What if Greenspan isn't a Hack?
Chip Hanlon
Delta Global Advisors
May 3, 2005
My use of the word "hack" in the title, of course,
is a reference to Senate Minority Leader Harry Reid's quote in
early March calling the Fed Chairman, "One of the biggest
hacks we have here in Washington." Now, even I have written
some rather tart comments about Mr. Greenspan in the past, but
when words such as these pop out of the mouth of someone like
Senator Harry Reid, I expect to find the exact opposite to be
true. Besides standing as a record-setting example of the pot
calling the kettle black, Reid's remarks just struck me as a
bit over-the-top and got my long-acquired contrarian radar buzzing,
forcing me wonder if anti-Greenspan rhetoric continues to run
just a little too hot.
Now, before I'm forever entombed in the "Dollar Bull Hall
of Fame," I'd like to remind readers that only in early
December of 2004 did I become an advocate of U.S. Dollar strength
in '05 after having been quite the opposite over the last few
years. It might also surprise some to know that on a couple of
recent occasions, I've half-written an essay entitled "Francisco
D'Greenspan," an article advancing the notion that our Fed
Chairman never really let go of his Ayn Rand-ian roots, that
lo these many years he has secretly fancied himself the living
incarnation of Francisco D'Anconia from Rand's "Atlas Shrugged,"
one of three characters literally out to stop the world, D'Anconia
by giving it exactly what it wants (in Greenspan's real-life
version, ever-increasing amounts of unsound money). A tiny part
of me still suspects this to be the case.
Rather than assuming that Greenspan is some evil villain, however,
what if the explanation for his actions is more benign? Isn't
it possible that he's someone who understands and might
actually prefer a system based perhaps on Austrian Economic principles,
but has decided to use his knowledge of economics to do the best
he can in a world of floating, fiat currencies?
Such words are akin, no doubt, to chewing on tinfoil for the
Dollar perma-bears, but just indulge me for a moment or two.
If such a benevolent explanation is even remotely close to the
truth, which is not just possible, but likely, then it's easier
to accept my suspicion that the Fed Chairman is simply engaged
in what I would call:
BUBBLE JUGGLING
Let's say you were the Fed Chairman and were confronted with
a bursting technology bubble and a potential economic meltdown
in the aftermath of 9/11; isn't it possible you'd say to yourself,
"I know it may create other imbalances, but I'm going to
make credit as easy as it has ever been in order to fend off
a disaster, then deal with the consequences later." Look,
I'm not penning my own version of "Maestro" here, but
playing devil's advocate. Although such an approach is indeed
fraught with peril, isn't it possible these were the thoughts
going through Greenspan's mind?
It's so easy to get caught up in the fanaticism and conspiracy
theories surrounding gold/the Dollar that sometimes it becomes
difficult to view the Fed's actions in an innocent light. If
the hypothesis above is close, then it makes sense to suspect
that Greenspan would consider us to be in the "dealing with
the consequences" phase right now.
So, perhaps a falling dollar never was the goal, but merely the
consequence of recent monetary policy; the goal might have been
to place the burden of economic activity squarely on the shoulders
of consumers while giving corporate America an opportunity to
clean up its balance sheets, even if it meant encouraging unhealthy,
leveraged economic decisions in the consumer sector for awhile.
If looked at from an unbiased perspective, this is essentially
what we've witnessed the last 3 years or so; while consumers
have responded to low interest rates by aggressively making use
of them, America's corporations are in a healthier economic position
now, by and large. Greenspan may think he's now simply engaged
in the process of taking the punchbowl away from the consumer,
even if it risks some asset price deterioration, hoping that
corporate America is ready to pick up the baton.
SOMETIMES CENTRAL BANKERS SPEAK CLEARLY
While it used to be virtually impossible to make sense of "Fedspeak,"
for sometime now the Federal Reserve, often through its minions,
has been very clearly signaling its policy intentions, perhaps
starting with the now-infamous helicopter reference of Ben Bernanke
in November, 2002. While some of the extremists set up their
own neighborhood sky-watch programs in search of the black helicopters
they've long feared, Bernanke was clearly just the water boy
carrying a clear message to the markets from the Fed.
Likewise, recent comments from the Federal Reserve show their
intentions to still be clear, albeit in a new direction; the
word "measured" plainly says that the Fed realizes
it needs to take away the record-setting monetary accommodation
it recently put in place, but also needs to do so very carefully
for fear of toppling a debt-dependent consumer/economy.
Bond market action confirms this.
THE FED'S BIGGEST CHALLENGE: LONG TERM RATES
Unfortunately for the Fed, while it has been nudging short-term
rates upward, the long end has not been cooperating. Now, some
would wonder why I'd use the word "cooperating," suggesting
the Federal Reserve would actually want higher long-term interest
rates, but I do think that's precisely what it wants, at least
modestly higher long rates.
See, while the Fed might like to take the Fed Funds overnight
rate up to the 4% range, it's the long-end that might not allow
this to occur.
The bond market isn't stupid; in fact this is the deepest, most
sophisticated pool of capital in the world and it's one that's
also quite fearful of inflation. Here, then, the bond market
has for some time been signaling exactly what the stock market
finally started to suggest in recent weeks and what commentators
are now acknowledging: the risk now is one of economic slowdown,
perhaps a nasty one.
One could speculate as to why the Fed is raising rates at this
time, but certainly one of the many reasons has to be concern
for the dollar. While interest rates alone don't determine a
currency's value, higher short-term rates here will certainly
help prop up the Greenback. Perhaps the greatest risk to the
continued wisdom of my own 2005 dollar-strength scenario is an
economy that can't withstand much more in the way interest rate
increases, one that ends up facing recession as a result of these
rate increases sooner than expected. Such an outcome would spook
the market into thinking that a new round of rates cuts might
soon be coming, once again putting the Dollar at risk.
If long-term rates keep coming in, the Fed may face precisely
this scenario, maybe before the year is out. Sticking with the
theme of central bankers speaking clearly, I believe this helps
explain the "why now?" of Greenspan's recent focus
on the risks associated with Fannie Mae and comments dealing
with excess speculation in the housing market. The bond market
isn't concerned that runaway economic strength will cause an
overheating, which could help move long-term rates up, so Greenspan
actually might not mind if other concerns, perhaps even those
about systemic risk actually did a little of that work for him.
Regardless, Greenspan needs room to take short-term rates higher,
largely in defense of the Dollar, and he may not care in the
short run how he gets that room to maneuver. The insightful Caroline
Baum of Bloomberg seemed to walk this path a few weeks ago when
she reminded us in a column that the Fed has little power over
the long end of the bond market except to try and talk it in
one direction or the other.
Given the above, expect the Federal Reserve to hike by only 25
basis points and, more importantly, to keep the word "measured"
coming out of this week's meeting; while Fed tightening cycles
typically result in economic pain, Mr. Greenspan can't further
scare the market into thinking he's going to risk hastening such
an outcome by stepping up the pace of rate hikes. He'd rather
be seen as being behind the inflation curve (which is, of course,
laughable since that's the Fed's permanent state), than being
seen by mainstreamers as an inflation hawk.
If lower long-term interest rates, then, are actually problematic
at this point in time, it raises the question of:
WHAT SORT OF DISASTER MIGHT WE FACE?
By this point in the article, the Dollar perma-bears are already
apoplectic; they truly can't relate to a word I've written above
because they see only one scenario unfolding: foreign central
banks decide they've had it with funding our deficits and not
only quit buying Treasuries, but walk from the ones they already
own, leading to sky-high interest rates here and a total collapse
of the U.S. Dollar.
Amazingly, some actually argue with a straight face that such
an outcome could occur while only impacting the United States,
that foreign economies would essentially go unscathed under this
scenario, which is preposterous.
Not only has our own Federal Reserve been speaking clearly of
late, but foreign central banks have, as well. As they danced
their "we might diversify out of the Dollar/no, we're just
kidding" dance recently, essentially these foreign institutions
were saying that they didn't like the position they were in with
regard to buying our debt, but they realize they can't extricate
themselves quickly without meaningful pain-they clearly can't
cut off their biggest customer cold turkey.
So, we come back to the question of, what form, then, would any
worst-case scenario take?
Before you go any further, it's important that you read my friend,
Gary Carmell's latest commentary go to Google and search the
phrase "What Conundrum" in parentheses and it should
be the first link you see. This brief article shows 2 charts
that are crucial to really relating to what I'm about to write.
Essentially, Gary's argument is that the past 40-plus years of
interest rates can be broken down into two distinct periods:
the "inflationary era" that ended in the early 1980's,
and the "dis-inflationary era" of interest rate cycles
which continue to produce lower and lower interest rate peaks,
which has been in place since then. The charts contained within
the article to make his case are truly eye-popping, so please
make a point of reading it.
My take-away from the charts in that article was this: what the
Dollar perma-bears are advocating, that we'll see sky-high interest
rates any day now (which many of them have been advocating for
years), is a prediction that stands in opposition to the 20-plus
year trend that is still in place. If an interest rate surge
(inflationary blow-off) was the outcome we saw at the end of
the "inflationary era," why wouldn't we expect to see
a blow-off in the direction of the trend as finish to this latest
era, meaning a deflationary meltdown accompanied by shockingly
low interest rates in a flight to safety?
To believe this is impossible, one would have to believe the
bond market is stupid, because this is clearly what it is saying
will be our next concern: deflation. To learn more on this possible
outcome, awhile back Bob Prechter wrote an excellent short essay
called "Jaguar Inflation" that is worth tracking down
and reading. Perhaps the U.S. consumer has gotten his fill, will
re-trench based on higher rates and a global economy built to
serve that consumer will spiral into a nasty recession or worse
as the American consumer vanishes.
This is not only possible but, according to recent market action,
likely and it holds major investment implications for those who
have loaded up on commodities, precious metals and foreign stocks
and currencies. At the very least, it's reasonable to place decent
odds on an outcome somewhere between Steve Saville's deflation
scare and Prechter's outright deflationary collapse.
CONCLUSION
Have Greenspan's policies contributed to an environment in which
we spend to much and save too little? Certainly. Is it right
to be worried about the infamous twin deficits (the blame for
which, by the way, is more appropriately laid at the feet of
our elected leaders than the Fed Chairman, but that's a topic
for another article)? Sure, but by far the more ominous of the
two is our enormous budget deficit a trade imbalance could be
sustainable for a prolonged period, but when accompanied by the
budget deficit, it is indeed worrisome because it suggests we'd
have a hard time covering these deficits ourselves were it necessary.
In reality, though, it's highly unlikely we'll be forced to cover
our budget deficit by ourselves anytime soon, nor is our economy
the only one that faces severe challenges. This doesn't excuse
our recent fiscal policies, but in a world of floating currencies
that are priced against one another, it's reality.
One can't look for economic malaise around every corner in the
U.S., then ignore the economic warning signs coming today from
the biggest European economies, can't decry our social security
challenge and then ignore the horrific demographic challenge
Japan faces and one can't scream about our consumer-based economy
and simultaneously love the British Pound, for example, when
consumer spending makes up 70% of GDP in the U.K, as well.
I've been writing a lot lately about the possibility of a U.S.
Dollar rally because the certainty of its fall has become a bit
too ubiquitous for my taste. Admittedly, there are some top-flight
economic minds who today suggest the Dollar has farther to fall,
but many of those who have gained notoriety lately are the fringe-types
who have been screaming the same story through the bullhorns
from their log cabins from time immemorial; in my opinion, its
likely that their recent notoriety and "foresight"
are likely to be proven to similar to that of Henry Blodget -
finally, they've been at the right place at the right time.
Maybe, as the extremists suggest, the end of American Empire
and history's greatest economic calamity are imminent; as an
advisor, however, I believe it's my job to remind people not
to bet the farm on events that can only happen once.
May 2, 2005
Chip Hanlon
President
website: Delta Global Advisors
email: chanlon@deltaga.com
800-485-1220
Chip Hanlon
is currently the President of Delta Global Advisors and the founder of
Green
Faucet.
321gold Inc
|