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-----Original Message-----
From: James Smith [mailto:JSmith@xxxxxxxxxxxxxxxxx]
Sent: Friday, May 12, 2000 10:29 PM
Subject: When 4 Economists agree on anything you have the makings of real trouble
The WSJ carried an article today about 4 prominent
economists who agree on a rather unconventional
idea.....that popping the bubble is a good idea and
that the FED and other Central Banks should do
precisely that.
This sort of thinking hasn't been popular since
around 1929. Its sorta lost appeal rather quickly
after about October 1929.
Isn't it interesting that economists are forever
coming to these "bright ideas" at precisely the
wrong point in time.
The reason for the 1929 Crash was due a FED that
provided too much liquidity to the system over
the course of 4 years from 1925 through 1929.
At the urging of Governor Strong of the NY Bank,
who was in the hip pocket of the Europeans, the
FED kept rates artificially low and supplied
excessive liquidity to the system from 1925 to 1929.
The Europeans wanted and easy money policy &
lower rates in the US to drive down the dollar,
and create more demand for the European financial
markets, thus masking the very real problems in Europe.
Well, it didn't work. Keeping rates artifically lower
and supplying too much liquidity to the system in
the US did not solve Europe's problems. But it did
create a bubble in the US. When the FED finally
decided to raise rates to "pop the bubble" they
succeeded beyond their wildest expectations.
The Moral: There are dangers to popping the
bubble once it is excessively large.
If we have a bubble in the tech and internet stocks
today, its partly because the FED has supplied
excessive liquidity to the system over the last
few years. Oh, there was a good excuse alright.
In 1997 you had the Asian Currency Crisis and a
need to provide liqudity during the crisis. In
1998 you had the LongTerm Capital Ponzi Fiasco
and the Russian Debt Default...again a real need
to provide liquidity. In 1999 you had the Y2K excuse...
the FED saw need to provide liqidity in late 1999
because of the potential panic arising from Y2K.
Even into the Year 2000, the FED continues to feed
the system, doing regular Coupon Passes, in which
the FED purchases treasury notes and bonds (also supporting
a bond market that is heading south) and injecting
liquidity into the system. These Coupons Passes are
not actively commented on by the media because....
because....I don't know??? Maybe the media is dumb!
The media would rather focus on the rate hikes.
The fact is, when you can make 20% or more on your
stocks year in and year out, are you deterred from
buying stocks by a 25 basis point rate hike?
Would 50 basis points matter? Probably not.
Especially if the FED continues to feed
liquidity into the system via Coupon Passes.
So why is the FED speeding up the economy by
injecting liqudity into the system on the one hand
(via Coupon Passes) and slowing down the economy
on the other hand via rate hikes???
Greenspan is a politician. He has to "appear" to be
vigilant against inflation. Fortunately. Congress is
too dumb or too corrupt to notice all the
liquidity sloshing thru the system. The right questions
never get asked during Greenspan's congressional
testimony...and they never will. Congress is full
of skaliwags, dunderheads, and blowhards all with just
enough intelligence to sustain ideas that can fit
into a TV soundbite...but not enough intelligence
to ask Greenspan an indepth question on the
economy.
Always has been, always will be.
But there is another reason for the monetary stimulus
of the last few years.
Lawrence Lyndsey sheds some light on Greenspan's
thinking in his book, "The Economic Puppet Masters."
Greenspan was very quick to recognize a Supply
Shock as represented by the technological advances
brought on by the internet and the computer revolution.
Technological innovation is a "supply shock" because
goods and services suddenly become vastly cheaper
almost overnight. This has certainly been well illustrated
by electronics goods, computers, and other modern gadgets.
Computers seem to drop in value even before you get
them out of the store because a new better one is always
coming out.
According the Lyndsey, Greenspan chose not to fight
the supply shock but to feed it. Meet increased Supply
with increased monetary stimulus. To fight a Supply
Shock with higher rates is to restrict growth and cause
unnecessarily high unemployment (hello Europe!).
But the risk of feeding liquidity into the system during
a Supply Shock, is that you create a financial market
bubble.
The fact is, the bubble has already popped. Many
tech and internet stocks are already down 40% ,50%, 60%,
or more. To raise rates aggressively at this point
would be a mistake. It would sharpen the decline dramatically.
Too sharp a rate hike (50 bps or more) would risk
a sharp decline that may damage the underlying
economy.
If Greenspan does go with a 50bps hike next week,
my guess is that he will have to feed liquidity into the
system at an even more aggressive pace. More
Coupon Passes. He may also have to take back
the rate hike if things get out of hand...meaning, if stocks
slide too fast he may be forced to lower rates
after having just raised them.
This is why bond traders are getting ready to buy
2 year notes and sell 10s and 30s. This is called
a yield curve steepening trade. You buy 2yrs
when you've seen the last rate hike for a while
and you sell 30yrs because you know inflation
ain't gonna disappear just because stocks are
tumbling. In fact, precisely because Greenspan
will be forced to feed liquidity into the system
as stocks slide, inflation will be all the more
apparent in the underlying economy going forward.
It represents a structural shift in our perceptions of
inflation. Even the dumbest of the dumb will suddenly
realize that inflation is back. Alright maybe there will
still be some economists on CNBC who won't get it,
but most people know inflation is back.
Can you now see the conundrum? No matter what
Greenspan does, stocks are headed lower at least
in the nearterm. Perceptions on inflation will cause
bonds to accelerate their recent decline...which
incidentally began in April....the same month our
Timing Models indicated for "Directional Change"
for bonds.
In fact Greenspan knows that stocks are going to slide.
but he won't make the same mistake the FED
made in 1929, meaning he won't keep rates higher if
stocks go into a freefall. Just as he did in 1987, if
stocks really head south in a hurry, the FED will
overwhelm the problem with excess liquidity...at least
until stocks stabilize.
But don't expect to Greenspan to stop the bubble
from popping!!! The FED isn't going to be there
to save your bacon just because you bought
tech stocks at the highs.
That is not his intention. He is going
to try to curtail the damage to the economy, but he
may not intercede til stocks are well down from curent
levels. He will supply liquidity as needed to avoid
damage to the economy....but probably not before
your neighbor who still owns tech stocks has pulled his hair out,
watching CNBC report the minute by minute slide.
We don't see a bubble in the DOW and the S&P,
as with the Nasdaq, but even these markets will suffer,....
maybe not as much as the Nasdaq, but they will suffer.
Stock markets globally are due for some rough weather.
This is NOT 1929, at least not in the US. Japan is
another case. The BOJ has the incredible opportunity to repeat
the US mistakes of 1929. If the BOJ tries to protect the
Yen instead of the Nikkei, you will see New Lows for
the Nikkei and global financial chaos as Japanese
banks go belly up en masse. The similarity to 1929
is that Japanese banks have cross shareholdings
with Japanese companies. (US banks likewise owned
stocks in companies in the 1920's which helped propel
the crash). As the Nikkei heads south, so too do the
Japanese banks.
If enough Japanese banks fail, you have the makings
of a serious global disaster in the financial markets.
Its is hard to believe the BOJ will be so stupid as to
NOT supply monetary stimulus as the Nikkei slides, but
one never knows what a plump plutocrat will do once
he digs his heels in. The BOJ fancy themselves as the
bastion of monetary conservatism....but the cows have
already left the barn. The BOJ is worried about repeating
their own mistakes of the 1980s by supplying too much
liquidity and creating a bubble. Apparently the BOJ have
not yet figured out the bubble has popped.
Remember Japan also raised the consumption tax
from 3% to 5% at precisely the wrong moment causing
their bear market to extend beyond 10 years. They
still don't get it.
It is perhaps not the Japanese who are most arrogant
in this case. That honor goes to an American. Greenspan
is so confident that he can handle the coming chaos
because he has already handled a very serious crisis
in 1987.
Perhaps its time for Greenspan to read Hoover's Memoirs.
Cycles are about a confluence of events that no one human
being can predict. When they converge, it can ruin your day.
Maybe our Modern Day Houdini (Greenspan) will escape
once again and marvel the crowds, but there is a curious
after effect to each of his successes.
Each time he saves the day (by supplying liquidity
in a crisis), he creates a broader base for an inflationary
trend going forward. Each succeeding crisis is
also likely to be bigger than the last til one comes
along that he can't handle.
In case you forgot, next week is a Panic Cycle
Week for both the S&P and the DOW. Time
to rock and roll. Panic cycles indicate larger
than normal volatility with huge swings in both
directions.
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