 The Great
Deluder
The Daily Reckoning PRESENTS:
Mr. Greenspan, revealed... but will anyone take note?
By Kurt Richebächer
The Daily
Reckoning
April 19, 2004
For us, Mr. Greenspan is the great deluder of the American public,
flatly deceiving it about the economy's true situation and prospects.
His speeches always convey the impression of extraordinary sophistication,
but the reality is that elementary knowledge of macroeconomic
aggregates or processes, such as saving or wealth creation, obviously
eludes him. It keeps amazing us how little critical response
he finds.
One reason for this generally silent complacency, we presume,
is an overwhelming desire among economists not to upset the prevailing
bullishness of public opinion. Bear in mind that Wall Street
economists dominate economic discussion in the United States.
Their main concern is the stock market. But we also note a widespread
lack of knowledge or interest in macroeconomic matters even of
crucial importance. Nobody cares about savings, nobody cares
about a credit expansion that has gone completely out of control
and nobody seems to realize that the huge trade deficit has been
the greatest profit-killer in the U.S. economy for years. Rather,
it is hailed as an emblem of economic strength.
The other looming danger in addition to the trade deficit, is,
of course, the immense risk it poses to the dollar and in its
wake to the whole financial system, both having become heavily
hooked on incessant, immense capital inflows. It seems to us
that this horrendous danger, too, is in general not at all appreciated.
Pointing to higher U.S. real GDP growth in America than in Europe
and Japan, the bullish American consensus has been hailing Mr.
Greenspan's aggressive monetary easing as a tremendous success.
In our view, this comparison is heavily distorted by different
calculations of inflation rates. Looking at the economic aggregates
that truly matter for people and the economy, like employment,
incomes, and production, the U.S. economy over the past three
years has performed most miserably among the industrial nations.
What went wrong in the first place? Actually, it seems easier
to first identify some factors that have plainly not been among
its causes. It is the first economic downturn in postwar history
that has not been precipitated by rising inflation and monetary
tightening.
As aggregate domestic demand eventually outpaced aggregate domestic
supply during past booms, inflation rates used to accelerate.
The Fed then pulled the brakes, invariably culminating in recession.
Monetary easing, starting about a year later, then promptly triggered
the subsequent V-shaped upturn. Within just two years following
the recession, the economic losses suffered during the recession
were more than offset by very steep economic recoveries.
Periods of recession implicitly reflected the liquidation of
the borrowing and spending excesses that had accumulated during
the prior boom. In this way, businesses came out of recessions
with strong balance sheets and great gains in efficiency.
The thing to see is that the borrowing and spending excesses
that accumulate in the course of the boom essentially disrupt
the economy's established pattern of demand, output, incomes,
relative prices and profits. These distortions hamper economic
growth directly over time, irrespective of the level of interest
rates.
But manifestly, both the U.S. economy's and the stock market's
sharp downturns in 2000 were not caused by tight money or credit.
Nonfederal credit rocketed in the year's second quarter when
the two began their plunge at an annual rate of $1,315 billion.
The increase during the year as a whole was $1,148 billion, after
$1,098 billion the year before. For comparison, during recession
year 1991, the total nonfederal credit rose $188 billion, after
$410 billion in 1990 and $632 billion in 1988.
Assessing the U.S. economy's prospects, we must be clear about
the extraordinary causes of the downturn that started in mid-2000.
In our view, the consumer borrowing and spending binge since
1997 is the U.S. economy's decisive primary maladjustment, certainly
the one that brought about the downturn in 2000. It was crucial
in generating the variety of dislocations and imbalances that
broke the economy's vigor - the collapse of personal saving,
the surge of the trade gap, the slump in business investment,
the profit carnage, and exploding consumer and business debt
loads.
In response, the Fed almost immediately began an unprecedented
campaign of monetary easing. According to the American consensus
economists, this campaign's success over the last three years
has been remarkable. As a result, according to the general mantra,
the U.S. economy did not suffer an economic slump of the kind
that followed the stock market's crash in 1929. In one of his
congressional testimonies, Mr. Greenspan actually emphasized
that "imbalances in the economy had not festered in the
past years."
But have the economic and financial maladjustments that precipitated
the economy's downturn in 2000 really been significantly remedied?
To repeat the key point in this respect: Since this downturn
was definitely not caused by tight money or credit, loose money
alone cannot be the solution.
What Mr. Greenspan has succeeded in doing is cushioning the impact
of the bursting stock market bubble on consumer spending, by
rapid and drastic rate cuts that promptly fuelled a housing and
bond bubble instead. The former created the soaring collateral
values that facilitated sharply higher borrowing, while the latter
served to slash borrowing costs.
For many observers, this was an ingenious new monetary policy.
For sure, it prevented for the time being a sharper economic
downturn. But it raises the last and most important question
of all: Has Greenspan's policy created the conditions that are
requisite to put the U.S. economy on the road of lasting recovery?
The credit excesses of the late '90s bubble economy implicitly
disrupted its underlying structures of demand, output, relative
prices and profits in many ways. The thing to realize is that
these bubble-related maladjustments depress the economy of their
own accord, as happened in the United States in 2000-01. In the
same vein, restoring sustainable economic growth requires liquidation
of the distortions that have accumulated in the economy and its
financial system.
We see absolutely no evidence of this having happened. Instead,
Mr. Greenspan has merely diverted these distortions, turning
them into even greater maladjustments elsewhere in the economy.
In the view of the bullish consensus, Mr. Greenspan has done
a brilliant job in preventing a deeper and longer recession than
might have been expected. This assessment, of course, ignores
the protracted employment and income disaster. In our view, America's
Great Deluder has done a miserable job: he has papered over existing
maladjustments from the boom through even bigger, new bubbles
and macroeconomic maladjustments, heralding much worse to come
in the future.
The structural damage to the economy has become far too big to
lend itself to a mild correction.
The next  downturn
will not be pleasant.
Regards,
Kurt
Richebächer
for The
Daily Reckoning
A version of
this essay was originally published in The Daily Reckoning, a
free daily email service brought to you by the authors of "Financial
Reckoning Day: Surviving
The Soft Depression of The 21st Century" (John Wiley &
Sons).
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