CHAOS-ONOMICS: Strangely Attracted to the Truth
May 1:
chaos-onomics.com
A man who has committed a mistake and doesn't correct it, is committing another mistake -
Confucius
In yesterday's newsletter I touched on my response to economic reasoning errors, re-education. Having discovered that the ideas in which I believed were not helping me make sense of the world, I decided to find new ones that did. As Francis Bacon wrote, truth comes more easily out of error than out of confusion, and confused aptly describes one who continues to believe ideas which have been proven ineffective. This confusion can be ascribed, I believe, to the public views of Chairman Greenspan and the faith both the administration and the financial markets have in his management of the economy. In a sense, Greenspan has become a totem, an icon of better times outside the realm of critical analysis. Yet his crystal ball, so to write, has rarely been accurate.
Recalling the first Bush administration, Chairman Greenspan was quite slow to realize the effects Gulf War I would have on oil prices and consequently US inflation. Thus interest rates were held at high levels for longer than was, in hindsight, necessary, to the chagrin of Bush and the delight of Clinton.
In early 1994 FOMC deliberations, Greenspan said, "I think we partially broke the back of an emerging speculation in equities.....In retrospect we may well have done the same thing inadvertently in the bond market." Hmmm, by my check the party, or in Greenspan lingo, "emerging speculation" was just getting started in the equity market in 1994 and the bond market bubble is still expanding.
However, the resolve to "break the back of emerging speculations" seemed to wane by the time 1997 rolled around. Despite expressing the view in early 1997 Humphrey Hawkins testimony that; "history is strewn with visions of such ‘new eras’ that, in the end, have proven to be a mirage. In short, history counsels caution. Such caution seems especially warranted with regard to the sharp rise in equity prices during the past two years. These gains have obviously raised questions of sustainability", he, in the main, restricted his back breaking efforts to lip service.
Then as 1998 rolled into 1999, he joined the party whose back was supposedly broken in 1994 arguing, "It is the observation that there has been a perceptible quickening in the pace at which technological innovations are applied that argues for the hypothesis that the recent acceleration in labor productivity is not just a cyclical phenomenon or a statistical aberration, but reflects--at least in part--a more deep-seated, still developing, shift in our economic landscape." This analysis was followed by the infamous, "you can't tell a bubble until it pops" analysis and the rest, as they say, is money in the bank, just not in your account.
Of late, he fails to see any problems in the US mortgage market, the subject of today's graph. Given the absence of official pressure, in the form of higher interest rates, the rising delinquency and foreclosure rates are signs of trouble beneath the surface. What happens when the Fed needs to tighten as the weaker US$ keeps feeding into domestic inflation thereby choking off the flow of funds necessary to keeping the bubble inflated? Will the Fed soon stoop so low as to accept non-performing mortgage debt as collateral for loans as the BOJ is near to doing? In 1999 Greenspan argued, "in economics, unlike in the physical sciences, we can never conduct fully controlled experiments for an overall economy." As a trained physicist I think his sense of the degree of control in physical experiments is off. Worse, if he doesn't think a Central Bank is an experiment, he is very confused.
I imagine the peanut gallery might be shouting, "if you're so smart what would you have done?" I don't believe in the notion of a Central Bank, by which I mean that I think the institution cannot succeed, relative to an explicit hard money standard, at its professed goals of low inflation and maximum sustainable growth. The tenure of Greenspan, in my view, bears this out. He was either clapping himself on the back for vanquishing yesterday's demons early on, when he was new in the job and filled with vim and vigor or worshiping at the altar of efficient markets, as things got out of control. A study of the performance of the Fed over time shows this cycle over and over. The resolve to keep things stable following recessions is strong early on, when least needed, and ebbs as the party gets going. Fed Chairmen who buck this trend lose their jobs as Greenspan is well aware.
This brings us to Greenspan's optimistic forecast, "I continue to believe the economy is positioned to expand at a noticeably better pace than it has during the past year." He believes this, in the main, according to his testimony, because the financial markets, which so sagely forecast great times ahead early in 2000, tell him so. Fool me one, shame on you, fool me twice, shame on me. |
