The Daily Reckoning
Paris, France
Thursday, 15 April 2004
The Daily Reckoning PRESENTS: Mr. Greenspan, revealed... but
will anyone take note?
THE GREAT DELUDER
By Kurt Richebächer
For us, Mr. Greenspan is the great deluder of the American
public, flatly deceiving it about the economy's true
situation and prospects. His speeches always convey the
impression of extraordinary sophistication, but the reality
is that elementary knowledge of macroeconomic aggregates or
processes, such as saving or wealth creation, obviously
eludes him. It keeps amazing us how little critical
response he finds.
One reason for this generally silent complacency, we
presume, is an overwhelming desire among economists not to
upset the prevailing bullishness of public opinion. Bear in
mind that Wall Street economists dominate economic
discussion in the United States. Their main concern is the
stock market.
But we also note a widespread lack of knowledge or interest
in macroeconomic matters even of crucial importance. Nobody
cares about savings, nobody cares about a credit expansion
that has gone completely out of control and nobody seems to
realize that the huge trade deficit has been the greatest
profit-killer in the U.S. economy for years. Rather, it is
hailed as an emblem of economic strength.
The other looming danger in addition to the trade deficit,
is, of course, the immense risk it poses to the dollar and
in its wake to the whole financial system, both having
become heavily hooked on incessant, immense capital
inflows. It seems to us that this horrendous danger, too,
is in general not at all appreciated.
Pointing to higher U.S. real GDP growth in America than in
Europe and Japan, the bullish American consensus has been
hailing Mr. Greenspan's aggressive monetary easing as a
tremendous success. In our view, this comparison is heavily
distorted by different calculations of inflation rates.
Looking at the economic aggregates that truly matter for
people and the economy, like employment, incomes, and
production, the U.S. economy over the past three years has
performed most miserably among the industrial nations.
What went wrong in the first place? Actually, it seems
easier to first identify some factors that have plainly not
been among its causes. It is the first economic downturn in
postwar history that has not been precipitated by rising
inflation and monetary tightening.
As aggregate domestic demand eventually outpaced aggregate
domestic supply during past booms, inflation rates used to
accelerate. The Fed then pulled the brakes, invariably
culminating in recession. Monetary easing, starting about a
year later, then promptly triggered the subsequent V-shaped
upturn. Within just two years following the recession, the
economic losses suffered during the recession were more
than offset by very steep economic recoveries.
Periods of recession implicitly reflected the liquidation
of the borrowing and spending excesses that had accumulated
during the prior boom. In this way, businesses came out of
recessions with strong balance sheets and great gains in
efficiency.
The thing to see is that the borrowing and spending
excesses that accumulate in the course of the boom
essentially disrupt the economy's established pattern of
demand, output, incomes, relative prices and profits. These
distortions hamper economic growth directly over time,
irrespective of the level of interest rates.
But manifestly, both the U.S. economy's and the stock
market's sharp downturns in 2000 were not caused by tight
money or credit. Nonfederal credit rocketed in the year's
second quarter when the two began their plunge at an annual
rate of $1,315 billion. The increase during the year as a
whole was $1,148 billion, after $1,098 billion the year
before. For comparison, during recession year 1991, the
total nonfederal credit rose $188 billion, after $410
billion in 1990 and $632 billion in 1988.
Assessing the U.S. economy's prospects, we must be clear
about the extraordinary causes of the downturn that started
in mid-2000. In our view, the consumer borrowing and
spending binge since 1997 is the U.S. economy's decisive
primary maladjustment, certainly the one that brought about
the downturn in 2000. It was crucial in generating the
variety of dislocations and imbalances that broke the
economy's vigor - the collapse of personal saving, the
surge of the trade gap, the slump in business investment,
the profit carnage, and exploding consumer and business
debt loads.
In response, the Fed almost immediately began an
unprecedented campaign of monetary easing. According to the
American consensus economists, this campaign's success over
the last three years has been remarkable. As a result,
according to the general mantra, the U.S. economy did not
suffer an economic slump of the kind that followed the
stock market's crash in 1929. In one of his congressional
testimonies, Mr. Greenspan actually emphasized that
"imbalances in the economy had not festered in the past
years."
But have the economic and financial maladjustments that
precipitated the economy's downturn in 2000 really been
significantly remedied? To repeat the key point in this
respect: Since this downturn was definitely not caused by
tight money or credit, loose money alone cannot be the
solution.
What Mr. Greenspan has succeeded in doing is cushioning the
impact of the bursting stock market bubble on consumer
spending, by rapid and drastic rate cuts that promptly
fuelled a housing and bond bubble instead. The former
created the soaring collateral values that facilitated
sharply higher borrowing, while the latter served to slash
borrowing costs.
For many observers, this was an ingenious new monetary
policy. For sure, it prevented for the time being a sharper
economic downturn. But it raises the last and most
important question of all: Has Greenspan's policy created
the conditions that are requisite to put the U.S. economy
on the road of lasting recovery?
The credit excesses of the late '90s bubble economy
implicitly disrupted its underlying structures of demand,
output, relative prices and profits in many ways. The thing
to realize is that these bubble-related maladjustments
depress the economy of their own accord, as happened in the
United States in 2000-01. In the same vein, restoring
sustainable economic growth requires liquidation of the
distortions that have accumulated in the economy and its
financial system.
We see absolutely no evidence of this having happened.
Instead, Mr. Greenspan has merely diverted these
distortions, turning them into even greater maladjustments
elsewhere in the economy.
In the view of the bullish consensus, Mr. Greenspan has
done a brilliant job in preventing a deeper and longer
recession than might have been expected. This assessment,
of course, ignores the protracted employment and income
disaster. In our view, America's Great Deluder has done a
miserable job: he has papered over existing maladjustments
from the boom through even bigger, new bubbles and
macroeconomic maladjustments, heralding much worse to come
in the future.
The structural damage to the economy has become far too big
to lend itself to a mild correction. The next downturn will
not be pleasant.
Regards,
Kurt Richebächer
for The Daily Reckoning