The Gods' Next Big Laugh
Bill Bonner
Provided as a courtesy
of Agora Publishing & DailyReckoning
written Mar 21, 2008
posted Mar 24, 2008
Hear that noise?
That's the sound of the gods
laughing They're laughing at Northern Rock, Bear Stearns, and
all the angels, archangels, seraphim and cherubim of the whole
financial industry. The geniuses thought they had put an ankle
bracelet on uncertainty. They believed that with their new tools
they could model risk, quantify it, and control it. Now, they're
going broke... and the gods are tumbling off their chairs.
But listen up, because the
biggest laughs are still ahead.
Alan Greenspan, the world's
best-known civil servant since Pontius Pilate, wrote in the Financial
Times this week. In the interest of saving readers' time, we
reduce his half-page circumlocution on today's financial crisis
to 4 simple words: it wasn't his fault. An unexpected and unpredictable
force had taken over in the financial markets, he explained...
a kind of 'dark matter' that caused everyone to act a little
funny. According to Mr. Greenspan the source of the proximate
problem is the home building industry. For some reason, (he decided
not to mention what), it overbuilt. The crisis will end, he continued,
"when home prices stabilize and with them the value of equity
in homes supporting troubled mortgage securities."
Mr. Greenspan further explained
that "trust" in the system was "badly shaken"
"when BNP Paribas revealed large unanticipated losses on
U.S. subprime securities. Risk management systems - and the models
at their core - were supposed to guard against outsized losses.
How did we go so wrong?"
He followed this rhetorical
question with what was essentially an elaborate feint, designed
to send the hounds barking up the wrong tree. Risk management
systems, he says, "do not fully capture what I believe has
been, to date, only a peripheral addendum to business cycle and
financial modeling - the innate human responses that result in
swings between euphoria and fear that repeat themselves generation
after generation with little evidence of a learning curve."
The former Fed chief has a point. The public is subject to mood
swings. It is just a shame he dodged credit for his own contribution
to the euphoria of 2002-'07.
Looking back at the long history
of the market's manic-depressive episodes, it is difficult to
find an instance in which extreme mood swing was not exaggerated
by something in the water. Neither the Mississippi Bubble nor
the South Sea Bubble would have happened had not John Law invented
the first central bank - the Banque Generale - in 1716. Americans
wouldn't have been so bumptious in '29 had it not been for Fed
chairman Benjamin Strong's little 'coup de whiskey' intended
to help out his friend Montagu Norman at the Bank of England.
The Japanese wouldn't have goosed their stock market up to 39,000
(currently near 12,000) had it not been for the exceptionally
low interest rates following the Plaza Accords in September 1985;
rates were cut four times the following year - sending Japanese
property and equities soaring. And Americans never would have
gone on a residential property binge had the prime rate not been
kept exceptionally low for an exceptionally long period under
the leadership of the very same person writing in the Financial
Times this week: Alan Greenspan.
Centrally-planned prices send
the wrong signals and cause people to miscalculate. And no price
causes as many miscalculations as the price of credit - controlled
at the short end by central bankers. Of course, anyone can make
a mistake. But to make the kind of mess we're seeing in the capital
markets now, you need a theory. Of course, central bankers had
one.
The foundation for modern central
banking theory was laid down in the very year Alan Greenspan
was born - 1926. That was when one of the first "neoclassical"
economists, Professor Irving Fisher, published "A Statistical
Relationship between Unemployment and Price Changes," arguing
that a little inflation was a good thing, since it seemed to
stimulate employment.
Then, "in the 1970s,"
writes Nobel Prize winner Edmund Phelps in the Wall Street Journal,
"a new school of neo-neoclassical economists proposed that
the market economy, though noisy, was basically predictable.
All the risks in the economy, it was claimed, are driven by purely
random shocks - like coin throws - subject to known probabilities"
By 2001, the Fed opened a new
museum in Chicago. Visitors were invited to look at the economy
as though it were a science project. They were confronted with
a problem and asked what would be the appropriate response -
lower rates or raise them? Then, they were given the correct
answer.
Today, America's central bank
applies a "rule based monetary policy" - supposedly
founded on the 'scientific' discoveries of Irving Fisher and
his heirs. What's the rule? Balance out inflation against unemployment.
When inflation threatens, raise rates. When the economy is menaced
by unemployment, cut them. And always, like a dishonest butcher,
make sure your thumb lingers on the inflation side.
Professor Fisher lived long
enough to see the gods laughing at him. Just days before the
stock market crash of '29 he wrote, "stock prices have reached
what look like a permanently high plateau." Then, when the
crash came he said that the "market was only shaking out
the lunatic fringe," and claimed that prices would soon
go much higher. A few months later, Fisher had lost his fortune
and his reputation, but still told investors that recovery was
just around the corner.
So far, Alan Greenspan has
only gotten a few chuckles, as he attempts to explain where he
was and what he was doing when the world's biggest bubble took
shape. But the more he explains, the more people understand:
that the 'science' of central banking is nothing more
than claptrap, and Mr. Greenspan is a scalawag.
Regards,
Mar 21, 2008
Bill Bonner
email: DR@dailyreckoning.com
website: The
Daily Reckoning
Bill Bonner
is the founder and editor of The Daily Reckoning.
Bill's book,
Mobs,
Messiahs and Markets: Surviving the Public Spectacle in Finance and
Politics, is a must-read.
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).
In Bonner and
Wiggin's follow-up book, Empire
of Debt:
The Rise of an Epic Financial Crisis, they wield their sardonic
brand of humor to expose the nation for what it really is - an
empire built on delusions.
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