Friday, June 26, 2009
Former Fed chairman Alan Greenspan writes in the Financial Times that, if only stock prices would keep going higher, we might have a chance at a sustained economic recovery.
The rise in global stock prices from early March to mid-June is arguably the primary cause of the surprising positive turn in the economic environment. The $12,000bn of newly created corporate equity value has added significantly to the capital buffer that supports the debt issued by financial and non-financial companies. Corporate debt, as a consequence, has been upgraded and yields have fallen.PLEASE!! JUST STOP!!
Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment...
You can't blow more bubbles just by writing an occasional op-ed piece in the Financial Times, an organization that, for their own perhaps perverse reasons, still allows you to air your thoughts to a wide audience on a regular basis.
Maybe the Financial Times still hasn't gotten over the whole "transfer of global superpower status" from six or seven decades ago and sees this as an opportunity to highlight some of the reasons why, in the decades ahead, this power will be shifting again.
Back to the Maestro, as he explains his thinking on perpetually rising asset prices.
I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the “green shoots” spotted in recent weeks to wither.It's too bad that not too many people listen to what 'ol Greenie has to say anymore because, in his later years, he's offering more insight into why he did what he did.
Stock prices, to be sure, are affected by the usual economic gyrations. But, as I noted in March, a significant driver of stock prices is the innate human propensity to swing between euphoria and fear, which, while heavily influenced by economic events, has a life of its own. In my experience, such episodes are often not mere forecasts of future business activity, but major causes of it.
As evidenced by that last paragraph above, he really believed that a bubble-based economy was the right way to go.
He goes on to talk about inflation, deflation, and political pressure on the Fed.
For the benevolent scenario above to play out, the short-term dangers of deflation and longer-term dangers of inflation have to be confronted and removed. Excess capacity is temporarily suppressing global prices. But I see inflation as the greater future challenge. If political pressures prevent central banks from reining in their inflated balance sheets in a timely manner, statistical analysis suggests the emergence of inflation by 2012; earlier if markets anticipate a prolonged period of elevated money supply. Annual price inflation in the US is significantly correlated (with a 3½-year lag) with annual changes in money supply per unit of capacity.While the statistical analysis referred to might be woefully underestimating the timeframe for inflation (look at what oil prices have done lately, just based on "green shoots"), the comments on political pressure are probably on the mark.
That will be Ben Bernanke's big test over the next year - to do what's in the best interest of the economy in the long-term despite there being a mid-term election approaching.
As for the demands of Congress and the White House during Greenspan's tenure, he learned his lesson well from the early-retirement of his unpopular (but now highly regarded) predecessor at the central bank, Paul Volcker:
Political pressure is a constant - if you want to be reappointed, keep the easy money coming.