September 19th, 2007 Price: Subscribe »

ARCHIVED COMMENTARY

Place your bets, folks! We’ve heard good arguments both for and against a Fed easing today but think the odds favor the doves. One of our regular correspondents, Erich Simon, actually expect the Fed to tighten – a very distant longshot, in our view – and we have reprinted his comments at bottom. One middle of-the-roader is Don Luskin, an acquaintance from our PSE options-floor days who now runs a company called Trend Macroclytics. Don had an op-ed piece in the Wall Street Journal last Thursday headlined “The Greenspan Myth”.  Expecting the essay to come down hard on the former Fed chairman, we were disappointed to see that it merely attempted to refute the widespread belief that Mr. Greenspan should be viewed as a hero for supposedly helping to prevent various crises of the recent past from turning disastrous:  Long Term Capital Management, Mexico, the 1987 Crash, Russia and the 9/11 terror attacks.  

 

 

Don makes a pretty persuasive case that Mr. Greenspan in each instance was too late with too little and that market forces eventually did the job, but the essay was less convincing in concluding that the Fed chief's overrated heroism should not be invoked to push his successor, Mr. Bernanke, into an unwarranted easing. Don sees the U.S. economy as too robust at the moment to warrant Fed intervention, and on that point we would differ sharply; for, nowhere in Don’s tally of the U.S. economy’s supposed strengths does he even acknowledge the potentially grave troubles that currently beset the real estate sector.

 

Greenspan to Blame

 

Immediately below is the response we sent to Don.  As Rick’s Picks  readers would expect, it eschews the genteel politeness toward Mr. Greenspan that writing op-ed for the WSJ requires. We dispense with such niceties not only because Mr. Greenspan’s theoretically challenged brand of economics is an embarrassment even to the Dismal Science, but because we are convinced history will hold the man directly responsible for the collapse of the global economic system. Here’s the letter:

 

“Greetings, Don, from your old PSE acquaintance.  Speaking as a loose cannon from the subterranean newsletter world,  I wanted to let you know that those who believe Greenspan to be either a fool or a liar, or a combination of both, are legion.  How else to explain why a guy with an MIT degree in economics would speak of a capital investment boom at a time when household savings growth was negative? It gets worse: Championing the crackpot notion that inflated home prices constitute real wealth, the man emboldened household borrowers to venture beyond mere recklessness and toward the pale of metaphysicality.

 

Why Deflation Is  Irresistible

 

“Austrian-school theorists are too genteel to characterize Greenspan and his successor in the way that I and my not-yet-ready-for-prime-time colleagues would, but Richebächer et al. had an oblique way nonetheless of making the point by calling us back to the indomitable logic of Hayek. Ironically, a weakness of the Austrians is that they have trouble choking out the word ‘deflation,’ especially during such cosmic credit inflations as we’ve just experienced.  But as far as I'm concerned, a ruinous debt deflation has by now become all but unavoidable, since it will be drawing its power from an as yet ‘unactualized’ derivatives-bubble whose notional value is currently estimated by the BIS at close to $500 trillion.

 

(Click on image to enlarge) 

 

 

“In the meantime, the rapidly metastasizing mortgage crisis -- the mention of which would have undermined the rosy logic of your op-ed piece -- is reason enough for us to expect such countermeasures as a 25 to 50-basis-point easing [on Tuesday].  I could be wrong about this, but if I am, it will probably be because Bernanke understands that any reaction perceived by Wall Street as half-hearted – i.e., a fleeting short-squeeze of the DJIA – would fatally give away the game.  If the Fed does ease, though, and an unimpressive short-squeeze results, I’ve advised my subscribers to short it till their heads cave in.”

 

Erich Sees Tightening

 

And here’s that hawkish letter from our erstwhile bird flu correspondent, Erich Simon:

 

“For all of the reasons I've enunciated, I continue to hold fast to a rate increase. I've been doing my nightly rounds of the Asian press for the H5 Juggernaut and have uncovered even more evidence that there will be no rate cut on Tuesday.

 

“Never mind Tuesday's being down days to shake out the Puts on Option's Expiration Weeks, especially significant this triple witch, and more free money for crony corrupt capitalism. I have been losing money every expiration for years now and have cut my exposure in that arena to just about nil. But my last remaining contracts appear to be set to expire worthless, and it will take some time (on the short side, but maybe not that long the way things are shaping up)before I recoup and begin a new out-of-the-money strategy in preparation for The Big One.

 

“I am not alone in my analysis, joined by the few remaining diehard bear realists. But I feel confident as one of the last of the breed that now, with all the short side money depleted, the Fed has no more favors to grant to its greedy, belly-stuffed social circle, while the balance of Amerika (sold over the years, part and parcel to foreign interest) goes down in flames.

 

“Most telling, Paulson is telegraphing that the ride is going to get bumpy. Greenspan is out telling of his misgivings and credit inflamed maelstrom now come home to roost. Bernanke is keeping a respectful distance, ready to drop the hammer. Greenspan is even waving the inflation card! Given this concerted game plan, why on earth would any rational market observant think that there is going to be a rate cut... (and then a hike?), especially when any 'salvage' operations can be accomplished through the discount window, foreign bank/currency support of the dollar, and the old stand-by, going into the bond pits and buying long bonds to inject liquidity. Also, these markets are now so distorted with their high PEs (a replay of March 2000) made all the worse by the ever growing telegraph of recession, so much so that a rate cut would be laudable!

 

“A rate cut now would invite the worst of the worst, the failure of what little structure remains of this global incongruity.”

 

 

A Greenspan Anecdote

 

The BBC recently interviewed economist Michael Hudson concerning his former employee, Alan Greenspan. Hudson's take on the Fed chairman fleshes out some of the points I've made above and further explains why Greenspan should be reviled rather than lauded:

 

Somewhat against my wishes, the interviewer insisted in starting the program with my anecdote about how I was designated to fire Mr. Greenspan in 1966. I was Chase Manhattan Bank¹s balance-of-payments economist at the time, and was writing a study of the balance of payments of the U.S. petroleum industry. Chase and Socony Oil Company each had paid $10,000 to finance the study, and Socony had insisted on bringing on Alan Greenspan. My boss in the Economic Research Dept., John Deaver, worried that Greenspan was so eager to get business by giving the client what it wanted, that few people had much confidence in his statistics. Greenspan was supposed to make statistics on US oil company capital investment. What he did was take a rough approximation ­ based on total worldwide investment. He told his two statistical assistants (Lucille Wu and one other) to assume proportionality.

 

"It¹s all implicit," she said. By "implicit," she meant, assuming that European and Near Eastern depreciation rates and other tax laws were identical to U.S. laws, obviously not the case. Mr. Deaver and I were invited up to David Rockefeller¹s dining room, who told me to inform Mr. Greenspan that unless he could provide specifically U.S. numbers ­ and/or be forthright about his assumptions ­ we would have to exclude his numbers. (Socony¹s rep. was a friend of his, and I think they made sure he got paid as their favorite business lobbyist de jour.)

 

A Lobbyist for the Rich...

 

Mr. Greenspan was an economic lobbyist for the rich, for large corporations and for Wall Street. That is the job of a Federal Reserve chairman these days. Like a good criminal defense lawyer or the ³expert witnesses² they hire, a good lobbyist makes a cover story believable. Mr. Greenspan crafted a myth that many people wanted to believe. The myth was that people ­ just about everyone ­ could get rich by going into debt, to buy property whose prices were being inflated by Federal Reserve policy of lowering interest rates and deregulating the financial sector to usher in a period of "wild finance."

 

Mr. Greenspan sponsored the confusion that increasing asset prices constituted ³wealth formation.² It was not the kind of wealth that Adam Smith meant in The Wealth of Nations. Posing as an enemy of ³inflation,² he tried to make people love one particular kind of inflation: asset-price inflation. The distinguishing feature of asset-price inflation ­ the bubble ­ is that it raised the price of property relative to labor¹s wages. This put the class war back in business ­ this time a class war by the financial sector against industry as well as against labor. It took more and more take-home wages to buy a house or a retirement income.

 

1) As the most vocal cheerleader for the Bubble Economy, Mr. Greenspan was more responsible than anyone else for loading the U.S. economy down with debt, leaving a legacy of negative equity in his wake. For almost the first time in history, people thought that they could get rich by borrowing to buy assets that were rising in price. This was the essence of America¹s Bubble Economy. Mr. Greenspan made America LOVE inflation ­ at least, asset-price inflation. The myth that he created was that people should treat their houses like a piggy bank. But borrowing is NOT like drawing down a bank account. It leaves a legacy of debt ­ that must be repaid. And while prices for real estate and stocks may go down, the debts remain in place. Lowering interest rates enabled a larger debt to be carried, by a given rental income. Lowering down payments, and even giving "reverse mortgages" where banks agreed to lend borrowers the interest, is what Hyman Minsky called the "Ponzi phase" of the credit cycle.

 

...and a Tax-Raiser

 

2) His main role as economic lobby for his financial clients was anti labor. Although he claimed to support cutting taxes to "spur markets," he played a major role in raising taxes for most wage-earners. He did this as head of the Greenspan Commission in 1982. The rhetorical ploy he suggested was to pretend that Social Security and health care should be treated as user fees, not as part of the overall budget. This freed the wealthiest tax brackets from having to finance Social Security for the bottom 90 percent of the population. Mr. Greenspan happily approved the Bush tax cuts of 2002 ­ but later, professed to be shocked, shocked, to find that there was gambling going on and the cuts on the higher tax brackets led to a large budget deficit, and recommended that the government cut back Social Security and medical care expenditures to pay for the tax cuts that benefited the upper brackets ­ his constituency.

 

3) In the above respects, Mr. Greenspan was the architect of dollar devaluation, by flooding the economy with low interest rates. He put short-term stock speculation and bank lending over the dollar¹s long-term stability. But then, finance always has lived in the short run. The ³pro-Greenspan² man on the interview was Ron Susskind of The Wall Street Journal, author of The 1% Solution. He gave a pretty balanced judgment on Mr. Greenspan, and said that after all, he had created a lot of wealth for a lot of people, and increased home ownership. True enough ­ but also a lot of debt and subsequently, foreclosures. Mr. Susskind made the good point that Greenspan praised Clinton, virtually as a good Republican for listening to Treasury Secretary Rubin and Mr. Sommers. True enough!

 

I wish I could have mentioned another anecdote. A few years ago the Minneapolis Fed asked me to write an article on Mesopotamian debt cancellations. I did, and was paid nicely for it. They had an artist draw up a really good diagram. But at the last minute, they cancelled the whole issue ­ not only my article, but the entire issue was junked. I asked why. There was a bit of embarrassment, and my contact told me that Mr. Greenspan had asked them to do a survey asking their subscribers who the greatest economist of the 20th century was. Mr. Greenspan apparently was disappointed with the result. ³Do you mean, that he wasn¹t Number One?² I asked, somewhat naively. There was almost a one minute silence. Finally I broke it. ³I see,² I said.