That Baffling Economy

October 5, 2002

Blue turns to gray

And try as you may

You just don't feel good

You just don't feel alright...

Blue Turns to Grey by The Rolling Stones

The economy reminds a casual observer of Keith Richards after a concert: he is still standing, but he looks as though he might have died during a riff in 'Sister Morphine.'

"We are at a loss for words," writes popular economist Paul Samuelson. "If nothing else, this baffling economy has defeated the vocabulary of economics."

Popular economic theory has only black and white, growth and recession, boom and bust...and a logic that has been proven dead wrong. Interest rates go up, they say, and an economy stifles; they go down and the economy grows. But in Japan, rates have been near zero for years... while the economy, off and on, sinks. American economists paid no attention. Japan was different. People eat raw fish...and make wine, yech, out of rice! No wonder they've got problems.

But now it is coming home. After 475 basis points of rate cuts in America, we are supposed to be in a recovery, "but it doesn't feel like one," says Paul Samuelson.

It doesn't feel like one, and here we offer a hypothesis as to why this may be: because it is not one. It is something else. In the rest of today's letter, we offer Samuelson and others a few old words to help us all understand just what it is.

Recently, we suggested 'bear market' to describe what is happening in today's market. Today, we offer "savings" and "debt" to explain why.

The words will be unfamiliar to modern American economists. In the last decade, Alan Greenspan, until recently the world's favorite economist and now a Knight of the British Empire, rarely used them. Instead, his speeches were greased with the hip new lingo of the New Era. Scarcely a single discourse failed to slip in 'structural productivity growth' wrought by 'technical innovation.' Missing were the tougher words of an earlier generation of economist - 'savings' and 'debt', for example. Also missing was any warning to investors about the huge bubble the illustrious chairman had suffered to expand during his watch at the Fed...or any effort to do anything about it.

Mr. Greenspan's carefully-chosen words and inaction won him a wide audience of admirers, friends and accomplices. Mr. and Mrs. Clinton, for example. Ken Lay. Dennis Kozlowski. The folks who run Fannie Mae... millions of negligent investors and almost everyone else who saw a chance for easy money. None was reminded that he needed to save in order to expect to improve his lot in life. Neither did the Fed chairman nag about debt levels. "Borrow as much as you want," he seemed to say. "This hot new productivity thing will make us all rich." When Mick Jagger received his knighthood, his partners were miffed. They accused him of 'selling out.' No such squeal was heard when Greenspan greeted the queen; it was understood that the former libertarian gold bug had sold out long ago.

But the Queen's honors committee is slow to catch on. By the time it has noticed a rising star, the poor thing is often already burnt-out...and cold as a dead analyst. "Now, hardly a day passes," says a Reuters report, "without some newspaper carrying a column sniping that [Greenspan] did not do enough to prevent the explosion in asset prices and mismanaged its aftermath."

The French had better timing. They gave Mr. Greenspan their highest award, the Commander of the Legion of Honor, 18 months earlier. "Like great musicians, you combine outstanding technical abilities and analytical skills," said Ambassador Bujon de l'Estang, as if he were Napoleon conferring a battlefield decoration on a sergeant, "with charisma and gusto."

The French ambassador to the US seems to have discovered that Alan Greenspan once played saxophone in a jazz band. He couldn't leave it alone:

"Like most great soloists you are also a team player. Most of all, you share with great musicians one additional attribute: an infallible ear..."

Mr. Greenspan had a good ear, no one can argue with that. He knew what tune the world still wanted to tap its toe to when he put on the "Cravate" of the Legion of Honor in January 2001 and began cutting interest rates. And he knew the words people wanted to hear, too.

But that was then; this is now. And Greenspan's latest honors are mocked. He should have been given "the Order of the Bubble", says David Hale in the Financial Times.

And now, as economists search for new words, we offer them old ones.

"It seems to us an exceedingly straightforward logic," writes our favorite old-school economist, not yet noticed by the Queen's honors committee, Dr. Kurt Richebacher. "Moreover, it has historical experience on its side. Assessing the present economic situation in the United States, the key point to realize is that for years it has been exposed to the most inordinate credit excesses in history. It has been crystal-clear for a long time that it was a typical bubble economy, being defined as an economy where unusually sharp rises in asset prices fuel extraordinary borrowing and spending binges, either in businesses (Japan) or by consumers (America)."

An economy makes progress, Dr. Richebacher explains, by saving money - that is, taking resources away from consumption and using them to build better machines or new technologies or more efficient systems.

Savings require discipline, forbearance and sacrifice. They are the 'something' without which you don't get but 'nothing'. But the word was forgotten by the last generation of American economists...and replaced in the dictionary of central bankers by the word 'credit', which promised to do the same work at much less cost.

Central bankers could create credit out of thin air. And it was widely believed that merely manipulating the cost of this credit - by raising or lowering short term rates - was the whole secret of keeping a modern consumer economy on the road to growth.

Credit was as big a hit in the America of the 1990s as its star central banker. But that was when Greenspan was called the 'maestro.' Now Greenspan's ear seems to fail him...the cool, blue jazz has turned gray...and the chattering classes are looking for new words to describe him.

More to come...

The total world's holdings of gold could be transported by a single solitary oil tanker.

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