May 23, 2005

Don't cry for me, Mr Greenspan

Posted in International Economy ·
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In the past few weeks, the world’s financial markets have acted in a confused, counter-intuitive, bipolar fashion. Are investors risk-seeking or becoming more risk-averse?

The recent rally in equity markets suggests the former; the fall in Treasury bond yields and the widening of credit spreads suggest the latter.

So what is going on? Is the global outlook improving or not? Is everything hunky dory or about to implode?

Or can we steer a Goldilocks-style middle ground of not too hot and not too cold? Bond markets are sanguine about inflation because they think that Greenspan and Co are not going to let inflation rip.

This is probably a bit too charitable, as inflation is already on the march. Anyone who cares to go shopping in this country already knows that. Try having a conversation that does not come around eventually to prices rising. Were it not for cheap Chinese-manufactured clothes and appliances, inflation would already be much worse.

However, the growing protectionist sentiment – articulated again last week in the US and the EU – suggests that the benign influence of cheap imports is beginning to be outweighed by considerations of their malign influence on US and European manufacturing industries. Think Dungarvan.

But all this is secondary. Even the increasingly grim reality in Iraq and the stubborn persistence of high oil prices – the two phenomena are strongly correlated in my opinion – are not the chief cause of the declining US economy.

The real issue is – would you believe – money.

But before explaining what the money problem is, let’s pose the following question: is it conceivable that, even one year ago, serious journalists working for respected publications would have dared suggest that the US might end up like Argentina? Suggesting that the currency might collapse, the banking system crumble and most people’s savings be wiped out? A year ago, anyone suggesting that would have been considered – in the best case – �off the wall’�.

Yet an AP reporter, Paul Blustein, has just written a book published by a respected house, in which he describes the process leading up to the implosion of the Argentinian economy in 2001.

In his book And The Money Kept Rolling In (And Out) – Wall Street, the IMF and the Bankrupting of Argentina, Blustein says that the US is already going in the same direction. If that is not enough, a senior columnist for Bloomberg (which is now the supplier of financial data and analysis favoured by most of the large financial institutions) has reviewed this book.

This review gives prominence to the Argentina-US comparison and, after making all the necessary caveats and qualifications, he applauds and agrees with the AP man’s analysis.

Let’s be clear: the point is not that the US is poised to collapse or even that this is likely. The point is that the US is no win such bad financial shape, that it is perfectly legitimate to suggest that, if something isn’t done, the US could end up like Argentina. And the people saying this are not a bunch of nuts holed up in an atomic bunker in the Rockies, equipped with three years’ supply of canned food and a copy of Thomas Paine’s Rights of Man (who incidentally began his pamphleteering career in Dublin).This is the mainstream.

What is it that so concerns these analysts? It can be summed up in the following quotation: �The amount Americans owed on home equity lines of credit, according to the Federal Insurance Deposit Corporation, jumped to about $491 billion at the end of 2004, up 42 per cent from a year earlier, and more than triple the amount at the end of 2000.�

This is taken from a recent item on the CNN website.

It relates to a phenomenon that has become central to all of us – consumer credit. There are two ways of looking at this phenomenon. The first view is that it is no big deal.

This is the perspective of the economic establishment and can be easily summarised by another CNN headline reporting on a speech delivered by the Chairman of the Federal Reserve Bank: �Greenspan: More credit is a good thing’�.

Many people in the global finance game regard Greenspan as the Almighty but, even if he isn’t actually God, Greenspan is at least his earthly representative – the Pope of Mammon.

He is the man responsible for the expansionary monetary policy of the US – and, by extension, the western world – over the last decade. Greenspan has overseen the creation of more money than anyone else, ever.

The result has been a prolonged period of economic expansion and, very significantly, the avoidance of several potential catastrophes. That’s why the chairman thinks that credit is a good thing – as he explained, in remarkably simple terms by his standards, in his speech that day.

But let’s go back to basics and consider how the credit system works. The central bank and its policy is the crucial element in determining how much money is available and hence which direction the economy goes.

But the central bank merely provides liquidity; it is the bankers and others who use this liquidity to create new money, where none previously existed.

They do this by providing credit to us and our firms.

This process is the essence of banking and the reason why banking and the financial system generally (not high-tech, not energy and certainly not health, education or social services) is the heart of the modern economy.

That means that the people responsible for the huge increase in home equity loans and consumer credit generally are the bankers. It is their lending policies that have generated this flood of credit.

To quote from another recent item on CNN: �Pretty much anyone can get a loan within reason,� said Robert Moulton, president of mortgage brokerage Americana Mortgage Group. Therein lies the real story: banks are now throwing money at anyone capable of signing their name on the loan documents – or even making their mark, if they are illiterate. That explains why the only positive recent data about the US economy relates to the housing market: �New home sales hit a new record, and mortgage applications are also strong.�

In short, reports of the imminent demise of the US housing boom have been grossly exaggerated.

But is this a good thing? If you accept the orthodox Greenspan/Wall Street approach to the economy, then of course it is. All credit is good, cheap credit is divine and all hail mighty Greenspan for providing so much of it.

There are, however, heretics around who reject this dogma.

The heretical view is that the reason people are buying more and more houses – in the US, Britain, Australia, Ireland, Spain, South Africa and Canada – is because the banks are ready and willing to finance them.

History suggests that this cannot last.

The longer it carries on, the worse the ultimate come-uppance will be. Yes, it is still very unlikely that the US economy will implode Argentina-style. But the mere fact that one can suggest a parallel of any sort between US 2005 and Argentina 2001 is instructive.

I’m not surprised the markets are confused.

The reason equities are rising is the same reason property is rising – because there is abundant credit out there driving prices. Can bonds and equities go up at the same time indefinitely?

Well, in the short term, two apparently contradictory things can be true, but longer term, I’m not so sure.


  1. adrian

    Great article David!
    The greenspan debt bubble has created too much cash
    chasing too few assets. Its now either a case of rampant
    inflation or interest rate rises (i.e reduced money
    supply).

    Its a bit like the Irish bar scene, too many bar stools –
    not enough bums! When are we going to get a cheap ‘pint of
    plain’ in this country?

  2. Dan Hayes

    David,
    And to think that Greenspan started his career as a
    disciple of Ayn Rand! Come to think of it, maybe this
    character’s past history is the key to his present-day
    unprincipled actions.

  3. john bennett

    “Many people in the global finance game regard Greenspan as
    the Almighty but, even if he isn’t actually God, Greenspan
    is at least his earthly representative – the Pope of
    Mammon.”

    Alan Greenspan has been fairly successful in steering the
    american economy and the global economy through these new
    uncharted waters. His policies have as you have stated
    created a huge increase in liquidity and debt. It has also
    accelerated the long term trend of “real jobs” fleeing to
    cheaper climates in Asia. Of course the credit expansion
    means that these jobs are replaced by “virtual jobs” in
    America and the West. More people in the West are now
    employed in services such as “the retail sector”
    and “financial services sector”. In other words selling
    stuff to each other rather than making it. This game can
    only go on so long as the credit expansion continues, if
    the credit expansion stops the game is up. The reality is
    that more and more real economic activity is going to Asia.
    For example Britain was the biggest ship builder in the
    world in the first half of the twentieth century. Now
    Britain no longer makes ships and no longer possesses the
    technical knowhow required, it is the same for heavy
    engineering in general. Indeed in the eighties when this
    process was at its height people were encouraged to move
    into the new areas of electronics and IT, but now these
    industries are leaving also. The net effect is that more
    and more real economic activity is happening in Asia and
    less and less in the West. So far this is being cammoflaged
    by the credit and consumption explosion in the West. It is
    worth noting that the big expanding industries in Asia are
    industries of Production whereas in the West the expanding
    industries (if you can use that word) are the industries of
    Consumption.

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