Pop Goes the Chairman
By Jim Rogers December 2002, Worth Magazine
Alan Greenspan could have prevented the stock market bubble by tightening the money supply. Now Mr. Bubble's easy-money policies are creating a whole new set of problems.
Pop Quiz: How do you know when you're witnessing a stock market bubble?
(a) Stock prices rise despite declining earnings.
(b) Investors borrow at a breakneck pace to keep plowing more money into the market.
(c) The S&P 500 index soars, even though more than half of its stocks are actually down.
(d) It pops.
According to Federal Reserve chairman Alan Greenspan, the answer is d. At least, that's the impression you get from his comments at an economic symposium in Jackson Hole, Wyoming, this past summer. At the time, our esteemed master of monetary policy said, "It was very difficult to definitively identify a bubble until after the fact—that is, when its bursting confirmed its existence."
Nonsense. Greenspan knew there was a bubble all along. After all, he caused it. During his 15-year reign as Fed chairman, Greenspan has made a series of decisions that are the economic equivalent of throwing gasoline on a bonfire. History will likely remember him as the man who could have burst the bubble before it got out of hand but chose only to make matters worse. If he doesn't change his current monetary policy soon, he'll also be remembered as the man who created the real estate and the consumer debt bubbles that have followed in the market bubble's wake.
Things weren't always so grim for the maestro. Remember the gravy days of the 1990s? From 1992 through 1997, the S&P 500 soared about 130 percent, an average of some 22 percent a year. It was the biggest bull market that longtime investors like me had ever seen. All the economic indicators were pointing in the right direction: Unemployment was down. Manufacturing hours were up. Corporate profits nearly doubled. These were good days for the U.S. economy, and Greenspan was quick to take credit. Many believed that the market had gone to a special place where stock prices always go up. Everybody gets rich. The new economy, I believe it was called.
We all know what happened to that myth. In 1997, corporate profits peaked. Manufacturing hours began to decline. A financial crisis in several key Asian economies, including Malaysia and Thailand, threatened to bankrupt many investors and powerful investment banks. Greenspan responded by printing money and extending credit, pumping liquidity into the U.S. economy to make sure that the problems in the East wouldn't rock the West.
This was a pivotal moment in Greenspan's career. He should have let the markets correct themselves, as they were already trying to do. Stocks would have fallen. Companies would have been hurt or possibly even destroyed by the normal economic decline. There would have been a bear market panic and an eventual selling climax. Many investors would have lost money. That's what bear markets do: They chasten those who get a little too greedy. As William McChesney Martin, Fed chairman from 1951 to 1970, put it, the central banker's job has always been to take away the punch bowl just when the party gets going. By injecting money into the economy, Greenspan spiked the punch.
During the next couple of years, a string of crises led Greenspan to keep priming the pump. In autumn 1998, it was the Russian market collapse and the fall of legendary hedge fund Long-Term Capital Management. In 1999, it was Y2K. All along, Greenspan's Federal Reserve was pumping out more cash. In fact, the money supply, as defined by M3 (a broad measure that includes all currency in circulation, liquid assets such as bank deposits, money market mutual funds, and time deposits) grew 61 percent from 1997 through 2001. During that period, Greenspan injected roughly $3 trillion into the economy while corporate profits were declining.
As we now know, even Greenspan couldn't stop the stock market from correcting itself in the end. Bubbles all work the same way: Eventually they pop. In this case, however, the glut of money and credit that Greenspan poured into the U.S. economy has created a host of new problems. The U.S. government's fiscal budget now has a huge deficit because so many projections were based on revenue from capital gains taxes that will never be realized. Employee 401(k) plans are in the toilet, and pension plans—both corporate and government—are in trouble, some in danger of disappearing entirely. Social Security and Medicare are certain to suffer.
Greenspan's actions have caused problems on a corporate level as well. All the easy credit that is available is propping up companies that are basically zombies—companies that should have gone out of business long ago. My guess is that many of the corporate accounting problems that have surfaced in the past year might not have happened if Greenspan had allowed the stock market to correct itself.
Even worse, Greenspan has created two new bubbles. Faithful readers know that I believe the real estate market is dangerously overvalued. Many investors have simply transferred assets from the stock market to their homes, thinking they can get rich quickly (or at least protect what wealth they have left). Greenspan has certainly fed this bubble, lowering interest rates 11 times since January 2001, enabling homeowners to refinance their mortgages and borrow even more money without raising their monthly payments. This would be fine if people were using the money to pay off credit card bills, car loans, or other debt, but that doesn't appear to be true. Consumer debt levels are soaring, creating a bubble that will devastate many people when it bursts.
The maestro's term is up in 2004. He is already lobbying to be reappointed, hoping to surpass William McChesney Martin as the longest-running Federal Reserve chairman in history. Greenspan shouldn't be reappointed; he should be run out of Washington. By then, things may be so bad that even he won't be able to hide what he's done. But who can blame investors for their irrational exuberance when the Federal Reserve chairman—the man entrusted with making the nation's most important financial decisions—seems more interested in protecting his own legacy than in doing what's best for the country.
Jim Rogers is a Worth senior contributing editor. Photos and a daily chronicle of his recent three-year journey around the world are available at www.jimrogers.com.
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