Greenspan waxes broadly once more as he takes his farewell tour.

[jon]

Greenspan is officially leaving office January 2006, but there are rumors as well that the White House wants him to extend given all of the vacancies to fill on the Fed. It is a real opportunity from our point of view to put more free market, supply side enlightened governors on the FOMC not to mention in the chairmanship. Thus there is a bit (just a bit) of question whether Greenspan will indeed leave come January.



Given Greenspan’s comments Friday, however, you would think he is still leaving because he continues to comment about everything related to the economy and more. Social security, tax policy, Medicare, energy policy, free trade, deficits. No subject is too big for Greenspan to tackle in his last couple of years after decades of public office. Friday was no different as Greenspan talked more on energy and then digressed to the housing market and, believe it or not, interest rates.



In fairness he was responding to questions regarding the latter two items. As for housing, Greenspan took a new course. He has steadfastly stated there was no bubble nationwide. He did not really change his view Friday, but now he says there are a lot of ‘mini-bubbles’ across the nation. He even said these areas were getting ‘frothy.’ Some areas are. Just as when the stock market was running higher and higher, fueled by easy money and billions pumped in ahead of Y2K, people are borrowing from other assets to participate in the housing rally. When your shoeshine person starts talking to you about a sweet little real estate deal he is cooking, then you know your area is in a bubble.



Reading between the lines you can see shades of ‘irrational exuberance.’ Sure his comments did not seem as forceful and direct as they were back then, but we need to understand Greenspan. Back in 1996 Greenspan was very direct with his attack, though it took him a few more years to really get nasty; Y2K kept him somewhat at bay with the concerns about infrastructure failures and toilet paper hoarding. This was less direct, the more seasoned Greenspan approach, but no less important in announcing direction. In short, the Fed is finding another reason to worry about the economy, and as with the stock/tech bubble in the late 1990’s, Greenspan is signaling that the Fed will, reluctantly as he would have us believe, have to take on the housing market, raising rates to engineer a ‘soft landing.’ Get out the air sick bags and assume the crash position.



Thus it was no surprise when queried on interest rates and comments from leading bond experts (Bill Gross though his name was not specifically mentioned) that Greenspan said he disagreed with prognostications that the 10 year treasury would hover in the 3.5% to 4% range for years. Why does he not believe that? Because he figures if he keeps raising short term rates (the Fed Funds rate) to 4% to 4.5% that the 10 year will have to go higher. That means brace yourselves, because barring a calamity, the Fed is going to get rates in the 4% range. Problem is, the Fed often causes the calamity with its actions. It just doesn’t know it until it is too late.



Greenspan is busy getting things set up for his predecessor. He does not want to be hung with the albatross of leaving the economy in an inflationary state. He does not want to leave the next Fed chairman feeling as if he has to start his term hiking rates. Greenspan was in that predicament in the late 1980’s, and his heavy rate hikes are widely attributed as providing the icing on the cake that sent the market cascading lower in 1987.



The problem with that focus is that the Fed is convincing itself that the economy is strong enough to handle the additional rate hikes it feels are necessary to give the successor enough ammunition if necessary without having to hike rates further. A nice gesture, but let’s not get off point here. The Fed chairman’s job is hard but that is not the focus; price stability and its impact on the economy is what Greenspan should be worried about. The indicators we see are not showing what Greenspan and company appear to see.



We have talked with quite a few economists of late who are also quite concerned about the Fed hiking rates to head off inflation when gold is diving and the bond market is rallying into rate hikes (i.e. yields are falling). That is not an indication of inflation. More and more economists are looking back at 1999 and 2000 when they blindly genuflected to the Fed and its new inflation indicators only to see the market and then the economy come crashing down. This time they are not blindly leaping off the cliff singing the central bank’s fight song on the way down.

[VJW]

Originally Posted by jon

Reading between the lines you can see shades of ‘irrational exuberance.’ Sure his comments did not seem as forceful and direct as they were back then, but we need to understand Greenspan. Back in 1996 Greenspan was very direct with his attack

And how wrong Alan was. He gave the warning of pending doom in the "irrational exuberance" speech on December 5th, 1996, when the Dow Jones Industrial Average was at 6,437. It has been above that level for eight years, and some 4,000 points above that level for years.

Greenspan said he disagreed with prognostications that the 10 year treasury would hover in the 3.5% to 4% range for years. Why does he not believe that? Because he figures if he keeps raising short term rates (the Fed Funds rate) to 4% to 4.5% that the 10 year will have to go higher.

Of course. Contrary to your prior observation, the 10-year Treasury will indeed be climbing higher over the next year.

More and more economists are looking back at 1999 and 2000 when they blindly genuflected to the Fed and its new inflation indicators only to see the market and then the economy come crashing down.

As well they should, as Alan has a consistent record of being WRONG:

* In February of '94, he stood up and claimed the economy was overheating, which would without a doubt lead to renewed inflation, therefore he needed to dramatically raise interest rates. Over the next year, the Fed Chairman raised interest rates 8 times. Unfortunately for Alan, the economy continued to expand robustly, and simultaneously, the inflation rates continued their decline. Alan was forced to reverse course and lower interest rates. His actions were an admission of his foolish blunder !

* In December of '96, the Fed Chairman claimed the stock market was suffering from "irrational exuberance", and was highly over-bought. The stock market then proceeded to double since this foolish proclamation !

* In March of '97, Alan announced that with the unemployment rate having fallen below 5.5%, inflation must surely be returning. He raised the fed funds rate .25%. The markets reacted badly, as there was no basis for an inflationary spiral. The Fed normally initiates interest rate moves in multiples, but inflation remained low, and the unemployment rate continued to fall. Once again, Alan had blundered badly, and he later had to reverse course and lower rates, once again !

Since then, poor Alan has been relegated to following the fixed-rate financial markets, not leading them.

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