Five Years Later and Still Floating By JAMES GRANT Published: March 10, 2005
TODAY marks the fifth anniversary of the peak of the great millennial stock market. What were you doing when the lights began to dim? Were you a bull or a bear? Rich or otherwise? What about today? Are you inoculated against the new alleged sure things? Or perhaps you believe in the permanent hegemony of the dollar in the world's currency markets? In the inevitability of rising house prices? Or of falling interest rates? Answer true or false: the chairman of the Federal Reserve Board is clairvoyant. >From the March 2000 top to the October 2002 trough, the United States stock market gave up more than half of its quoted value, some $9.2 trillion. Five years ago today, Cisco Systems was the world's biggest company by market capitalization. Its line of business, the computer networking business, was universally heralded as the industry of the future. Owners of Cisco still devoutly hope it is. They have lost 75 percent of their investment. Americans hate to lose, especially when it comes to money, and they've demanded an accounting of the misdeeds of the bubble era. A certain number of former chief executives, like Bernard Ebbers of WorldCom, have had to answer the charges against them in court. And Congress, in 2002, overhauled and stiffened the nation's securities laws. But the chairman, governors and staff of the Federal Reserve have yet to be called to account. Booms and busts are recurrent in history and in nations. In not every episode was there a culpable central bank. But in virtually every case, there was a clever neighbor. The unbearable sight of a neighbor getting rich in the stock market in the late 1990's made millions of Americans bipolar. Shopping at Wal-Mart, they would pay any price except full retail. Investing in the stock market, however, they would pay nothing but. By the late 1990's, stocks had lost any connection to the value of the businesses in which they represented partial ownership. Picture an artful consumer settling into a discounted hotel room for the night. Now try to imagine this savvy individual formulating a calculated financial decision to make a meal of the $10 cashews and the $6 candy bars on sale in the hotel minibar. That was Wall Street a half decade ago. And, to a lesser but still striking degree, it is still Wall Street today - and Main Street, too. The Federal Reserve did not stand idly by after the bubble burst. It radically reduced the interest rate it controls (the so-called federal funds rate), pushing it from 6.5 percent in May 2000 to 1 percent by June 2003. Alan Greenspan, the chairman of the Fed, had worried about a stock market bubble as early as 1995, had warned against "irrational exuberance" in 1996, and batted around the possibility that there might, indeed, be a stock-market bubble in discussions with his Federal Reserve colleagues as late as 1999. But he was not the man to stick a pin in the bubble. Indeed, he himself became a vociferous booster of the "New Economy." In a speech he gave only four days before the Nasdaq touched its high, he sounded as if he were working for Merrill Lynch, cheering that "the capital spending boom is still going strong." Should the boom turn to bust, the chairman had testified before Congress less than a year before, the Fed would "mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion." In so many words, Mr. Greenspan promised that the Fed would make money cheaper and more plentiful than it would otherwise be. He would override the market's judgment with his own. Nobody in earshot quoted the words of the German central banker Hjalmar Schacht, who protested in 1927: "Don't give me a low rate. Give me a true rate, and then I shall know how to put my house in order." Someone should have. Interest rates are the traffic lights of a market economy. To investors, they signal when to go and when to stop. Under the Fed's bubble recovery program, every interest-rate light turned green With no lights flashing red or even amber, investors sped through the financial intersections. They paid more for houses, office buildings and junk bonds than they would have if interest rates were not hugging 40-year lows. The proliferation of dollars helped to lift the stock market out of its doldrums - though the doldrums of 2002 were singularly shallow ones. In comparison to earlier bear market lows, bargains were scarce on the ground (by March 2000, stocks were uniquely overvalued; never before had a dollar of corporate earnings been so costly to buy). At the checkout counter, inflation was well-nigh invisible. On Wall Street, however, it was - and still is - on the rise. To hear Mr. Greenspan tell it in 1999, post-bubble damage control was as simple as cutting interest rates. He passed lightly over the possible consequences of the rates he cut. The list so far includes a bubble-like housing market (geographically localized but ferocious), an overheated debt market (this one spans the globe) and a steady depreciation in the foreign exchange value of the dollar. Consuming much more than it produces, the United States emits hundreds of billions of greenbacks into the world's payment stream every year - about $600 billion in 2004. The recipients of these dollars willingly invest them in American assets if the price is right. On the evidence of the dollar's decline, the price - the available rate of return - is too low. Ultra-low interest rates not only serve to inflate the value of bonds, stocks and real estate. They also entice investors in those assets to employ the elixir called "leverage." Leverage means debt. Borrowing at 2.5 percent, a speculator can invest at 3 percent and still make a handsome living - if he or she can be sure when 2.5 percent might be raised to 2.75 percent or 3 percent. The Fed is happy to oblige. Forswearing the element of surprise in its policy actions, it has told the market exactly what it proposes to do. Paying close attention, professional investors, including thousands of hedge funds, have borrowed fearlessly. A little fear would help to improve the quality of financial stewardship. "A stock well bought is half sold," said the Wall Street ancients. What they meant is that success in investing depends on one's entry price. As Congress debates an overhaul of Social Security to permit tax-advantaged saving by millions of new investors, a passage from the new Berkshire Hathaway annual report warrants attention. "We don't enjoy sitting on $43 billion of cash equivalents that are earning paltry returns," writes Warren Buffett, Berkshire's chairman. "Instead, we yearn to buy more fractional interests similar to those we now own or - better still - more large businesses outright. We will do either, however, only when purchases can be made at prices that offer us the prospect of a reasonable return on our investment." Five years later, the bubble is still unpopped. James Grant, the editor of Grant's Interest Rate Observer, is the author of "John Adams: Party of One." Five Years Later and Still Floating By JAMES GRANT Published: March 10, 2005 TODAY marks the fifth anniversary of the peak of the great millennial stock market. What were you doing when the lights began to dim? Were you a bull or a bear? Rich or otherwise? What about today? Are you inoculated against the new alleged sure things? Or perhaps you believe in the permanent hegemony of the dollar in the world's currency markets? In the inevitability of rising house prices? Or of falling interest rates? Answer true or false: the chairman of the Federal Reserve Board is clairvoyant. >From the March 2000 top to the October 2002 trough, the United States stock market gave up more than half of its quoted value, some $9.2 trillion. Five years ago today, Cisco Systems was the world's biggest company by market capitalization. Its line of business, the computer networking business, was universally heralded as the industry of the future. Owners of Cisco still devoutly hope it is. They have lost 75 percent of their investment. Americans hate to lose, especially when it comes to money, and they've demanded an accounting of the misdeeds of the bubble era. A certain number of former chief executives, like Bernard Ebbers of WorldCom, have had to answer the charges against them in court. And Congress, in 2002, overhauled and stiffened the nation's securities laws. But the chairman, governors and staff of the Federal Reserve have yet to be called to account. Booms and busts are recurrent in history and in nations. In not every episode was there a culpable central bank. But in virtually every case, there was a clever neighbor. The unbearable sight of a neighbor getting rich in the stock market in the late 1990's made millions of Americans bipolar. Shopping at Wal-Mart, they would pay any price except full retail. Investing in the stock market, however, they would pay nothing but. By the late 1990's, stocks had lost any connection to the value of the businesses in which they represented partial ownership. Picture an artful consumer settling into a discounted hotel room for the night. Now try to imagine this savvy individual formulating a calculated financial decision to make a meal of the $10 cashews and the $6 candy bars on sale in the hotel minibar. That was Wall Street a half decade ago. And, to a lesser but still striking degree, it is still Wall Street today - and Main Street, too. The Federal Reserve did not stand idly by after the bubble burst. It radically reduced the interest rate it controls (the so-called federal funds rate), pushing it from 6.5 percent in May 2000 to 1 percent by June 2003. Alan Greenspan, the chairman of the Fed, had worried about a stock market bubble as early as 1995, had warned against "irrational exuberance" in 1996, and batted around the possibility that there might, indeed, be a stock-market bubble in discussions with his Federal Reserve colleagues as late as 1999. But he was not the man to stick a pin in the bubble. Indeed, he himself became a vociferous booster of the "New Economy." In a speech he gave only four days before the Nasdaq touched its high, he sounded as if he were working for Merrill Lynch, cheering that "the capital spending boom is still going strong." Should the boom turn to bust, the chairman had testified before Congress less than a year before, the Fed would "mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion." In so many words, Mr. Greenspan promised that the Fed would make money cheaper and more plentiful than it would otherwise be. He would override the market's judgment with his own. Nobody in earshot quoted the words of the German central banker Hjalmar Schacht, who protested in 1927: "Don't give me a low rate. Give me a true rate, and then I shall know how to put my house in order." Someone should have. Interest rates are the traffic lights of a market economy. To investors, they signal when to go and when to stop. Under the Fed's bubble recovery program, every interest-rate light turned green With no lights flashing red or even amber, investors sped through the financial intersections. They paid more for houses, office buildings and junk bonds than they would have if interest rates were not hugging 40-year lows. The proliferation of dollars helped to lift the stock market out of its doldrums - though the doldrums of 2002 were singularly shallow ones. In comparison to earlier bear market lows, bargains were scarce on the ground (by March 2000, stocks were uniquely overvalued; never before had a dollar of corporate earnings been so costly to buy). At the checkout counter, inflation was well-nigh invisible. On Wall Street, however, it was - and still is - on the rise. To hear Mr. Greenspan tell it in 1999, post-bubble damage control was as simple as cutting interest rates. He passed lightly over the possible consequences of the rates he cut. The list so far includes a bubble-like housing market (geographically localized but ferocious), an overheated debt market (this one spans the globe) and a steady depreciation in the foreign exchange value of the dollar. Consuming much more than it produces, the United States emits hundreds of billions of greenbacks into the world's payment stream every year - about $600 billion in 2004. The recipients of these dollars willingly invest them in American assets if the price is right. On the evidence of the dollar's decline, the price - the available rate of return - is too low. Ultra-low interest rates not only serve to inflate the value of bonds, stocks and real estate. They also entice investors in those assets to employ the elixir called "leverage." Leverage means debt. Borrowing at 2.5 percent, a speculator can invest at 3 percent and still make a handsome living - if he or she can be sure when 2.5 percent might be raised to 2.75 percent or 3 percent. The Fed is happy to oblige. Forswearing the element of surprise in its policy actions, it has told the market exactly what it proposes to do. Paying close attention, professional investors, including thousands of hedge funds, have borrowed fearlessly. A little fear would help to improve the quality of financial stewardship. "A stock well bought is half sold," said the Wall Street ancients. What they meant is that success in investing depends on one's entry price. As Congress debates an overhaul of Social Security to permit tax-advantaged saving by millions of new investors, a passage from the new Berkshire Hathaway annual report warrants attention. "We don't enjoy sitting on $43 billion of cash equivalents that are earning paltry returns," writes Warren Buffett, Berkshire's chairman. "Instead, we yearn to buy more fractional interests similar to those we now own or - better still - more large businesses outright. We will do either, however, only when purchases can be made at prices that offer us the prospect of a reasonable return on our investment." Five years later, the bubble is still unpopped. James Grant, the editor of Grant's Interest Rate Observer, is the author of "John Adams: Party of One." ------------------------ Yahoo! Groups Sponsor --------------------~--> What would our lives be like without music, dance, and theater? Donate or volunteer in the arts today at Network for Good! http://us.click.yahoo.com/TzSHvD/SOnJAA/79vVAA/NJYolB/TM --------------------------------------------------------------------~-> �������������������������������������������������������� This is ZESTEconomics. Post economics-related articles and event info to [email protected] If you got this mail as a forward, subscribe to ZESTEconomics by sending a blank mail to [EMAIL PROTECTED] OR, if you have a Yahoo! ID, visit http://groups.yahoo.com/group/ZESTEconomics/join ==theZESTcommunity====================================== [1] ZESTCurrent: http://groups.yahoo.com/group/ZESTCurrent/ [2] ZESTEconomics: http://groups.yahoo.com/group/ZESTEconomics/ [3] ZESTGlobal: http://groups.yahoo.com/group/ZESTGlobal/ [4] ZESTMedia: http://groups.yahoo.com/group/ZESTMedia/ [5] ZESTPoets: http://groups.yahoo.com/group/ZESTPoets/ [6] ZESTCaste: http://groups.yahoo.com/group/ZESTCaste/ [7] ZESTAlternative: http://groups.yahoo.com/group/ZESTAlternative/ [8] TalkZEST: http://groups.yahoo.com/group/TalkZEST/ Yahoo! Groups Links <*> To visit your group on the web, go to: http://groups.yahoo.com/group/ZESTEconomics/ <*> To unsubscribe from this group, send an email to: [EMAIL PROTECTED] <*> Your use of Yahoo! Groups is subject to: http://docs.yahoo.com/info/terms/
