NOW, HE TELLS US !?
Chris Temple, Editor/Publisher
The National Investor
www.nationalinvestor.com
20 September 2005
At the late-August gathering of the world's top bankers in Jackson, Wyoming, the mood this year was part reflective, part laudatory and part anxious. After all-though he may not have been the center of attention every year at the big, annual confab hosted by the Kansas City Fed-this year's star attraction was making his last official appearance as, perhaps, the most powerful and influential central banker of all time. After more than 18 years at his post, the accumulated wisdom of Alan Greenspan was what the attendees were coming to hear, together with the expected valedictory comments and a little glimpse from the Maestro into the future.
Greenspan's audience got most of what it wished for. Simply being the presence of a man knighted by Queen Elizabeth, lionized by the overwhelming majority of Wall Street and academic and the savior of markets more than once after some form of crisis, was enough. The audience also got a bit more than it bargained for, however, as Greenspan greatly ratcheted up his "cover you're a _ _" campaign he started several months ago.
As the August 29 issue of USA Today put it in an article penned by Sue Kirchoff, the fed chairman in his speech, "… scolded investors who were bidding up house and stock prices on the dangerous belief that good time would roll on and markets could not reverse". Besides giving on updated and broader warning reminiscent of his famous December, 1996 "Irrational exuberance" speech, Greenspan also delivered blunt new warnings of the unsustainability of both the federal budget and current account deficits, predicting that the inevitable consequences will be higher inflation and interest rates.
As we first started musing following the Federal Open Market Committee's December, 2004 policy meeting, the Greenspan let Fed-albeit rather belatedly-has at least started to come to grips with the reality that it has been chiefly responsible for creating for investors what's been dubbed the "Greenspan put". The central bank has been the enabler-in-chief not only for stock investors, but for those the world over who have chased all manner of securities higher, supported by the certainty that, if crisis strikes, they'll be bailed out of any losing position. Over the last few years, everyday consumers have behaved just as have investors in the financial markets. For them, no asking price has been too high to pay in a housing market stoked by Greenspan's E-Z money policies, nor has any consumer product been viewed as anything but a necessity as millions have been able to tap "equity" in their home to keep America front-and-center as the world's over-consumer of last resort.
Were Greenspan indeed the genius and artful central banker he has been portrayed as, the world might indeed have ended up being a different place today. For starters, this nation's accumulated debt might not have grown nearly as large had the more sober and responsible man of Greenspan's youth been on the job. One of the legacies for which the chairman will properly be remembered is the mushrooming federal debt. In less than two decades, Greenspan's bank did not merely preside over the more-than-tripling of the accumulated (and admitted) debt, from $2.3 trillion to a current $7.8 trillion or so. It enabled the creation of this debt. It is true that, during his tenure, Greenspan in some instances defied or even deftly rewrote the age-old rules of central banking; to some extent, to be fair, he does deserve a few accolades for keeping all the balls in the air for as long as he has. But among the worst cases of his suspending the rules of economics and banking has been to remove any remaining hint of fiscal prudence-even sanity-from the 535 Americans who decide how much they can spend and borrow, and their partner in the White House. In the past, spendthrift politicians were inevitably checked in their reckless largesse by rising interest rates; in those days, there was a price to pay for living beyond our national means. For the time being, Greenspan has suspended those consequences; he has held up a trick mirror to the nation that shows us trim and vital, even though we are bloating and are actually destined for the mother of all coronaries.
Rather than focusing solely on the wisdom inherent in Greenspan's warnings in Jackson about the "economic imbalances" that he created (he now assign that moniker to housing valuations as well), the pundits should have scorned Greenspan for his gall and hypocrisy. For the most part, they did not.
No matter what your view on Greenspan's "new paradigm", one thing is sure: when the inevitable bust comes, nobody will be able to say they were not warned, and by the man who made it all possible, no less. After chastising those who have come to believe that increases in stock, bond and housing prices are "structural and permanent" and, therefore, available at all times to feed ever more excess, he properly pointed out how the bust will eventually materialize. Once the point of over-investment, over-consumption and the willingness to accept "low risk premiums" has been reached where the rubber band simply can be stretched no further, a vicious cycle of debt liquidations and defaults will take over. Those who can will unwind their irresponsibility's of recent years, selling all manner of assets in order to jettison debt that becomes unserviceable, or is deemed to risky to carry any further. Ultimately, a mad dash for the exists will ensue, which could devastate asset prices. All of this will have been a consequence of far too much credit having artificially inflated prices beyond all reason or economic justification in the first place. Said Greenspan, "This is the reason the history has not dealt kindly with the aftermath of protracted periods of low risk premiums".
Should he be grated further good health following his retirement next January we are confident that in years to come, as he makes his way around the rubber chicken circuit, the Maestro will always be quick to offer an "I told you so".
WHAT NOW FOR THE FED?
"There may come a time when we hold our policy stance unchanged, or even ease, despite adverse price data, should we see signs that underlying forces are acting ultimately to reduce inflation pressures." --- Fed Chairman Greenspan, February 22, 1995
In the aftermath of Hurricane Katrina and its apparent body blow to the U.S. economy-and this on top of the already-worrisome hit that consumers have been taking due to high energy costs-Wall Street is increasingly betting that Greenspan's bank will suspend its now-14 month campaign of interest rate hikes. Of course, there is ample precedent for the Fed, especially under Greenspan, to ride to the rescue in a crisis, the attacks of September 11. 2001 are the most recent (and, in that case, appropriate) example. Further, what most acknowledge to be the dampening effect of ever-rising energy prices may be taking a sufficient toll at last to do some of Greenspan's work for him; energy's "tax" on pocketbooks constituting one of the key "underlying forces…acting ultimately to reduce inflation pressures".
Prior to Katrina's epic destructive work, futures markets had priced in the certainly of a 4% federal funds rate by year-end, with 25 basis points coming at the next F.O.M.C. gathering on September 20, and another in either November or December. Now, virtually nobody expects two more rate hikes in 2005; and a growing minority believes that the Fed won't raise the funds rate at all, in deference to the markets' view of how it should respond to the devastation in the Gulf.
What the Fed ultimately does will first be revealed on the 20th (for what it's worth, we're in the majority camp: the F.O.M.C. will make some mention of the hurricane's anticipated near-and medium-term expected impact on the economy; however, we'll be surprised if the Fed eventually halts or suspends its rate hikes due solely to Katrina.
There is no question that the storm is having, and will continue for a while, to have an impact. Initial forecasts are innumerable, and all over the map. Generally, though, economists expect that U.S. growth will be cut for the full year by as much as .75-1%. All things being equal, though, whatever rebuilding efforts ensue should add to the nation's economic growth once 2006 rolls around. Thus, were the Fed to relent now (or soon thereafter) and suspend its rate-hiking campaign, it could leave more work for the Fed-and Greenspan's successor-come next year. Don't forget that, by most any historical measure, the Fed's policy-even after 10 quarter-point rate hikes-is still accommodative, as the F.O.M.C. asserted once again following its early August hike of the federal funds rate to 3.5%. As you see from the accompanying chart gleaned from a recent issue of The Economist, the real federal funds rate (arrived at by subtracting the increase in consumer price inflation from the nominal fed funds rate) is well below where it has typically been three years into an economic recovery/credit-tightening phase. The chart also shows that, in spite of the surge in oil prices, consumer prices thus far have not jumped nearly as much as in the two major oil price shocks of the 1970's. But pressures are building; and the Fed can ill afford to become complacent (or chicken-hearted) yet.
Consider also that the jolt to the U.S. following the 9-11 attacks was a different matter than Katrina; one which arguably required the drastic easing the Greenspan engineered. The financial nerve center in New York was debilitated. Markets-frightened and uncertain-threatened to freeze without the substantial boost that the Fed provided. Extra liquidity was needed; not only to soothe fears and arrest a plunging stock market, but literally to insure that the system could function properly.
Despite Hurricane Katrina's considerable damage to some sectors of the economy-which will include delays in both importing and exporting a variety of goods-more liquidity in the banking and financial systems is the last thing we need right now. Rather than declining as happened following the events of four years ago, stocks have rallied in the aftermath of Katrina, clearly in the belief that the Fed's hand will be stayed. Ditto the bond market (though there has been at least some discernment, as corporate bonds have not enjoyed the rally that Treasuries have). Plenty will be done to alleviate the specific financial headaches being suffered by the people on the Gulf Coast; already, banks, merchants, tax collectors are providing easier terms, deferred payments and much more. There is simply no need for the Fed to change its policy for an entire nation because of this.
Hopefully, the Fed will stick to its game plan to "remove monetary accommodation at the pace that is likely to be measured", and not be swayed by political considerations (including the pleas that President Bush likely made in his private meeting with Greenspan right after Katrina hit). Long before the storm drove crude oil to record prices over $70 per barrel and natural gas to over $12 per mcf, it was the Fed flooding the world with cheap dollars that drove up the prices of these and other dollar-denominated commodities. Bit by bit, the Fed's monetary inflation has worked its way through the food chain and fostered higher producer and consumer prices; not only here, but-to a somewhat lesser extent-elsewhere. It is either serious about trying to mop up some of the speculative and inflationary pressures it created, or it's not.
As we've written before, Greenspan seems to understand that-ion order to begin curbing the various economic imbalances which exist-a stable or stronger dollar and higher long-term interest rates will be needed. The chairman's preference is not to stop raising rates until long-term rates begin to respond and the markets take him seriously. Right now, they clearly don't. The worst way for the Fed to behave would be to confirm the markets' wishes, and underwrite yet more of the markets' willingness to speculate and accept low risk premiums that Greenspan told his Jackson audience was a bad thing.
Thus, we feel that the Fed will raise rates on September 20; AND at least one more time in its last two meetings of 2005. If we're right, that means that the stock and bond markets, which presently anticipate less, are in for a rough autumn.
Such a stance should help the U.S. dollar to stabilize following its recent correction; one exacerbated most recently by currency traders' own belief that the Fed will suspend its rate hikes. However, the strong 2005 rally for the greenback (one we accurately predicted some nine or so months ago) is about over. At best, we might see a rally to the summertime peak in the U.S. dollar index. At worst, brightening financial and political pictures in both Japan and Germany could well give some shine to the yen and the euro, respectively. On top of that, the Congress is hell bent on throwing money at the wake left by Hurricane Katrina and asking questions later. Some of the early numbers being bandied about suggest that, eventually, a staggering $200 billion could be appropriated for the cleanup and rebuilding. Such a budget-smashing figure isn't likely to do the dollar's value a whole lot of good, especially when the chances of Washington offsetting a meaningful part of this via budget cuts are somewhere between slim and none.
This is one of the main reasons why we're convinced that gold's price will soon make a new bull market high, prompting us to add back Goldcorp to our recommended list several weeks ago.
20 September 2005
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