What if Greenspan isn't a Hack?
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 is 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:
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. [Ed's note: Gary's essay is at SafeHaven]
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.
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.