“Once stock prices reach the point in which it is hard to value them by logical methodology, stocks will be bought as they were in the late 1920’s, not for investment, but to be unloaded at a still higher price. The ensuing break could be disastrous because panic psychology cannot be summarily altered or reversed by easy – money policies.”
This guy’s a genius! And his statement has proven to be true over the years. It was written in 1959 by a man who at that time was an ardent gold bug. His conservative philosophy served him well as he built Wall Street’s most prestigious economic forecasting firm throughout his career.
His name is Alan Greenspan!
Yes, the same Alan Greenspan who told the Senate five years ago to be cautious of “irrational exuberance” in the stock market, and who, since then, has continued to pump up the money supply at record levels so that in twenty years he has become known as “America’s greatest inflationist”.
“Maestro” long ago caught “Potomac Fever”. The power and recognition of his position has clouded former conservative economic judgment and helped account for the following:
A “bubble economy” in which we have had a “stock market bubble”, a “tech bubble”, and a “housing bubble”. The first two have, and are continuing, to burst. Housing is next.
An increase in the money supply, which has fostered the greatest outflow of dollars in history. The U.S. current trade deficit exceeds one billion dollars a day.
An increase in consumer spending that is unparalleled in history to the point where 71% of the U.S. economy is attributable to consumer spending. Who would have ever guessed at the end of WWII that such a statistic was attainable?
Easy money has encouraged homeowners to negotiate large credit lines known as second mortgages (“home equity loans”), which are now at record levels.
Let’s take it from the top, analyze them, and see if we can predict
how they may affect OUR near term economic future:
BUBBLES. We already know that the bubble created in the tech stock area has, and continues, to burst. The stock markets are in “phase II” of a major bear market decline. The big bubble, however, that has not yet burst is housing. The value of the U.S. housing market is $11.1 trillion dollars. Thirty eight percent of homes are owned debt free, quite an impressive statistic. Various forms of debt, the most risky of which are the home equity loans, therefore encumber sixty-two percent of homes. Housing prices were up 6.4% in the second quarter of this year as compared to the second quarter last year, but housing prices and home refinancing have leveled off. As capital spending, travel, corporate earnings and employment decrease, less money will flow throughout the economy. With less money and more layoffs we will find ourselves in a position where the riskiest of home loans, the home equity loan, cannot be serviced and foreclosures will escalate. This bubble in housing prices, like all bubbles, is created by easy and excessive credit. All bubbles burst. The housing market is likely to be next.
MONEY SUPPLY. The huge increase in the money supply (easy credit) has resulted in a consumer buying spree, and consumer demand, that could not be supplied by domestic production. The consequence for the rest of the world has been a shipment of goods to America as quickly as products could be made and a consequent outflow of American dollars to pay for those goods. This has resulted in a negative trade balance unparalleled in history currently exceeding one billion dollars a day! The only reasons foreigners are willing to take dollars is because of a strong belief in the U.S. economy, higher returns from holding dollars, or as a substitute for their own currency. With the U.S. dollar coming off of its recent highs, and the increase in the value of the Euro and the Yen, are we now seeing the beginning of the lowering of confidence by foreigners in our dollars, in our economy’s strength, and in the security of holding dollars as compared to holding other currencies?
CONSUMER SPENDING. Easy money has worked in tandem with the explosion in Madison Avenue advertising billings that has encouraged consumers to consume and consume and consume. We have been on a buying spree in this country for jewelry, vehicles, boats, furniture, houses, stocks and bonds – everything – to the point where the poor, strapped consumer has borrowed billions of dollars to satisfy his appetite, much of which has been borrowed on high interest rate credit cards and home equity loans.
EASY MONEY. Bankruptcy’s and credit defaults are already up and climbing, with personal bankruptcy’s this year expected to exceed past records.
Is this a warning of what we can expect to “trickle down” to the
consumer in the next twelve to twenty-four months?
While “Maestro” has been reading biographies about himself and articles in the New York Times pointing out how he is the second most powerful man in the world, the aftermath of his policies are likely to spell disaster. Could the conductor have been leading us all along in an “atonal symphony” that, at final curtain call, will provide neither applause nor requests for encore?
The stock market’s “recovery” is falling short despite the Federal Reserve’s continuing huge weekly increases in the money supply. Looking at history indicates the Dow Jones recent lows of around 8200 will be tested again with the likelihood that lower levels will be obtained. Those levels are likely to test historical Dow Jones statistics of a dividend yield in excess of 4% (more than double the current yield) and a price earnings ratio of around 14 times earnings (one half of existing price earnings ratios). Those historical values will produce a Dow Jones of around 5000. The market has a long ways to go on the downside. Patient investors, who are currently liquid, would be faced with a once in a lifetime buying opportunity at that point.
George W. Rauch
October 31, 2001
Note: Money of zero maturity (called MZM, which really means “cash”) has increased at an annualized rate of almost 30% between August 12th and October 15th. Next week we’ll tell you why the Fed is doing that and what you can do to protect yourself.
