balancing the budget and creating a 10% individual flat income tax and a 15% corporate income tax. His economy grew at 4% last year and is expected to achieve similar growth this year. Russia is the advanced country in the world whose stock market is in the first stages of a 10 year bull market. It is also the only country to jettison itself from the control of the IMF, World Bank, and the axis of London and New York finance.
The United States is not in the situation that Argentina was. But its economy has been damaged by a decade of Federal Reserve policies that put the interests of Morgan Stanley and Goldman Sachs above those of the rest of the country. In the end Greenspan will resign or be replaced. Lessons will be learned. And his predecessor won't make the same mistakes or be as corruptable. It will be a behind scenes coup.
This won't the first time in American history that this happened.
And it won't be the first time that the power of the Federal Reserve board and international finance will have to be checked for the good of the country.
It has been checked before. When Franklin Roosevelt became President and delivered his first inaugural address he said this:
"We are stricken by no plague of locusts. Compared with the perils, which our forefathers conquered because they believed and were not afraid, we have still much to be thankful for. Nature still offers her bounty and human efforts have multiplied it. Plenty is at our doorstep, but a generous use of it languishes in the very sight of the supply. Primarily this is because the rulers of the exchange of mankind's goods have failed, through their own stubbornness and their own incompetence, have admitted their failure, and abdicated. Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men."
"True they have tried, but their efforts have been cast in the pattern of an outworn tradition. Faced by failure of credit they have proposed only the lending of more money. Stripped of the lure of profit by which to induce our people to follow their false leadership, they have resorted to exhortations, pleading tearfully for restored confidence. They know only the rules of a generation of self-seekers. They have no vision, and when there is no vision the people perish. The money changers have fled from their high seats in the temple of our civilization. We may now restore that temple to the ancient truths."
Like the bankers of his day Alan Greenspan and his yes men on the Federal Reserve Board have failed. Roosevelt replaced the Federal Reserve Chairman. The man who replaces Alan Greenspan will be completely different and will create real prosperity.
I have been saying these sort of things for over the past year and a half. But now the mainstream press is slowly becoming skeptical of the Scared Crow.
Let me quote to you passages from an article that appeared in the Wall Street Journal just two weeks ago:
"Today, Fed policy makers are debating whether they went too far. The answer could help determine whether the current recession is a temporary aberration in an era of swift growth or whether the rapid growth of the late 1990s was itself the aberration."
"Mr. Greenspan hasn't lost the faith...."
"But others at the central bank - many of whom only belatedly embraced their leader's optimistic views at the peak of the boom - now have re-embraced a less sanguine view. During 2001, the Fed's research staff has steadily marked down its estimate of the rate at which the economy can grow during the next two years without sparking inflation."
"Mr. Meyer, an economic forecaster and consultant who joined the Fed in 1996, was uncomfortable with the low-interest-rate approach and the Greenspan notion that basic changes in the economy would allow it to grow faster without sparking inflation. In a January 1998 speech, he branded the prior year's growth spurt unsustainable."
"The Fed's own research staff had Greenspan doubters. Economist Daniel Sichel's 1997 book, The Computer Revolution, punctured tales of companies using new technologies to boost workers' productivity to permanently higher levels. Mr. Sichel crunched the numbers to show that for all the attention computers received in the 1990s, they represented such a tiny portion of the nation's capital stock - 1.1% - that they couldn't possibly make a big difference."
"Outsiders also attacked the Greenspan view. At a meeting the chairman hosted in April 1999, Paul Romer, a Stanford University economist, displayed a chart of productivity during the past 100 years. 'People in Silicon Valley are talking about hockey-stick growth curves,' compared with the 1970s and the 1980s,' Prof. Romer recalls telling the attendees. But in fact, the improvement of the previous three years wasn't such a historical anomaly, he pointed out. The U.S. had racked up even more impressive growth rates in the 1960s."
"The Fed traditionally seeks consensus in fashioning monetary policy. Over the four-year period from 1996 through 1999, Mr. Greenspan persuaded his colleagues, first, not to raise interest rates, and then, when rate increases became inevitable because of inflation fears, to institute them more slowly than many would have wanted."
"So persuaded were Mr. Greenspan and his colleagues of his optimistic outlook that they seemed to have trouble accepting the bursting of the high-tech bubble when it happened last year. As business investment weakened in late 2000, Fed officials told one another that technology had proven so valuable to companies that they would likely resume higher purchasing levels soon, Fed minutes show."
"The staff forecast prepared for the December 2000 policy meeting predicted that consumer spending would slow because of falling stock market-wealth. But 'business fixed investment, notably outlays for equipment and software, was projected to remain relatively robust,' according to the minutes. Mr. Greenspan himself was taken aback in October 2000 by a chart accompanying an article in the Wall Street Journal that showed a huge gap between the rapid growth of fiber-optic capacity and the much-slower growth of demand for the technology, a discrepancy that soon led to the collapse of a raft of start-up broadband companies."
"Early this year, the Fed was cutting interest rates in an effort to keep growth from stalling, while still issuing upbeat statements about the New Economy. 'To date there is little evidence to suggest that longer-term advances in technology and associated gains in productivity are abating,' the central bank's policy makers said after their first rate cut in early January."
"Some economists now say that because Mr. Greenspan and his colleagues believed so fervently in the fundamental benefits of technology, they didn't recognize that much high-tech spending in the late 1990s was wasted. 'Virtually no one, official or outside the Fed was talking about the fact that high stock prices were essentially generating too much investment' by businesses in high-tech gear, says Stephen Cechetti, head of research at the Federal Reserve Bank of New York from1997 to 1999 and now an economics professor at Ohio State University."
"But as capital spending continued to collapse this winter and spring, Fed Research department's models showed that the economy's potential to grow over the next two years was slipping to about 3% from its estimate of more than 4% in early 2000."
"As companies have continued to work off excessive inventories for nearly a year, some Fed officials now believe they have placed too much faith in such New Economy tenants as the idea that better supply management would make long downturns less likely."
"In July, it emerged that the statistical foundation of the Greenspan view hadn't been as impressive as it once seemed. Government statisticians recalculated their official estimates for output and productivity in the late 1990s after discovering they had overestimated software sales. For 2000 the overall growth rate was knocked down from an eye-popping 5% to 4.1%."
This is the first year that the economy and the stock market will spend in recovery from the Greenspan bust. The market will go up. It will go down. And eventually the albatross that is hanging over the neck of the world - Alan Greenspan AKA The Scared Crow - will vanish. When he is gone we can proclaim a "Year of Jubilee" - in the old Biblical sense of justice and liberation - and the world will look foward to a bountiful harvest in the years to come. In the end strong stocks will rally and weak ones will crash. Let's have fun. |
