even more questions than answers.
First of all, this is all JHMO (gotta start with that disclaimer).
I start with the premise that Greenspan is a monetarist, hence his actions have revolved around expanding and contracting the money supply for as long as he's been the Chairman of the Fed.
Second, I believe that all of Greenspans levers and buttons are no longer getting the results he expects. Basically, the economy is out of his control, partially due to globalization, some of the changes of the Clinton admin, the reliance on foreigners to finance our debt, the increasing reliance on deriviatives and their associated risks in creating more liquidity and the asset bubbles in real estate and the stock market.
We have to start with a basic understanding and agreement of the terms inflation and deflation. If you don't buy these definitions, then the rest of this post probably isn't going to be worth your time reading.
The following is from http://www.kitco.com/ind/Fox/feb262004.html
Yes, it is a bit "goldbuggie", but the author does a good job at explaining my view of the terms.Bad Inflationsnip>
This type of inflation typically means an expansion of the money supply and bank credit ahead of gains from productivity and asset growth. More money and credit chasing fewer goods and services typically means higher prices over the long run.
snip>
Government and central bank spokesmen typically call this good inflation. They claim that credit expansion and government deficit spending “stimulus” helps to generate full employment and full capacity utilization. This in turn supposedly generates additional
earnings and economic growth that offset any increased indebtedness and long-term price inflation.
From their “top down” macroeconomic vantage point, this is definitely good inflation to the extent that it allows government and Fed officials to create money and bank credit out of thin air and spend heavily without the aggravation of overtly raising taxes and receiving immediate negative political blowback.
One reason why this is really bad inflation is because it results in an eventual loss in real purchasing power for the average consumer. This is a hidden form of taxation. Creating more money and credit per se does not in itself create any new wealth any more than a
counterfeiting ring. The act of simply increasing spending and the process of creating more useful goods and services in a balanced economy are usually two very different things.
“Stimulus” spending typically creates the short-term illusion of prosperity at the long-term price of distorting the economy and debauching the currency.
In the short run, the price inflationary impact of new money and credit is usually muted and ignored by most investors. One reason often involves governmental deceit. The article “They
Are Lying to Us Again,” archived at www.jimrogers.com describes how government can selectively edit and misrepresent statistics.
Price inflation may also remain initially muted because excess liquidity can first find its way into stock, real estate, or bond asset bubbles. It may experience a prolonged delay in running up commodity and consumer prices.
Lastly, price inflation has been reduced because the dollar has served as a global reserve currency since World War II. Dollars currently comprise around 68% of global reserves.
Foreign banks and trade surplus partners have been willing to sop up excess dollars for their own reserve needs or to try to humor the “last remaining global superpower.”
Bad Deflationsnip>
Bad deflation is typically the back-side of the aforementioned bad inflation cycle, where over-inflated asset prices created by excessive “stimulus” start coming down. As discussed in my paper “Amidst Bullish Hoopla: A Behind the Curtain Look at Fed Desperation and Intervention Wizardry,” where I describe stock market overvaluation in more detail, the Fed has been fearful that if the stock market bubble starts deflating too quickly, this could lead to a negative wealth effect, reduce consumer confidence and spending, undermine bank collateral, dramatically increase bankruptcies and unemployment, and risk a depression.
However, by dropping the Federal Funds rate down to 1% and by gunning the money pump by about 10% a year over the past few years to stave off asset bubble deflation, the Fed has risked creating more bubbles elsewhere, such as in the real estate and bond markets. This money supply growth has been showing up in rising consumer prices. This is the type of inflation that the Fed and US Government try to ignore. Hence, we are now simultaneously experiencing consumer price inflation while witnessing overvalued stock, bond, and real estate markets that threaten serious deflation.
snip>
Negative real interest rates mean that the rate of real inflationary erosion in purchasing power from the long-term impact of the underlying growth of M3 is greater than the nominal interest rates one can get from CDs at the bank. Although Americans have been in a negative real interest rate environment since at least the mid- 1990’s, it has become particularly dramatic since the Fed reduced the Federal Funds rate down to 1% by summer 2003 while maintaining broad money base (M3) growth in the 8-10% a year range.
An important cause of negative interest rates is central bank intervention. Let us compare how interest rates set by the Fed may differ from those that might be created by a free market. The Fed has dropped its Federal Funds rate to a 45 year low of one percent to ostensibly stimulate the economy to avoid a collapse of puffed-up asset prices. The Thirty Year Treasury bond hovered around 4.9% as of mid Jan 2004. In my Amidst Bullish Hoopla article, I discuss how hedge funds can work with the Fed and allied Wall Street firms to
transmit lowered interest rates out the yield curve with the bond carry trade. Also, the Fed can use Open Market Operations to buy bonds to prop up bond prices and drive interest rates down, often by making purchases with money created out of thin air that ultimately create a hidden tax on the average American.
Contrast all of this with M3 growth, a truer indicator of real long-term inflation. This has been growing between 7%-10% a year since 1995. Let’s say 8% on average. If the free market were to price a bond, it would probably take into account this truer long term inflation rate, and add on top of that a risk premium of let’s say a historical average of around 2.50% . That gives us 10.5% as a rational hurdle rate for setting a free market floor on expected interest rates. Now, let’s deduct the aforementioned Thirty Year Teasury rate of 4.9%, and we get a possible real negative interest rate of 5.6%. For individuals in money market funds that pay less than 1%, the negative spread could be over 9.5%.
snip>
Fraud note: From the Austrian viewpoint, bad inflation cannot go on forever, even as a way to stave off bad deflation. Bad inflation stimulates speculative mal-investment, excessive debt, and asset bubbles that distort the economic system while debauching the currency. The economy may become so distorted that new waves of money only generate stagnation and inflation (“stagflation”), analogous to a drug addict whose fixes start breaking down the body. Since summer 2003 the M3 growth and money velocity charts have been tapering off,
partly because the system is getting so saturated with cheap credit that the Fed is beginning to push on a string. Also, a debauched currency may trigger a currency crisis (a rapid exchange rate slide) that can cause foreign imports (10% of US GDP) to become more expensive and contribute towards prolonged malaise.
So, if you believe that Greenspan has been executing basically bad inflationary policies since he took office, what else is the natural outcome for debt/credit based assets other than bad deflation? :shrug:
About Greenspans broken levers and buttons
The following is from this link posted the other day in the SMW. It is from shortly after the 9/11 terrorist attack, but I think it is still pertainant to the discussion as things haven't changed much in the securities market as the usual "bond vigilanties" have been silenced by foreign purchasers of our debthttp://www.trendmacro.com/a/luskin/20010919luskin.aspsnip>
Now the global financial aftermath of last week's terrorist attacks are shaping up to be the perfect storm for the US dollar. And Alan Greenspan has totally lost control of the boat. On Monday he admitted as much, by stating that for the duration of the crisis he wasn't going to enforce the new interest rate level that he had just declared.
In the statement from the Federal Open Market Committee that accompanied Monday's rate cut, Greenspan said, "...the actual federal funds rate may be below its target on occasion in these unusual circumstances." And look what's happened: on the same day as he set the fed funds rate at 3%, funds traded at an average rate of 2.13% Monday, with some transactions taking place at rates near zero.
This means that interest-rate targeting has now become the latest in a series of failed experiments in how to regulate the nation's money supply in a post-gold world. Call it the Greenspan Standard -- and now we're off it. That's great, as far as I'm concerned. I've argued for years that the Fed shouldn't arbitrarily set the price of money -- interest rates -- any more than it should set the price of hamburgers or jet engines.
But now that we're off the Greenspan Standard, we're not on any standard at all. And that means that the potential for serious inflationary or deflationary error is now greater than ever, just when the economy desperately needs stability.
In the decade or so after the US abandoned the gold standard in 1971, the Fed went on a "money supply standard." Mechanistic targets were set for the level of monetary aggregates such as "M1" and "M2," and the Fed's open market operations were keyed to nothing but achieving those targets -- interest rates were free to do whatever they wanted to do. The result was the worst inflation in American history, and interest rates above 15%.
So that didn't work. In the early 1980s it was replaced by the "interest rate standard," in which the fed funds rate is targeted instead of the money supply. The Fed's open market operations are geared to move the market to the chosen interest rate -- and the money supply is free to do whatever it wants to do.
That's been Alan Greenspan's operating mechanism throughout his tenure as Fed chairman -- the Greenspan Standard. It seemed to work for a while there, long enough to make Alan Greenspan's reputation as a master of the universe. But it hasn't been working very well for the last four deflationary boom-and-bust years, and Greenspan's reputation has now almost entirely worn off. And in the global panic set off by last week's terrorist attacks, interest-rate targeting has been thrown into intellectual bankruptcy. And Alan Greenspan's reputation has been thrown in the dust-bin of history.
This is a time when markets -- just like the people who participate in them -- are hungry for stability, and for a clear vision of how terrifying problems are going to get solved.
Instead, we've abandoned the Greenspan Standard and replaced it with nothing. There is no stability. There is no vision.
Now what about that change that happened during the Clinton adminstration that got those foreigners so willing to buy our debt? http://www.atimes.com/atimes/Front_Page/FB24Aa02.htmlIt was not until Robert Rubin became special economic assistant to president Clinton that the US would figure out its strategy of dollar hegemony through the promotion of unregulated globalization of financial markets. Rubin, a consummate international bond trader at Goldman Sachs who earned $60 million the year he left to join the White House, figured out how the US was able to have its cake and eat it too,
by controlling domestic inflation with cheap imports bought with a strong dollar, and having its trade deficit financed by a capital account surplus made possible by the same strong dollar. Thus dollar hegemony was born.
The US economy grew at an unprecedented rate with the wholesale and permanent export of US manufacturing jobs from the rust belt to low-wage economies, with the added bonus of reining in the unruly domestic labor unions. The Japanese and the German manufacturers, later joined by their counterparts in the Asian tigers and Mexico, were delirious about US willingness to open its domestic market for invasion by foreign products,
not realizing until too late that their national wealth was in fact being steadily transferred to the dollar economy through their exports, for which they got only dollars that the United States could print at will but that foreigners could not spend in their own respective non-dollar economies.
By then, the entire structure of their economies, and in fact the entire non-dollar global economy, was enslaved to export, condemning them to permanent economic servitude to the US dollar. The central banks of these countries with non-dollar economies competed to keep the exchange values of their currencies low in relation to the dollar and to one another so that they can transfer more wealth to the dollar economy while the dollars they earned from export had no choice but to go back to the US to finance the restructuring of the dollar economy toward new modes of finance capitalism and new generations of high-tech research and development through US defense spending.
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