The
Greenspan Legacy
Adam Hamilton
Archives
Jan 27, 2006
January 31st, 2006 marks the
end of a financial era. The long-time Chairman of the Federal
Reserve, Alan Greenspan, will retire after 18 years at the helm
of the United States' central bank. Widely lionized at the pinnacle
of his career, Greenspan's legacy will profoundly affect investors
worldwide for many years to come.
As Greenspan's tenure as the
most powerful man in the financial universe is debated among
investors today and historians tomorrow, his many decisions will
be dissected and evaluated. But I fear most of this debate will
overlook the most foundational and crucial issue. Before Greenspan's
actions are considered, the very notion of the Fed itself
ought to enter the limelight.
The Federal Reserve is not
a capitalistic entity compatible with free markets. Instead it
functions just like the miserably failed old-school command-and-control
Communism model. The core philosophy of the Fed and its Federal
Open Market Committee that controls short-term interest rates
is that mere mortals meeting in secret like a conspiracy cabal
are better suited at setting the price of money than the free
markets.
Regardless of who leads the
Fed, the whole organization exists because price controllers,
no different from those in 20th century Russia, think they alone
can divine the price at which the supply of savings equals the
demand for savings. The price of money, or interest rate, leads
savers to decide how much of their income to save and debtors
to decide how much of someone else's savings to borrow.
Out of all the goods and services
available on the planet, the price of money is probably the most
important one to ensure is not manipulated. Interest rates
act as signals to direct capital from unproductive uses to productive
ones, which helps build great wealth for nations when the free
markets dictate interest rates. But when manipulators try to
artificially manipulate interest-rate signals, capital is misappropriated
and wasted leaving nations poorer.
Bubbles are the ultimate case
in point. Whenever too much paper money floods into a financial
system, which is the inevitable result of artificially low interest
rates, it floods into some class of goods or services or investments
and inflates prices far beyond where they would be if interest
rates were set by free markets. It is ironic as the destination
of this excess capital determines whether it is good or bad in
investors' minds.
When artificially-low-interest-rate-driven
excess money floods into technology stocks or tract houses in
suburbia, Americans rejoice and think it is a great thing until
the resulting bubbles inevitably burst and wreak great pain.
But if this same excess money drives up the prices of general
goods and services and commodities like gasoline, the inflation
is considered bad. Indeed the Greenspan Fed spent much time trying
to jawbone money into inflating politically correct assets like
houses instead of politically incorrect ones like commodities.
So before we delve into Greenspan's
record on monetary inflation and interest rates, realize he is
as far away from being a free-market capitalist as one can possibly
be. He is a Communist-style elitist who believes that the price
of money and even money supplies should be centrally planned
as if by the Communist Politburo. This is no less ridiculous
than the idea of the Fed mandating the price of every dinner,
every pair of shoes, or every book sold in America. History has
proven time and time again what an asinine idea central planning
truly is.
So how did Alan Greenspan,
price fixer and market manipulator, do in his years at the Fed?
His record is mixed. Initially he showed some constraint and
tried to fight inflation, the scourge of the middle class, but
five or six years into his run he started to embrace and nurture
inflation. Amazingly in monetary growth terms he wasn't a great
deal better than the horrible Fed chairmen of the 1970s, Arthur
Burns and William Miller.
Our first chart this week looks
at 45 years of annual broad money supply (M3) growth compared
to annual price inflation as measured by the Consumer Price Index.
From a free-market standpoint the more stable a money supply,
meaning the slower it grows, the more prosperity it generates
in all socio-economic strata of society. The faster money supplies
grow the harder life becomes for average Americans with slowly
growing incomes.
All these charts run from 1960
to the end of 2005. I chose this scale because I wanted to be
able to see the results of Alan Greenspan's decisions in context
with history. The blue-shaded area to the right marks Greenspan's
tenure. Before we get into the Greenspan years though, it is
useful to recall all the financial pain of the 1970s which was
caused by excessive monetary growth and the severing
of the remaining gold standard.
Note the red M3 line above,
which is the year-over-year growth rate in the broad US money
supply. For virtually the entire 1970s the Fed was allowing the
money supply to expand at a breakneck pace usually exceeding
10% a year. With so much new money flooding into the system,
the supply of real goods and services on which to spend it just
couldn't keep pace. So relatively more money was chasing after
and bidding up the prices of relatively less goods and services.
The results of this excessive
monetary growth spawned by the Fed artificially manipulating
interest rates far lower than the free markets would have set
them was the massive inflation of the 1970s. The blue CPI growth-rate
line above tracks some of this, with costs of living rising 12%
and 15% in just a year during their worst spikes. Everything
in the US became more expensive in the 1970s and Americans felt
poorer since incomes didn't grow as fast as money supplies.
This was such an enormous problem
for our nation that, like an elephant in the living room, even
Washington and the Fed couldn't hide it under the rug. So Paul
Volcker, the Fed Chairman for the 8 years before Greenspan's
appointment, finally let interest rates float high enough in
the early 1980s to strangle the damaging monetary excesses out
of the system. Volcker also ensured monetary growth rates continuously
declined in the 1980s which drove down inflation to multi-decade
lows.
When Greenspan became chairman
in August 1987, the Fed was doing about as well as it possibly
could for a Communist-style command-and-control price-fixing
entity. Monetary growth rates continued to fall, inflation was
acceptable, and other than the fluky October
1987 stock market crash Greenspan had it easy. All he had
to do was not mess around with interest rates and keep
the Fed from mucking around too much in money supplies by buying
and selling US Treasuries.
And Greenspan was largely successful
at this in his early years. Broad monetary growth continued lower
and inflation stabilized for the first time in decades. But for
some reason near the beginning of 1995 Greenspan forgot about
his mission to keep prices stable by not allowing excessive monetary
growth. The M3 annual growth rate began to rocket higher and
challenged 11% in the late 1990s and exceeded 13% in the early
2000s.
As you can see on this chart
above, after 1995 monetary inflation exploded upwards to staggering
rates not witnessed since the 1970s. Whenever excessive money
supplies are pumped into the pipeline of an economy, they will
have to find a home somewhere. Typically this is in the form
of general price inflation shown in the CPI growth spikes of
the 1970s. But strangely in the mid-1990s the CPI ignored the
monetary surge and a major discontinuity was created.
Some believe that the Clinton
reelection effort ahead of the 1996 elections involved cooking
the books in terms of government statistics. If the CPI was
reported to be low through the use of statistical wizardry like
hedonic deflators, then the stock market would thrive, Americans
would feel happy about the economy, and the Democrats would win
another term. Whether this was the reason or not, the CPI seemed
to stop reflecting true monetary inflation in 1995 or so.
With no gold standard and no
accountability in the official inflation stats the markets watched,
Greenspan allowed M3 growth to rocket up to 1970s levels. This
was the bubble fuel for the massive stock market bubble
of the late 1990s, as we'll see in the next chart. Alan Greenspan
warned of "irrational exuberance" in 1996 and then
he inexplicably kept feeding the very stock-market bubble
he saw growing. Eventually he even bought into the New Era nonsense
and foolishly believed the "productivity miracle" justified
extreme stock
prices.
By the dawn of 1999 Greenspan
seemed to once again get concerned and start pursuing Fed policies
for lowering the blistering monetary growth rates. But then Y2k
came along and everyone including the Fed was scared so it injected
huge amounts of new money into an already frothy system. Then
the NASDAQ crash
of early 2000 led to another long surge of increasing monetary
growth in an irresponsible attempt to bail out stock speculators.
All of this incredibly excessive
1970s-type monetary growth created the situation in which we
find ourselves today, with prices of goods and services rising
as the Fed's monetary promiscuity floods into the general economy.
In terms of monetary growth, Greenspan didn't do much better
than the terrible 1970s Fed chairmen and he certainly utterly
squandered the inflation-fighting legacy of his predecessor Volcker.
History will rightfully remember
Alan Greenspan not as an inflation-fighting hawk, but as a socialist
Keynesian advocate of endless inflation that betrayed his own
principles that he expressed early in his life. In 1966 Alan
Greenspan wrote an awesome essay, "Gold
and Economic Freedom", where he said the following.
"In the absence of the gold standard, there is no way to
protect savings from confiscation through inflation. Deficit
spending is simply a scheme for the "hidden" confiscation
of wealth."
In light of his surprisingly
poor monetary record Greenspan's legacy will be remembered as
one of the confiscators of Americans' wealth that he so despised
early in his life. His senseless inflation contributed to the
moral decay of this nation, gutting the purchasing power of retirees'
savings and ensuring that most American families would have to
have two wage earners in order to keep a semblance of middle-class
living.
If you are blessed enough to
have surplus capital to invest and not live on a fixed income
like older or less fortunate Americans, you may not be worried
about inflation. Last spring I had a discussion about the Greenspan
record with the CEO of a medium-sized publicly-traded US corporation.
As one blessed to earn a lot of money, he couldn't care less
about inflation and didn't seem to understand how damaging it
is to average folks. Well, Greenspan's policies also inflicted
enormous pain on the wealthy investor class too.
This next chart shows the actual
M3 money supply versus the S&P 500. Excessive monetary growth
courtesy of the Greenspan Fed directly kindled the dangerous
stock-market bubble of the late 1990s.
The investor class can often
earn more than enough to stay ahead of inflation. Who cares if
a hamburger at McDonald's costs $20 if you are earning $500k+
a year? But Greenspan's pro-monetary-inflation policies at the
Fed also caused literally trillions of dollars of damage
to investors. If there was one individual alive who could have
greatly moderated the 1990s stock-market bubble, it was Alan
Greenspan using his Fed.
Early in his career he continued
Volcker's policy of disinflation, slowing the monetary growth
rate as the red actual M3 line above shows. When Greenspan took
the reins at the Fed there was well less than $4t US dollars
in circulation. But in 1995 when Greenspan suddenly became a
manic inflationist, he unleashed the floodgates of monetary growth
just like the failed Fed chairmen of the 1970s. M3 literally
started soaring.
As these torrents of paper
money freshly created out of thin air cascaded into the economy,
many of them gravitated to the stock markets. The surge in monetary
inflation that started at the Greenspan discontinuity marked
the very moment in time when the US stock markets left a reasonable
normal
growth ascent slope and went parabolic. While the Fed-fed
equity bubble may have been fun for a few years, its ultimate
consequences were, are, and will continue to be catastrophic.
After five years of relentless
monetary inflation pouring into stocks, by March 2000 the flagship
S&P 500, the 500 biggest and best companies in America, was
worth about $13t, a staggering sum of capital. Yet all this was
only an inflation-fed fiction just like past bubbles. These companies
didn't have the earnings to support these tremendous valuations,
but investors just bid them up indiscriminately anyway because
Fed money kept flooding in.
But the Greenspan bubble, like
every other bubble in history, eventually had to end. It topped
in March 2000 and its first Great Bear downleg lasted until March
2003 or so. Over this period of time the S&P 500 companies
lost about 40% of their bubble value, about $5.5t in these
elite companies alone! This loss is just mind-blowing, and it
damaged the investor class immeasurably. Monetary inflation hurts
the wealthy too when the bubbles it creates suddenly pop and
wreak great havoc.
At this point Greenspan, if
he had loved free-market capitalism, would have acknowledged
he screwed up in the late 1990s with his monetary promiscuity
and he would have stepped back to let the necessary painful readjustment
happen. But instead he did the dumbest thing he could possibly
do, something that fits in with his true character as a central
planner and market manipulator. He brazenly attempted to bail
out stock speculators by slashing interest rates to artificial
half-century lows.
Before we get to our next chart
showing Greenspan's unbelievably aggressive interest-rate manipulations,
note that the red M3 line exceeds $10t today as he leaves the
Fed. Why is everything getting more expensive today, from food
to medical care to insurance to cars to houses? Because under
Greenspan's watch the Fed allowed US money supplies to rocket
185% higher! This is becoming such an embarrassment that
the Fed is actually going to quit tracking and publishing M3
in a couple months to hide its horrific Greenspan record.
Our final chart compares 1-year
interest rates with the value of the US dollar. After the 1995
discontinuity the dollar went on a wild ride that ended soon
after Alan Greenspan attempted to bail out stock speculators
upset that they were foolish enough to buy in to a massive bubble.
While the Fed's primary mandate is to not grow the money
supply very fast in order to prevent inflation, the stability
of the dollar's purchasing power is a related mission and the
Greenspan Fed failed miserably on this front too.
When money supplies grow too
rapidly and inflation and inflationary expectations take root
as they did in the late 1970s, the only way to sop up all of
this excess liquidity is with far higher than normal interest
rates. Greenspan's predecessor understood this and was willing
to be unpopular in order to get the US economy back on track.
For nearly six years straight in the early 1980s one-year
interest rates exceeded 10%.
At times during this painful
period of sopping up excessive 1970s monetary growth, 30-year
fixed mortgage rates exceeded 18%! Thanks to the massive Greenspan
inflation of the late 1990s there is a very good chance we will
again see mortgage rates well into the teens before his inflation
is purged from the system. Folks with adjustable-rate mortgages
will be ripped to shreds if this happens, all courtesy of the
Greenspan legacy.
Early in Greenspan's career
he established the precedent of slashing interest rates rapidly
for long periods of time in a Keynesian attempt to centrally
plan and manage economic growth. It appeared to be successful
at the time, but now a decade later the folly of this approach
is quite evident. If interest rates hadn't fallen so far in the
early 1990s then the speculative culture that helped drive the
stock-market bubble would probably not have taken root to such
an extent.
But the biggest mistake Greenspan
made was when he launched his bold
gambit in early 2001. Even though artificially cheap money
had never stopped a bubble bust from fully running its course
in history, Greenspan's supreme hubris led him to try anyway.
He didn't want his precious public image and acceptance tarnished
(read Bob Woodward's excellent "Maestro" to learn of
Greenspan's love of status") so he decided to bail out stock
speculators. Rather than letting stock speculators learn from
their own mistakes, Greenspan mollycoddled them.
In order for a free-market
society to work, people must be free to succeed or fail.
Failure is more important than success in many ways since it
teaches the best lessons of life, builds character and wisdom,
and lays the foundation for future successes. By trying to buoy
the stock markets with artificially low interest rates Alan Greenspan
attempted to short-circuit countless valuable financial
lessons from the bust. Instead of becoming more conservative
and learning just as speculators in the 1930s had, in the 2000s
speculators exercised the Greenspan Put.
A put, of course, is an options
contract that protects an investor from downside by guaranteeing
him a selling price regardless of market conditions for a period
of time. Greenspan's bailout was widely seen as putting a floor
under the stock markets which encouraged 1999-style speculative
excesses all over again such as we see in Google today. Stock
speculators never learned the lessons they should have in the
past five years.
When speculators and businesses
aren't free to fail, it creates a huge moral hazard problem.
After all, if the Fed is going to pull out all stops to keep
capital cheap and flowing into the stock markets, then why not
continue to bet aggressively? Rather than being wise and prudent
and deploying capital in sectors that really needed it like commodities
infrastructure, the Greenspan bailout encouraged a renewed tech-bubble
focus.
But Greenspan's Gambit of artificially
low interest rates created other problems. Capital markets rely
on a balance between savers and debtors, between savers earning
a fair return on the income they didn't spend and debtors paying
a fair price for the income they didn't earn. When interest rates
are not where the free-markets would set them, the saver-debtor
transactions are no longer mutually beneficial and capital
flows are grossly distorted.
Thanks to Greenspan aggressively
punishing prudent savers to subsidize wanton debtors, savings
rates in the US fell to all-time lows. Rather than save capital
and put it into productive assets that will make America a stronger
nation, many Americans instead stuck it into overvalued real
estate and created the housing bubble. The bursting of this second
Greenspan-spawned bubble in housing will be far more devastating
than the stock crash since it will affect all Americans with
a mortgage, not just the wealthier stock-investing class.
In light of Greenspan's inflationist
record, I suspect his legacy won't be very positive. He made
many poor anti-free-market decisions as a command-and-control
price fixer and it will take years or decades for the consequences
of these to work through our system. For instance, due to the
Greenspan bailout our current stock bear is likely to last 17 years instead
of just a few as in the early 1930s, and we are only 6 years
into it today. Thanks Mr. Chairman.
And when the housing bubble
spawned by Greenspan's attempt to bail out stock speculators
with artificially low rates bursts, watch out. Markets are cyclical
and artificially low prices are always followed by higher
than normal ones to balance things out regardless of what the
manipulators want. Hence the price of money is headed a lot
higher. The economic pain as real estate prices correct in most
places and crash in some is going to be tremendous. It is all
courtesy of Alan Greenspan's brazen interest-rate manipulations.
I realize this is a heavy and
sobering narrative and I don't like the Greenspan legacy either.
There are a few bright spots though, ways investors can capitalize
on Greenspan's sorry legacy. We are continuing to focus on these
opportunities and are being blessed with excellent realized profits
on our stock trades.
During the latter 2/3rds of
Greenspan's reign, his highly inflationary easy-money policies
led to enormous misallocations of capital into first tech stocks
and then houses. With capital flowing into these counterproductive
bubbles, industries that really needed this very capital starved
and withered. This contributed to a massive structural undersupply
of crucial commodities.
And this capital-starved commodities
industry is highly physical, unlike information industries that
can be wished into existence overnight. It will take more than
a decade to find and deliver enough oil, natural gas, copper,
gold, silver, and other key commodities to meet today's demand.
And not only are commodities prices rising because their producing
infrastructure was starved in the 1990s, but Greenspan's massive
monetary inflation is also filtering into commodities boosting
them directly too.
At Zeal we are zealously researching
elite commodities producers and developing tools to time trades
in these companies. While we have already been blessed with awesome
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newsletter today and capitalize on some of the massive capital
distortions that need to now be righted thanks to Greenspan.
The bottom line is Alan Greenspan,
despite his huge fan club today, is no different from the Communist
party bosses of Russia before the Cold War ended. Rather than
sitting back and letting the invisible hand of the free markets
determine the price and growth rates of money, Greenspan chose
to play God and horribly messed everything up like all other
would-be demi-gods in history. Price manipulators always
fail in the end!
Greenspan's legacy is one of
a failed market manipulator and price fixer, a dangerous enemy
of free-market capitalism in sheep's clothing. In five or ten
years from now once the full spectrum of the consequences of
his highly-inflationary and moral-hazard-ridden policies become
apparent, I suspect Greenspan will be remembered as a goat, not
a guru, a blight on our great nation and economy.
Adam Hamilton, CPA
January 27, 2006
Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!
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