On December 5, 1996, Chairman of the Federal Reserve Board Alan Greenspan asked: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?” Greenspan was worried about the stock market, particularly the booming tech sector, but for the next three years they just got more exuberant and more irrational.
The subsequent crash took 38 percent off the DJIA and 77 percent off the tech-heavy NASDAQ in a couple of years. Speculators who were short the tech stocks and indexes made buy-an-island profits, but most of them had already been carried out on stretchers. The NASDAQ had gone from 1492.4 in 1998 to 5048.62 at its 2000 high, a gain of 238 percent. Up to the crash, speculators justifiably said, “This is insanity,” bet accordingly, and lost their shirts. The NASDAQ bottomed in 2002 at 1139.9, below where it had begun its final lift-off in 1998. Greenspan had been derided for his “irrational exuberance” speech for three years, but by 2002 he was hailed as a seer.
Greenspan’s speech incorporated no extraordinary analytical insight, merely recognition that in a finite world, off-the-chart returns can’t last forever, or as the old traders’ adage puts it: trees don’t grow to the sky. The paradox of Greenspan is that he made such a public utterance about a financial condition that he bore responsibility for perpetuating. He has never acknowledged what became known as the “Greenspan put,” first instituted in response to the stock market crash of 1987. Every significant financial perturbation was met with more and cheaper money, and the Greenspan Fed even launched a preemptive strike against a threat that never materialized. (Anybody remember the Y2K disaster?) That pre-millennium largess sparked the equity indexes’ final spasmodic rapture before the tech wreck.
Greenspan’s flood of money after that wreck launched the great housing bubble, and again those who muttered, “This is insanity,” and bet accordingly lost their shirts—until they didn’t. The tech bubble had been fed by dreams of technologies most of the dreamers didn’t understand, a belief in magic and a “new economy”. There’s nothing magic about a house. It’s a wasting asset, and for most of U.S. history it has been regarded as a place to live, not as an ATM, investment, or retirement nest egg. And certainly not as a speculative asset, bought on leverage, held for a short time, and flipped for a profit.
So there was not even a belief in technological magic to “excuse” the housing bubble, just a lot of people on TV, in academia, on Wall Street, and in the government, proclaiming that house prices never go down (they did in the Great Depression), so buy one, or several, or many, before prices went up next month. But for the easy, cheap money spewed by the Greenspan and Bernanke Feds, the housing bubble would never have happened. When it burst the DJIA lost 54 percent from its 2007 peak to its 2009 low. Many of the derivatives created on the financial back end were worthless. Some of the shorts found themselves on the Forbes 400, but not before they had suffered substantial losses. It’s tough to time a bursting bubble.
Which brings us to the present day. If the tech mania was based on magic, and the housing mania was based on a supposed fact that was historically untrue, today’s mania is a mania of manias, interlinked and resting on premises that are patently illogical, contradicted by both the historical record and current experience. Those premises are: central planning works, government debt promotes prosperity, and economic growth stems from central banks buying that debt with money they create from thin air. On these premises rest manias in governments, their debts, and central banking.
If central planning worked, there would still be a USSR and China would not have tossed Mao’s brand of communism into the dustbin of history. These historical bastions of non-prosperity had to resort to “demand management.” When their economies were unable to provide the basic necessities of life, their enlightened rulers slaughtered millions. The US imported central planning with the Great Depression, but it worked no better here than it had for Stalin. Since then, government failures have been legion while the Information Revolution has transformed the economy, but the belief in central planning—and hostility towards markets and the profit motive—is unshakeable. Millions supported Obamacare, a big step towards centrally planned and provided medicine, probably after reading about it on their iphones.
The term “developed country” now refers to those countries whose governments have developed mountains of debt and future commitments they have no hope of repaying. The valleys are demographic; most of those nations have birth rates that aren’t replacing the current aging populations, and fall far short of providing a sufficient workforce to fund the old folks’ benefits. Japan has the dubious honor of having one of the highest mountains—its government’s debt is over 240 percent of its GDP, and one of the deepest valleys. Its birthrate is among the world’s lowest, and it stringently restricts immigration.
Most government debt doesn’t go towards projects that will produce an economic return; it funds consumption. The belief (hope?) persists that such consumption somehow leads to economic growth, although a weak “recovery” in the face of the greatest global governmental debt binge in history offers no support. Germany, which has incurred relatively little debt since the financial crisis, has had one of the world’s best-performing economies, while Japan, which has buried itself in IOUs, just reentered recession.
The debt binge hasn’t worked out as planned, but the quack economic central planners have more snake oil: central bank monetization of that debt to suppress interest rates. The Japanese central bank has monetized its government’s debt at low rates for years. It is currently buying 100 percent of the government’s issuance, and the yield on its ten-year bond dropped to .31 percent, but Japan has endured serial recessions. If central bank balance sheet expansion and low interest rates were the road to riches, why not monetize everything and create universal wealth? The absurdity of that proposition is self-evident, but equity markets the world over rally every time a central banker hints of more balance sheet expansion and continuing microscopic interest rates (see “Ms. Yellen Whispers Sweet Nothings in Mr. Market’s Ear,” SLL, 12/19/14)
Tulips, the South Sea Bubble, the new economy, the housing bubble—at some point the greatest fool has bought into an absurdity and a market that could only go one way goes the other way, precipitously. If the tech wreck was a jump off a thirty-meter platform and the 2008 financial crisis a plunge off the cliffs of Acapulco, the end of this multiple-absurdity mania of manias will be a swan dive from the top of the Empire State Building into a two-foot wading pool.
Seismic economic and financial upheaval will shake political foundations around the world. What will governments and central banks do? They are already buried in debt, and interest rates are at zero or below. Yet their constituents have bought into the absurdities of their supposed omniscience and omnipotence. They will, like spoiled children, demand immediate solutions to decades-in-the-making problems caused by central planning, and its attendant debt promotion and central bank machinations.
Of course, the same prediction could have been made at the end of 2013, 2012, 2011, 2010, and 2009 (and SLL made it at the end of some of those years), and it may be a just a prediction, not a reality, at the end of 2015. A good mechanic can listen to an engine’s rattle and correctly predict the car will break down, but not necessarily say whether it will be 50 or 500 miles down the road. Who knows when the jerry-rigged contraption known as the global economy will fall apart? It’s belching blue smoke. The oil market serves as a reminder that not all assets can be monetized and not all prices “administered” by the central planners. It may also be the dashboard red light that goes on just before the engine gives its death rattle and the car stops (see “Oil Ushers in the Depression,” SLL, 12/1/14, and “Oil Economics, Part 2,” SLL, 12/3/14).. This time, however, there will be no deficit-financing or central-bank-monetization AAA tow truck a cellphone call away to come rescue it.