Today was another defeat for the bulls and seems to confirm my thoughts last night that yesterday was a key reversal which should bring new yearly lows for the Nasdaq and even the DOW. Despite a 4th Quarter GDP number that was revised upward and a positive Chicago Purchasing Index the market dropped. And some stocks dropped hard. EXTR fell 18.5%, FLEX fell 5.7%, INTC was down 4.5%, and BRCD was down 9.1%. At the same time the VIX rose only .04, so the move didn't scare people.
Some people might shake their heads and wonder why the market fell on good news. All of the CNBC people have been telling us that the market was bottoming and stocks were waiting for some good economic reports to go up. We finally get the reports and stocks drop anyway!
Well, the stock market is forward looking, not backward looking and as I'll mention in a few minutes there are reasons to believe that the economy will slip back into negative growth in the summer and at the least their are strong reasons to believe that any economic growth that may come will be very weak. It certainly won't match the predictions that Wall Street is giving us, as even Alan Greenspan admitted yesterday.
Aaron Task of TheStreet.Com had a theory today about why the GDP report was sold:
"One possibility is that they'll conclude fourth-quarter growth was artificially -- or at least temporarily -- induced by aggressive monetary policies and robust government spending after the Sept. 11 attacks, as well as by deep incentives from automakers. Clearly, there is evidence to support this argument, which in turn supports the double-dip theory of (among others) Morgan Stanley's Stephen Roach. With a gain of 4.1%, personal consumption was the biggest contributor to GDP. Of that total, record vehicle sales accounted for about 70% of the increase. With a gain of 1.8%, government spending was the second leading contributor to fourth-quarter GDP. It was the biggest quarter for government spending since 1978. "
As I pointed out when the preliminary GDP numbers were released almost all of the economic growth that came in the last quarter of 2001 came from government spending and consumer spending. Investment spending continued to collapse and as a report on corporate investment showed this week there is no sign yet of an end to this trend - and there will be no real recovery until corporate investment spending picks up.
I want to turn today to Alan Greenspan's testimony yesterday and people's reaction to it. There is so much focus day by day on tidbits of economic data that you need to look at the big picture to see what is happening. And Greenspan tried to give it to us yesterday, although at times I must admit his nose got a little long.
Here are excerpts from his speech with my comments in between:
Testimony of Chairman Alan Greenspan
Federal Reserve Board's semiannual monetary policy report to the Congress
Before the Committee on Financial Services, U.S. House of Representatives
February 27, 2002
federalreserve.gov
"A coincident deceleration in activity among the world economies was evident over the past year, owing, at least in part, to the retrenchment in the high-technology sector and the global reach of the capital markets in which the firms in that sector are valued and funded. However, before the terrorist attacks, it was far from obvious that this concurrent weakness was becoming self-reinforcing. Indeed, immediately prior to September 11, some sectors exhibited tentative signs of stabilization, contributing to a hope that the worst of the previous cumulative weakness in world economic activity was nearing an end."
Ever since I have been writing this newsletter every time Alan Greenspan gives a speech to Congress I go through it just as I am doing today. And every time he lies. This is the beginning of his speech and he begins with a set of lies. This is nothing knew. Often he will make a statement in one speech claiming he is thinking one thing and then in the next speech deny that he ever thought that. For instance when he started to raise interest rates in 1999 he said he was targeting the "wealth effect" - stock prices - in fear if it continued to rise it would create inflation. A year later he gave a speech and said that this was a bad theory and that he had never thought about doing that. A total lie. But when he made the second statement he wanted the market to go up instead of down.
This statement above is a total lie also. I have been saying that the US economy began a slowdown in the 4th quarter of 2000 when investment spending collapsed. Tech spending dived and so did general corporate expansion. Eventually this trickled into the economy and caused a recession. The Economic Research Bureau pins the beginning of the recession to last March. Here above Greenspan claims that the economy was not in a recession and only entered one after September 11th. He also claims that the economy was about to recover and that this was obvious.
This is lie.
At the time he was saying that that the economy was still weak and he may have to cut interest rates. This was a two weeks before September 11th in which he said that. Now he says that back then everything was great.
Why is he lying?
We are in a recession that is being led by a collapse in corporate investment spending because Alan Greenspan lowered interest rates in 1998 and created a debt, investment, stock market bubble. The recession is the aftermath of that bubble. He lies in an attempt to take your attention away from his responsibility and mismanagement and place all blame on the terrorists.
Greenspan does not want you to doubt his abilities and wants you to worship his public persona and power. This is what his testimonies in front of Congress are about. They aren't about telling you the truth. They are all about making it appear as if he is on top of things.
"That hope was decisively dashed by the tragic events of early September. Adding to the intense forces weighing on asset prices and economic activity before September 11 were new sources of uncertainty that began to press down on global demand for goods and services. Economies almost everywhere weakened further, a cause for increasing uneasiness. The simultaneous further slowing in activity raised concerns that a self-reinforcing cycle of contraction, fed by perceptions of greater economic risk, could develop. Such an event, though rare, would not be unprecedented in business-cycle history."
Again terrorism made the stock market drop. Truth is the stock market was already in a downtrend before the terrorists struck and probably would have fallen hard anyway. That is why I started shorting stocks last August.
"But that impetus to the growth of activity will be short-lived unless sustained increases in final demand kick in before the positive effects of the swing from inventory liquidation dissipate. Most recoveries in the post-World War II period received a boost from a rebound in demand for consumer durables and housing from recession-depressed levels in addition to an abatement of inventory liquidation. Through much of last year's slowdown, however, spending by the household sector held up well and proved to be a major stabilizing force. As a consequence, although household spending should continue to trend up, the potential for significant acceleration in activity in this sector is likely to be more limited than in past cycles."
As we noted in the comments on the GDP numbers and before almost all of the growth in the economy is coming from the consumer. The consumer is holding everything up. However, the consumer is doing that by going deeper and deeper in debt. This is unsustainable. And the economy cannot grow much more unless corporate investment spending picks up. This is what the Scared Crow is hinting at here.
.
"Perhaps most central to the outlook for consumer spending will be developments in the labor market. The pace of layoffs quickened last fall, especially after September 11, and the unemployment rate rose sharply. However, layoffs diminished noticeably in January, and the reported unemployment rate declined though adjusting for seasonal influences was difficult last month. Moreover, initial claims for unemployment insurance have decreased markedly, on balance, providing further evidence of an improvement in labor market conditions. Even if the economy is on the road to recovery, the unemployment rate, in typical cyclical fashion, may resume its increase for a time, and a soft labor market could put something of a damper on consumer spending."
Greenspan predicts more unemployment and notes that this would harm consumer spending.
"The retrenchment in capital spending over the past year and a half was central to the sharp slowing we experienced in overall activity. The steep rise in high-tech spending that occurred in the early post-Y2K months was clearly not sustainable. The demand for many of the newer technologies was growing rapidly, but capacity was expanding even faster, and that imbalance exerted significant downward pressure on prices and the profits of producers of high-tech goods and services. New orders for equipment and software hesitated in the middle of 2000 and then fell abruptly as firms re-evaluated their capital investment programs. Uncertainty about economic prospects boosted risk premiums significantly, and this rise, in turn, propelled required, or hurdle, rates of return to markedly elevated levels. In most cases, businesses required that new investments pay off much more rapidly than they had previously. For much of last year, the resulting decline in investment outlays was fierce and unrelenting. Although the weakness was most pronounced in the technology area, reductions in capital outlays were broad-based."
Greenspan brings up the reality that a collapse in tech and investment spending began in the middle of 2000 and filtered into the rest of the economy. What is amusing here is that he says there was a "steep rise" in tech spending "in the early post-Y2K months" that "was clearly not sustainable." Greenspan created this bubble in tech spending and tech stocks by increasing the money supply like mad due to fears of a Y2K run on banks that never came. This was one of his big mistakes. But here he makes no mention of his foul up. What is also funny here is that he says at the time this clearly wasn't sustainable. Well, at the time he said that maybe it was, maybe we were in a "new economy." Greenspan always rewrites history to cover up his misperceptions. My beef with him isn't that he isn't always right - no one can be - but that he never admits a mistake and lies over and over again to hide the fact.
"These cutbacks in capital spending interacted with, and were reinforced by, falling profits and equity prices. Indeed, a striking feature of the current cyclical episode relative to many earlier ones has been the virtual absence of pricing power across much of American business, as increasing globalization and deregulation have enhanced competition. In this low-inflation environment, firms have perceived very little ability to pass cost increases on to customers."
An interesting passage. Inflation has been low over the past few years, however back during the bubble days Greenspan said that this was because of the miracle of technology productivity. Studies done by the Fed in the summer disputed this and said it was due to the competition of the global labor market - which is probably the truth. This is the first Greenspan has factored this into one of his speeches.
"On balance, a recovery in overall spending on business fixed investment is likely to be only gradual; in particular, its growth will doubtless be less frenetic than in 1999 and early 2000--a period during which outlays were boosted by the dislocations of Y2K and the extraordinarily low cost of equity capital available to many firms. Nonetheless, if the recent more-favorable economic developments gather momentum, uncertainties will diminish, risk premiums will fall, and the pace of capital investment embodying new technologies will increase."
No return to the bubble days, but the market is pricing in a return to big 1999 growth
"As a consequence of increased access to real-time information and, more arguably, extensive deregulation in financial and product markets and the unbundling of risk, imbalances are more likely to be readily contained, and cyclical episodes overall should be less severe than would be the case otherwise. If this is indeed the case--and it must be considered speculative until more evidence is gathered--the implied reduction in volatility, other things equal, would lower risk and equity premiums."
Greenspan admits here that there are imbalances in the economy - the huge personal and corporate debt levels and the current account deficit are the main ones. But incredibly here he seems to claim that they will just go away thanks to technology - "real-time information". So maybe this is a "new economy" after all? Yeah right. A year ago he claimed that the speed of information would enable companies to plan ahead well enough to avoid a recession - they wouldn't overproduce and create surplus goods. That idea was a joke and so is this one.
"Other things, however, may not be wholly equal. The very technologies that appear to be the main cause of our apparent increased flexibility and resiliency may also be imparting different forms of vulnerability that could intensify or be intensified by a business cycle."
Now he back tracks on that idea....is it or isn't?
"Indeed, on a historical cost basis, the ratio of debt to net worth for the nonfinancial corporate business sector did rise, from 71 percent at the end of 1997 to about 81 percent at the end of the third quarter of last year, though it is still well below its level at the beginning of the recession in 1990. The ratio of interest payments to cash flow, one indicator of the consequence of leverage, has crept up in recent years, reflecting growth in debt. However, owing to lower interest rates, it remains far below its levels of the early 1990s."
Read this carefully. Corporate debt grew from 71% to 81% during the years everyone said we were in a "new economy."
"For the period just ahead, the central tendency of the forecasts of the members of the Federal Open Market Committee is for real GDP to rise 2-1/2 to 3 percent during 2002. Such a pace for the growth of real output is somewhat below the rates of growth typically seen early in previous expansions. Certain factors, such as the lack of pent-up demand in the consumer sector, significant levels of excess capacity in a number of industries, weakness and financial fragility in some key international trading partners, and persistent caution in financial markets at home, seem likely to restrain the near-term performance of the economy."
Greenspan lists some of the obstacles that the economy face. He leaves out debt though.
"Despite its forecast that economic growth is likely to resume at a moderate pace, as I already noted, the Federal Open Market Committee at its meeting on January 30 saw the risks nonetheless as continuing to be weighted mainly toward conditions that may generate economic weakness in the foreseeable future."
Greenspan concludes by saying that the risks to the economy are still towards the downside.
The main danger that the economy faces now is the high levels of corporate/individual debt and the current account deficit. I've talked about this before and it is a real danger and could trigger a drop in the dollar and a real economic crisis. It is the next bubble. In fact the US current account deficit is the largest of any country in history and makes the US look like a third world country. Trade deficits are financed by foreign money flowing back into the US in the form of loans and investments. That is the reason why the US dollar is so high. The danger is that if there were inflation or fear of a greater economic downturn the foreign money would flee the dollar and cause it to fall rapidly. That would depress stock prices. This is essentially what you are seeing now in Argentina. I'm not saying something on that magnitude could happen, but in response to a dollar crisis either the Federal Reserve would jack up interest rates or else would just let it drop and let inflation run rampant. Neither option would bode well for the economy.
Now current account deficits tend to fix themselves during recessions. We had a large one in the mid 1980's that was cured when the trade deficit shrank during a short recession.
However, Greenspan is not letting this happen. Instead of allowing debt imbalances to work themselves off he is in fact increasing the US debt levels in an attempt to stop the US stock market and economy from tumbling. The fear is that he only temporarily keeps things afloat and just sets the stage for an even larger crisis in the future. Better to just let things settle and reach equilibrium.
Back in 1998 the whole world feared an economic collapse and Greenspan created a debt bubble as a band aid. Now that debt bubble went bust and he is trying to fix the bust by printing more money and creating more debt because he is afraid that the bust will turn in a Japanese style or 1929 style economic collapse....this is what continued bail outs get you - larger and larger potential crisis. This process must be stopped.
But this is why I call him the Scared Crow. Instead of allowing the natural forces of the economy to work off problems he is always so frightened of the crisis of the moment that he is willing to sacrifice the future for the present. This is my second beef with Greenspan and main reason why he makes me angry at times.
He did this in 1998 when he bailed out international bankers and hedge funds that cried for help because they made some bone headed investments. Greenspan came to the rescue and cut interest rates three times. As a result we had a stock market bubble that went bust. Then months later he jacked up the money supply to protect banks in case there was a Y2K computer bug. The market went up even more. That bubble set the stage for a destructive bear market and economic slowdown.
See bail outs aren't free and they come with a price. In 1998 the banks got a bail out for free. People who saw their stocks drop over the past two years or lost their jobs paid the price. And for the debt Greenspan is creating now there will be another price - either sluggish economic growth for years or a total collapse.
This is a complicated subject. To read an article that explains it better than I do click here:
news.ft.com
I'm not the only one saying these things.
Yesterday 2 Congressman asked some pointed questions to Alan Greenspan. Bernie Sanders from Vermont personally attacked him, saying that he didn't believe his "rosy" picture of the economy and claimed that Greenspan was causing unemployment and suffering to protect "economic royalists." Ron Paul, a Texas Congressman, then attacked Greenspan for using "fiat money" to turn the Federal Reserve into an "Enron" type operation.
Those descriptions might be overblown, but an even more devastating one was penned by Stephen Roach, the head economist of Morgan Stanley.
On Sunday I told you about a newly released transcript from a Fed meeting in 1997. At that meeting Lawrence Lindsey, who served on the Fed Board, warned the whole board that if they didn't stop the stock market from turning into a bubble than there would be a horrible crash. He closed out the meeting by saying that 5 years later when this transcript is released people will look back on it as a defining moment. Greenspan than proceeded to lower rates and create the very bubble Lindsey warned about. Lindsey resigned, sold every stock he owned, and wrote a book called "Economic Puppet Masters" which warned of the coming collapse and placed its blame on the Federal Reserve, World Bank, and the IMF. He now serves as one of Bush's economic advisors and has been talked up as potential replacement to Greenspan so there is hope.
Yesterday Roach today used this transcript to brand Greenspan a liar and a coward. I suggest you read his whole article in its entirety::
morganstanley.com
Here are some key quotes:
" To this very day, the Federal Reserve denies its role in nurturing the US equity bubble. Sure, Chairman Greenspan warned of "irrational exuberance" in his now infamous speech of December 5, 1996. Yet it took the central bank another three months to act on those concerns. And when it did, all the Fed was able to muster was a mere 25 bp of tightening on March 25, 1997. That action unleashed a torrent of politically inspired criticism that sent the Fed quickly running for cover. Any further assault on the bubble was promptly shelved. "
Chairman Greenspan then went on to compound the problem by embracing the untested theory of the New Economy -- in effect, setting out the conditions under which the exuberance might actually be rational, when the bubble might not be a bubble. After all, sharply accelerating productivity growth was the sustenance of sustained earnings vigor, went the logic at the time. Under those conditions, maybe the markets might have had it right all along -- lofty multiples made great sense in an era of ever-expanding profit margins. In any case, the Fed sent an important signal to financial markets -- that it was willing to be unusually passive in tolerating the rapid growth of a high-productivity economy. This then set up the delicious moral hazard that speculators quickly pounced on. With the Fed out of the game, there was no stopping the equity market. "
Alas, if the Federal Reserve only knew what was to come -- the dot-com implosion, the excesses of telecom debt, a massive capacity overhang, an unprecedented consumption binge, a record debt overhang, and obfuscation of underlying corporate earnings growth. Had it seen such a perilous post-bubble future, maybe the central bank would have reacted differently. Easier said than done, of course -- hindsight is the ultimate luxury."
Yet it turns out that the Fed knew a lot more than it claimed at the time. Recently released transcripts of policy meetings back in 1996 -- verbatim reports of actual conversations rather than the sanitized minutes that are published approximately 45 days after each FOMC gathering -- leave no doubt, in my mind, that Chairman Greenspan and several of his colleagues appreciated the full gravity of the rapidly emerging US equity bubble. (Note: These transcripts are released with a five-year time lag and are available on the Fed’s Web site at federalreserve.gov. The problem was the US authorities lacked the will to act. Had the Fed taken actions based on its concerns at the time, the US economy and financial markets would undoubtedly have traveled a very different road.
History often has a way of catching up with you, especially if the real story comes out after the fact. For a central banker who publicly expressed great doubt over the very existence of a US stock market bubble, consider the following statement by Chairman Greenspan, taken from the transcript of the September 24, 1996 FOMC meeting: "I recognize that there is a stock market bubble problem at this point." For the record, the Dow Jones Industrial average closed at 5,874 on that date, about half the level it was eventually to reach in early 2000. Nor was Greenspan reticent in expressing his opinion back in September 1996 on what should be done to pop the bubble. Again in his words, "…it is not obvious to me that there is a simple set of monetary policy solutions that deflate the bubble. We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, whatever it is, that will do it." But in the end, of course, the Fed refrained from taking any such actions, keeping margin requirements unchanged, as they had been since 1974 -- in effect, electing to sit on the sidelines as mere observers of the Great American Asset Bubble. The reluctance to make such a surgical strike on the equity market can best be summed in Greenspan’s admission, "My concern is that I am not sure what else it (raising margin requirements) will do." End of story -- beginning of the real bubble.
All this is not to say that Alan Greenspan and the Fed were lacking in insights as to how to proceed in dealing with this critical issue. Ironically, it turns out that the near hero in all this was then Fed Governor Larry Lindsey -- whose day job now turns out to be Assistant to the President for Economic Policy. The same transcript of the September 24, 1996 FOMC meeting says it all: In Lindsey’s words, "…the long-term costs of a bubble to the economy and a society are potentially great. They include a reduction in the long-term saving rate, a seemingly random distribution of wealth, and the diversion of scarce financial human capital into the acquisition of wealth. As in the United States in the late 1920s and Japan in the late 1980s, the case for a central bank ultimately to burst that bubble becomes overwhelming. I think it is far better that we do so while the bubble still resembles surface froth and before the bubble carries the economy to stratospheric heights." Lindsey’s analysis was prescient, to say the least. All Greenspan could offer in response was, "…I agree with Governor Lindsey that this is a problem we should keep an eye on."
Of course, in the end, that’s about all the Fed ever did -- keep an eye on the bubble. About 10 weeks after that fateful policy meeting in September 1996, the Dow had risen another 10% and Greenspan dared to speak of "irrational exuberance." Three and a half months later -- and another 7% gain for the Dow -- the Fed took its one feeble shot at the bubble with the March 25, 1997 rate hike. And that was basically it. After having put on a tightening bias back in July 1996 and maintaining that bias through June 1998 (except for two crisis-related exceptions in December 1997 and February 1998), the Fed was astonishingly timid. Then along came the full force of the Asian and LTCM crises, and yet another dose of even greater monetary accommodation was added to the equation. That set the stage for an even greater liquidity injection -- just what every asset bubble needs.
Particularly troublesome, in my view, was the Fed’s very public campaign against using margin requirements as a means to pop the asset bubble. It smacked of a central bank attempting to make the case that there was really nothing it could do to address a serious problem. I must confess that I’ve heard that one before. As a young Fed economist in the 1970s, I remember all too well when then-Chairman Arthur Burns claimed that there was little he could do to counter a deeply institutionalized inflation. How wrong he was. Ultimately, as Paul Volcker demonstrated with great clarity, it was just a matter of will.
Yet in direct contradiction to Greenspan’s own private views, as noted above and expressed at the FOMC meeting back in September 1996, the Fed made every effort to convey the impression that there was nothing it could do to tame the equity market. For example, only six months after that meeting, Greenspan publicly stated in congressional testimony in March 1997 that "Our authorities (sic) on margins is one, an anachronism and two, inappropriately positioned in the Federal Reserve." A few years later, in January 2000, he went further and claimed that "…the level of stocks prices (has) nothing to do with margin requirements…" Vice Chairman Roger Ferguson also took up the cause in February 2000 and put it succinctly, "I believe that the Federal Reserve should not foster the impression that we are targeting the equity market by adjusting our one tool in the margin area, namely initial marginal requirements."
A few lonely souls on Wall Street, of all places, lobbied vociferously to the contrary. Paul McCulley of PIMCO and Steve Galbraith, then an obscure financial services analyst from Sanford Bernstein, testified in front of Congress in early 2000 in favor of hiking margin requirements. I penned a piece in Barron’s around the same time making a similar argument (see "It’s a Classic Moral Hazard Dilemma," Barron’s, March 27, 2000). The Fed stonewalled this criticism, but alas, by then, it was far too late.
In the end, the lesson is painfully obvious. The asset bubble is one of the greatest hazards that any economy or financial system can face. From Tulips to Nasdaq, the record of economic history is littered with the rubble of post-bubble economies. It takes both wisdom and courage to avoid such tragic outcomes. Sadly, as the full story now comes out, we find that America’s Federal Reserve had neither. " |
