 Greenspan's
Whopper
Bill Bonner
The
Daily Reckoning
February 14, 2005
The Daily Reckoning PRESENTS:
There are some stories that just need to be told... the legend
of the first Christmas, the chronicles of Christopher Columbus...
and the epic tale of Alan Greenspan and the U.S bubble economy.
Read on . . .
"You are wasting your
life and your talents writing about Alan Greenspan every day,"
said an old friend.
For years, we have been working
on Greenspan's obituary. As far as we know, the man is still
in excellent health. But we do not want to be caught off guard.
Maybe we could even rush out a quickie biography, explaining
to the masses the meaning of Mr. Greenspan's life and work.
Perhaps our friend is right.
But then again, we weren't doing anything special before we started
keeping up with the Fed chairman. Besides, we see something in
Alan Greenspan's career... his comportment... his betrayal of
his old ideas... his pact with the Devil in Washington... and
his attempt to hold off nature's revenge at least until he leaves
the Fed... that is both entertaining and educational. It smacks
of Greek tragedy without the boring monologues or bloody intrigues.
Even the language of it is Greek to most people. Though the Fed
chairman speaks English, of course, his words often need translation
and historical annotation. Rarely does the maestro make a statement
that is comprehensible to the ordinary mortal. So much the better,
we guess. If the average fellow really knew what he was talking
about, he would be alarmed. And we have no illusions. Whoever
attempts to explain it to him will get no thanks; he might as
well tell his teenage daughter what is in her hotdog.
We persevere anyway, more in
mischief than in earnest.
The background: The U.S. economy
faced a major recession in 2001 and had a minor one. The necessary
slump he held off by a dramatic resort to central planning. The
"invisible hand" is fine for lumber and poultry prices.
But at the short end of the market in debt, Alan Greenspan's
paw presses down, like a butcher's thumb on the meat scale. The
Fed quickly cut rates to head off the recession. Indeed, never
before had rates been cut so much, so fast. George W. Bush, meanwhile,
boosted spending. The resultant shock of renewed, ersatz demand
not only postponed the recession; it misled consumers, investors
and businessmen to make even more egregious errors. Investors
bought stock with low earnings yields. Consumers went further
into debt. Government liabilities rose. The trade deficit grew
larger. Even on the other side of the globe, foreign businessmen
geared up to meet the phony new demand; China enjoyed a capital
spending boom as excessive as any the world has ever seen.
What the Greenspan Fed had
accomplished was to put off a natural, cyclical correction and
transmogrify an entire economy into a monstrous ECONOMIC bubble.
A bubble in stock prices may do little real economic damage.
Eventually, the bubble pops and the phony money people thought
they had disappears like a puff of marijuana smoke. There are
winners and losers. But in the end, the economy is about where
it began - unharmed and unhelped. The households are still there...
and still spending money as they did before... hand the companies
still in business. Only those that leveraged themselves too highly
in the bubble years are in any trouble - and they probably deserve
to go out of business.
Even a property bubble may
come and go with little effect on the overall economy. House
prices have been running up in France, for example, at nearly
the same rates as in America. But in France there is very little
mortgage refinancing... or "taking out" of equity.
The European Central Bank was repeatedly urged to lower rates
in line with those in America. It refused to budge. Without falling
rates, there was no "refi boom." Nor were European
banks offering "home equity lines of credit." Property
could run up... and run down... and the only people who cared
would be the actual buyers or sellers, who either cursed themselves
or felt like geniuses, depending on their luck.
But in Greenspan's bubble economy
something remarkably awful happened. Householders were lured
to "take out" the equity in their homes. They believed
that the bubble in real estate priced created "wealth"
that they could spend. Many did not hesitate. Mortgage debt ballooned
in the early years of the 21st century - from about $6 trillion
in 1999 to nearly $9 trillion at the end of 2004. Three trillion
dollars may not seem like much to you, dear reader. But it increased
the average household's debt by $30,000. Americans still lived
in more or less the same houses. But they owed far more on them.
We had given up all hope of
ever getting an honest word out of the Fed chairman on this subject
when, in early February, in the year of our Lord 2005, the maestro
slipped up. His speech was entitled "Current Account."
Jet lagged, his defenses down, the poor man seems to have committed
truth.
"The growth of home mortgage
debt has been the major contributor to the decline in the personal
saving rate in the United States from almost 6 percent in 1993
to its current level of 1 percent," he admitted. Thus, he
did bring the up the subject. Then, he began a confession: The
rapid growth in home mortgage debt over the past five years has
been "driven largely by equity extraction," said the
man most responsible for it. By this time, listeners were beginning
to put Mr. Greenspan at the scene of the crime. And pretty soon,
even the dullest economist in the room was adding 2 and 2. Mr.
Greenspan lowered lending rates far below where a free market
in credit would have put them. With little to be gained by putting
money in savings accounts... and a lot to be gained by borrowing...
households did what you would expect; they ceased saving and
began borrowing. What did they borrow against? The rising value
of their homes - "extracting equity," to use Mr. Greenspan's
own jargon. The Fed chairman had misled them into believing that
house prices increases were the same as new, disposable wealth.
But the world's most famous
and most revered economist didn't stop there. He must have had
the audience on the edge of its chairs. He confessed not only
to having done the thing... but also to having his wits about
him when he did it. This was no accident. No negligence. This
was intentional.
"Approximately half of
equity extraction shows up in additional household expenditures,
reducing savings commensurately and thereby presumably contributing
to the current account deficit. The fall in U.S. interest rates
since the early 1980s has supported home price increases,"
continues America's answer to Adam Smith.
People take money out of their
homes. With this source of spending power available to them,
they see no reason to save. Instead, they spend - often on foreign-made
goods. With no savings available domestically, America must look
overseas for credit.
"The obvious and most
important point is that rapid growth of U.S. mortgage debt did
not come out of thin air," comments Stephen Roach. "It
was, of course, a direct outgrowth of the Fed's hyper-accommodation
of the post-bubble era -- namely, short-term interest rates that
have been negative in real terms for longer than at any point
since the 1970s."
.
The crime of which Mr. Greenspan is guilty is fraud. Putting
interest rates at an artificially low level, the Fed chairman
intentionally misled Americans. Were it not for the Fed's low
rates and easy lending policies, Americans wouldn't have thought
themselves so rich. Their houses wouldn't have gone up so much;
they wouldn't have taken out so much equity, because they wouldn't
have had any equity to take out. They would have had to spend
less, which would have reduced the U.S. current account deficit
and diminished household indebtedness.
"Lacking in job creation
and real wage growth," explains Roach, "private sector
real wage and salary disbursements have increased a mere 4% over
the first 37 months of this recovery -- fully ten percentage
points short of the average gains of more than 14% that occurred
over the five preceding cyclical upturns. Yet consumers didn't
flinch in the face of what in the past would have been a major
impediment to spending. Spurred on by home equity extraction
and Bush Administration tax cuts, income-short households pushed
the consumption share of US GDP up to a record 71.1% in early
2003 (and still 70.7% in 4Q04) -- an unprecedented breakout from
the 67% norm that had prevailed over the 1975 to 2000 period...
A long last, Chairman Greenspan owns up to the central role he
and his colleagues at the Federal Reserve have played in fostering
these developments."
Our own Fed chairman, guardian
of the nation's money... custodian of its economy... night watchman
of its wealth...
How could he do such a thing?
And yet he has done it. He turned a financial bubble into an
economic bubble. Not only were the prices of financial assets
ballooned to excess... so were the prices of houses... and so
were the debts of the average household.
Where does it lead? The force
of a correction is equal to the deception that preceded it. Mr.
Greenspan's whopper must be followed by a whopper of a slump.
Regards,
Bill Bonner
 The Daily Reckoning
Editor's Note:
Bill Bonner is the founder and editor of The Daily Reckoning.
He is also the author, with Addison Wiggin, of The Wall Street
Journal best seller Financial
Reckoning Day: Surviving the Soft Depression of the 21st Century (John Wiley &
Sons).
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