The Bear's Lair: Greenspan's Ponzi Scheme By Martin Hutchinson UPI Business and Economics Editor Published 11/24/2003 5:36 PM
WASHINGTON, Nov. 24 (UPI) -- A Ponzi scheme requires three things in order to be (temporarily) successful: a massive source of outside money, a sophisticated PR campaign, bloviating about its glories, and a "magic mushroom" to make people believe in it. U.S. monetary policy currently has all three. For those not around in 1920, Charles Ponzi ran a scam in which money was supposed to be invested in international postal coupons (the exchange rate disruptions of World War I had made it at least theoretically profitable to buy Spanish coupons and use them to pay U.S. postage.) The postal coupons were the "magic mushroom" -- providing the hallucinogenic ingredient that people didn't really understand, but that appeared to make it possible to make fantastic returns. By publicizing the success of early "investors," paying back investors who demanded their money, and even agreeing to be audited, Ponzi created a PR campaign that attracted new money. By operating in the major money center of Boston, he maximized the access to new investors, whose money could be used to pay off old ones -- he was taking in $1 million per week at the peak, real money in 1920. Needless to say, Ponzi was imprisoned -- one of three prison terms he was to serve -- after which he emigrated to Mussolini's Italy, followed by post-war Brazil, scamming as he went. The equation of Greenspan to Ponzi does not suggest criminal intent -- just that many features of current U.S. monetary policy strangely resemble Ponzi's empire, and are likely to lead to similar painful results for all of us. With the exception of what seems now like a brief halcyon period in 1945-73, the last couple of centuries have been full of British financiers prognosticating gloomily about the unsoundness of the U.S. economy. In the 19th century, this gloom stemmed from experience -- more good British money was lost down the rat-holes of U.S. state finance in the late 1830s and U.S. railroad finance in the early 1890s than I care to think about. >From a British viewpoint, there is indeed a good case for regretting that the City of London was so quick to finance transatlantic boondoggles (Argentina in 1826 and 1890 were also cases in point), and so slow, throughout the nineteenth and early twentieth centuries, to finance sound industrial projects at home. With a more domestically-oriented and more industrially-oriented City of London, Britain today might have large and successful electrical equipment and automobile industries, in both of which sectors she led initially. As an English banker by training, I am therefore conscious of a certain lack of credibility, particularly in a year when the U.S. stock market has risen nearly 20 percent, in warning of unsoundness in the U.S. economy. Nevertheless, British financiers, while generally in the last 200 years wrong about the U.S., were on a few occasions right; notably in 1837 (when state defaults and the lack of a banking system retarded U.S. growth for nearly a decade,) 1893 (when only masterly intervention in early 1895 by J. Pierpont Morgan prevented a U.S. default) and, most notoriously, in 1929-32. The period since 1996 has been one in which British-style complaints about "unsoundness" have reached a new crescendo, only to be met with mockery by the permabull analysts of Wall Street. In 2001-2002, of course, bears appeared to be right, as the excesses of the dot-com era wore off, and the bulls admitted that yes, in 1999-2000 they did go a little overboard. Nevertheless, since March 2003, the stock market has rallied, on the back of a loose monetary policy pursued by the Fed, and grudging respect for the bears has once again been replaced by mockery. Currently, the United States is running a $500 billion trade deficit, and a budget deficit that may well see that level only in passing, as Medicare, homeland security and election-year spending propel it ever upward. Hence the need for financing; like Ponzi, the U.S. economy needs huge supplies of new money to finance the twin deficits, since domestic savings have shown no signs whatever of stepping up to do so. The new investors are Asian central banks, who appear to be motivated by domestic economic considerations (they want to keep their currencies weak, to maintain exports) rather than by rate of return calculations, and thus to be prepared to invest 80-90 percent of their payments surpluses in U.S. Treasury obligations. This is a change from the late 1990s; during that period the somewhat smaller U.S. payments deficit was financed by inflows of private capital, the investors of which may have been misguided, but were unquestionably profit-seeking via investment in dot-coms and other U.S. technology. European portfolio investors have so far been notably absent in the stock price run-up of 2003. With political and domestic economic motivations, Asian central bankers cannot be relied upon to maintain their enthusiasm for U.S. Treasuries -- a trade dispute, such as that possibly started by the administration's quotas on Chinese textile imports, could result in a rapid withdrawal of support from the Treasuries market, with excitingly unpleasant consequences. The PR campaign is unquestionably in high gear, and has been for several years. Traditionally, central bank chiefs are expected to pour cold water on the enthusiasms of politicians, counseling fiscal prudence, raising interest rates at awkward times, and generally "taking away the punchbowl just as the party gets going" in William McChesney Martin's immortal phrase. Not Greenspan. Having acted in traditional fashion in December 1996, warning of "irrational exuberance," he then reversed himself, found a "productivity miracle" in the U.S. economy since 1995, and used the supposed rapid rise in productivity to justify M3 money supply growth at close to 10 percent per annum and short term interest rates frequently well below the inflation rate. At the Cato Institute on Thursday, far from worrying about the U.S. trade imbalance he remarked that "spreading globalization has fostered a degree of international flexibility that has raised the probability of a benign resolution to the U.S. current account imbalance." Of course, he's covered -- it could have raised the probability from zero to 5 percent -- but for a central banker, that statement amounts to a sunny insouciance that is breathtaking, since the last time the U.S. had a similar but smaller imbalance, in the mid 1980s, rectifying it involved undergoing the largest single day stock price drop in history. Productivity provides the "magic mushroom," the element that allows investors to suspend their disbelief, based on decades of past experience, and convince themselves that this time, $500 billion twin deficits really are financeable and the Standard and Poors 500 share index really is worth 30 times earnings (or alternatively, that the "extraordinary items" of 40 percent of net income, excluded from S&P 500 earnings calculations, really are extraordinary.) During the latter years of the 1995-2000 share price rocket, Greenspan joined with Wall Street shills in proclaiming a "productivity miracle" that had moved potential U.S. economic growth onto a permanently higher plateau. Had there been such a miracle, then some though not all of the higher valuations would be justified; if the S&P 500 Index is selling on 20 times earnings, and productivity growth undergoes a secular and permanent increase of 1 percent per annum, without a change in real interest rates, then the S&P 500 should start selling on 25 times earnings (an earnings yield of 4 percent rather than 5 percent.) In 1997-2000, with the advent of the Internet, it appeared that such a productivity miracle, permanently raising U.S. growth rates, might indeed be happening. However, initial productivity figures, published quarterly, are not the end of the story. Several months after the end of each year, generally in August, the Bureau of Economic Analysis and Bureau of Labor Statistics publish revised Gross Domestic Product and productivity statistics, that can change significantly the figures that were initially trumpeted to the world. In the three years to August 2002, the revisions substantially lowered the figures initially announced, to the extent that we now know that (if the "final" figures are themselves correct) labor productivity in the U.S. grew between 1995-2001 at a slightly SLOWER rate than in the preceding decade, much slower than in 1947-73 and faster only than in the oil-crisis decade of 1973-82. Moreover, the figures for multi-factor productivity, including the use of capital, (for which 2001 statistics were announced in March 2003) are even grimmer: the tsunami of capital spending in the late 1990s forced multi-factor productivity growth well below previous levels, and made it negative, MINUS 1 percent, in 2000-2001. Greenspan is now proclaiming from the rooftops that productivity began to rocket upwards again after 2001, and the figures initially published for 2002-2003 would tend to support him. There are two reasons to be doubtful, however. First, there was no new technology kicking in around 2001 that could have caused such an unexpected surge, merely a long, grinding recession. Second, the GDP and productivity figures for 2002, that would confirm or refute Greenspan at least for that year, have been delayed by "technical revisions" and will now be published only on Dec. 10 (GDP) and January 7, 2004 (productivity.) The economy has therefore been "flying blind" since August, with the newest reliable figures almost 2 years old and no solid data at all to determine whether the "productivity miracle" is real. Greenspan, and the U.S. economy, could get lucky; by January 7 we will have a better idea of whether he did. That chance alone perhaps separates him from Ponzi, for whom long-run success, once the scheme took off, became impossible. But that's clearly not the way to bet. If the post-2001 "productivity miracle" disappears, or is sharply diminished by the new figures, there are two possible outcomes. One is that favored by the majority of the participants at the Cato conference, who determined that the Euro-dollar exchange rate would reach $1.60 by 2005. That would bring the U.S. trade deficit well back towards balance, at the cost of exporting a wholly unwarranted recession to the eurozone countries, whose currencies would at that point be about 50 percent above purchasing power parity with the dollar. Since the EU is unlikely to tolerate such an exchange rate lurch, there is another way to rebalance the U.S. payments position -- a devastating U.S. recession, worse than anything seen since the 1930s, probably accompanied by substantial inflation. The recession, by slashing imports, would reduce the payments deficit, while the inflation, by devastating holders of Treasury bonds (and quasi-government obligations such as those of Fannie Mae) would in economic terms balance the U.S. budget deficit. That's what comes of getting your economic policy from Charles Ponzi! (The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
