Saturday, September 26, 2009
[This post originally appeared on October 05, 2005. ]
Never before have so many borrowed so much.
Never before have so many become so wealthy.
Never before have so many been so deluded.
In recent months, much has been written about the legacy of Federal Reserve Chairman Alan Greenspan, who, after eighteen years, will retire in January. Most of the legacy discussion has been based on the steady hand of the Fed Chairman - a steady hand that has resulted in an era of low reported inflation and mild recessions, while fostering sustained growth through what many have hailed as superb monetary policy.
Others don't see it that way.
Some believe that the Greenspan legacy will be one of debt and delusion - debt of all kinds piled high, lingering far into the future, and delusion in reflecting back, at how we have all behaved during recent years.
Debt is "money owed". It is present today in huge quantities, for everyone to see - not too many people seem to care. As long as asset prices rise faster than personal debt and there are buyers for U.S. Treasuries, debt just doesn't seem to matter. It just keeps piling up.
It is as if it never has to be paid back.
More debt has been created in recent years than anyone could have possibly imagined just a short time ago. A "culture of debt" has been created - from the Federal Government all the way down to Wal-Mart credit cards.
Over the course of nearly two decades Alan Greenspan has facilitated this debt - he has overseen a system that has supplied the credit that has created the debt that has sustained an entire nation. An entire nation that has been the envy of the world for its dynamic growth. Growth which is based to an ever-increasing degree on new debt creation, and a populace willing to continue its profligacy.
Up until the 1980s, most people probably still agreed with Benjamin Franklin's view toward debt, "Rather go to bed without dinner than to rise in debt", and Adam Smith's wisdom as well, "What can be added to the happiness of a man who is in health, out of debt, and has a clear conscience?"
Today, as individuals and as a nation, we accept debt as an integral and necessary part of a lifestyle to which we have become accustomed, but a lifestyle that we increasingly can not afford.
Wealth is defined as "goods and resources having value in terms of exchange or use". Surprisingly, it maintains no relationship with debt. Debt does not offset wealth, they coexist. An individual or a nation can be very wealthy at the same time that they are hopelessly indebted to others. It is under these circumstances that time becomes a factor, as wealth is converted into money to service the debt.
Our nation has acquired much wealth in the last two decades, under the stewardship of Alan Greenspan. The quantity and value of goods and resources has increased dramatically - so has debt. Rising values for stocks and now housing have made many Americans much wealthier than they could have ever imaged just a short time ago.
Spending money borrowed against the rising value of homes has been called the "wealth effect". Many people think they are spending their own money, but this is not the entire story. They are converting their wealth into money, which they can then spend - in the process they have created new debt. They are no less wealthy as a result, in fact, since debt does not offset wealth, they are indeed wealthier - they still have the home, from whence the new debt and new money came, but now they also have more goods that the new money has purchased.
They have become wealthier, and they have acquired more debt.
The wealth effect has been good for our consumption-based economy - many new jobs have been created as a result of converting more and more wealth into money which is then be spent on more goods and services.
One problem with wealth, however, is that it is not constant - it can change over time. Since wealth is based on the value of goods and resources, wealth changes as the market value of these goods and services change. Debt, on the other hand is constant. Debt service can change with fluctuating interest rates, but the debt itself remains as is, until it is added to or paid down.
Delusion is the "act of deluding", or "the state of being deluded". Misleading or being misled. One of the difficulties with this terminology is the tense. By definition, one can not knowingly be deluded or misled - it is only after the fact, when one is wiser and takes time to reflect back, that the delusion is recognized and understood.
Some people believe that today's high housing prices and hence individual wealth, have become far detached from fundamentals and are not likely to continue into the future. They feel that the masses are being misled - not with respect to the current wealth of homeowners, this is real, but in the expectation that housing prices will maintain current levels or continue to rise.
There are questions about whether current wealth will endure.
Many people believe there is nothing unusual about a home, unchanged from five years ago, which is now valued at say, $300,000 more than it was then. It is valued at this level because other people are able and willing to pay that much for similar homes, and hence the homeowner, who may also be unchanged from five years ago, is now $300,000 wealthier than before. Moreover, the homeowner believes his current wealth will be projected into the future.
Time and stability have a way of reinforcing beliefs such as these.
Most homeowners today truly feel wealthy; otherwise we would not see home-equity driven consumption at the levels that have been witnessed in recent years. If they suspected that maybe they were being misled regarding their prospects for continued wealth, they likely would not spend this wealth at current rates.
A legacy is something that is "transmitted or received from a predecessor". Like delusion, it is does not really work in the present tense - it is only after the predecessor has left the scene that one knows, factually, what the legacy of the predecessor is. Any discussion of the legacy of a contemporary is just speculation.
So, what kind of legacy will Alan Greenspan leave? Surely it will be a legacy of debt. There is so much debt at all levels - personal, business, government - and this debt will not go away quickly. It will linger, and it will need to be serviced. Will it all be repaid? Likely not. Many individuals are in far over their heads and do not have the same advantage that the government has in paying future debt with a currency which loses value.
But what else will the legacy consist of?
The legacy could also consist of continued wealth - current wealth could continue at these levels or rise as we charge into the future. But that depends on many factors. Most individuals today are wealthy due to rising real estate prices - if this trend does not continue, or worse, reverses, much of this wealth could disappear.
The Fed Chairman has been warning of this scenario often lately.
With the way individuals have unwittingly overextended themselves recently, it is a good bet that much of this wealth will disappear in the years ahead - that many loans will go bad, home prices will decline, and wealth will decrease.
So, can housing wealth be replaced with wealth created from some other source?
After the 1980s bond and real estate boom went bust, it was replaced with a technology boom. After the 1990s technology boom went bust, it was replaced with another bond and real estate boom. If the most recent boom goes bust, what will replace it?
That is the key question.
If there is something to replace housing as a source of wealth in the future - a technology boom in renewable energy, or nanotechnology perhaps - then in the years ahead the Greenspan legacy may be thought of as one of debt and wealth. Not bad really.
As long as wealth stays ahead of the debt, things will be fine. This has worked well so far.
However, if in the years ahead, it becomes clear that there is no new asset class that can be inflated to generate wealth for the millions and millions of Americans accustomed to rising debt to support their standard of living, then maybe people will look back at this period of time and think that maybe they have been misled.
Maybe people will come to understand that they behaved in ways that they shouldn't have because they were led to believe that their current wealth was based on sound fundamentals and that it would endure. Maybe people will realize that they were duped into acting in ways that they now regret and were swept up in a mania, the likes of which the world has never seen before. The Great Real Estate Bubble.
At that point, they will realize that they were misled, deluded.
This is the scenario that seems to make more sense - that the Greenspan legacy will be one of debt and delusion.