|Forecasting America's Destiny ... and the World's|
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Most news reports of Alan Greenspan's Friday, Feb 5, speech to the Advancing Enterprise 2005 Conference in London put a positive spin on it by focusing on the two words "positive effect" in a paragraph where he explained that the weakness of the dollar has been having a positive effect on exports.
Those words help the New York Times, for example, to say, "Alan Greenspan ... said on Friday that America's record trade deficit might be poised to stabilize and even fall because of market pressures and belt-tightening by the Bush administration."
But those positive points were pulled out of the middle of a speech that expressed quite a bit of alarm.
Greenspan began by saying that major structural changes have occurred since 1995 (the year that the stock market bubble began), in the world economy, thanks to a huge increase in globalization:
This is the important point: That something fundamental has changed, something that hasn't been seen before. "The dramatic advances over the past decade in virtually all measures of globalisation have resulted in an international economic environment with little relevant historical precedent," he said.
A much blunter appraisal was given by Morgan Stanley chief economist Stephen Roach, who said that the economic prosperity of the world rests on a bargain "where China produces, America consumes and the rest of the world gladly pays the bill and goes along for the ride."
Roach is saying the same thing that Greenspan is saying: That we now perhaps understand what happened in 1929 and its aftermath, but that knowledge isn't particularly useful anymore because of globalization. It's the whole world.
As I've written before, there's something of a logical paradox: if there's going to be a major financial crisis (like a stock market crash leading to a Great Depression), then it has to be a surprise to the general public, because if it weren't a surprise, then the general public would already have panicked, and the financial crisis would already have begun previously. Therefore, the general public must be ignorant of the danger until the crisis actually occurs.
That means that each new world financial crisis has to be different in significant ways from the previous ones, so the general public won't know what's going on.
That's what's happened if you look at the major generational financial crises throughout Western history:
These generational crashes all had something in common: they occurred after investors had gone heavily into debt and competed with each other to bid up the prices of some investment (tulips, stocks, or whatever). That's what all bubbles have in common, the essential factor that makes a bubble a bubble.
But they were fundamentally different in other ways: They were centered in different regions, they spread in different ways, and they involved different kinds of investors and investments.
Today, we're in the period following the late 1990s bubble but, unlike the early 1930s, the bubble hasn't yet fully burst. Stocks today are still overpriced by around 100%, according to historical price/earnings ratio.
However, while the basics of the bubble are the same as all the previous times, many things are very different, and both Greenspan and Roach are saying it: Today's economy depends on massively manufactured Chinese goods flowing to America; Americans and the American nation going into debt to pay for them; the Japanese, Chinese and Europeans buying American debt to balance the books.
And it's deeper than that: Some people fantasize that America could cut back on Chinese imports, and go back to manufacturing for our own needs, and then get out of debt. But that's completely impossible. We no longer have anything like the manufacturing capacity to meet our own needs. When those jobs went to China, the factories were closed and torn down or turned into warehouses. The jobs are gone, the factories are gone, and the capacity is gone. We've crossed a line and can't go back.
In other words, it's a bubble, but it's not at all like 1929 at all. The bubble hasn't occurred entirely on Wall Street. Today's bubble depends on the flow of money and products around the world. And every country has an essential role in the bubble. If the Chinese cut back on exports, or Americans cut back on purchases, or the world cuts back on buying American debt, then the chain will be broken.
Any bubble depends on that kind of credit chain. If A depends on B, B depends on C, and C depends on A, then the bubble is in a chain that is as weak as its weakest link.
So, what both Greenspan and Roach are saying is that we're in a fundamentally different situation than ever before.
When Greenspan and the Fed "allowed" the bubble to occur in the late 1990s, he believed that he could deal with its aftermath by aggressively setting interest rates to near-zero when the bubble was bursting. That was, in fact, the Fed policy after 2000, and the Fed reduced interest rates 12 times by June, 2003. That was the policy that Greenspan believed would have worked in 1929.
So now let's repeat what Greenspan said on Friday:
Holy bankrate, Batman!! Greenspan isn't just making an idle comment about the state of the world economy. Greenspan is repudiating his own 1996 reasoning on letting the bubble occur. Do you get this? It's all buried in Greenspan's convoluted language, but it's there very clearly: "My 1996 assumptions were wrong. Maybe we're in a lot more trouble than I thought."
This is a complete turnaround from last year. A year ago, Greenspan almost broke his arm patting himself on the back. Here's what Greenspan said in a speech in January of 2004:
When I commented on his speech at that time, I pointed out that Greenspan was wrong about this, and that Greenspan had merely postponed the crash, not prevented it.
Throughout most of 2004, Greenspan kept congratulating himself. By October, 2004, Greenspan was finally beginning to express some doubts. He was still in a state of denial, as I commented at the time. Still, he said the following:
Notice that it still hadn't yet dawned on Greenspan that it's more complicated than this because of globalization.
It wasn't until November 22, after the Presidential election, that Greenspan finally began to hint that there was a real danger. He said that America's debt level to other countries has "risen to more than 5 percent of GDP," and "cannot continue to increase forever in international portfolios at their recent pace." According to the BBC, Greenspan had finally joined with other economists in saying that an "adjustment" was undoubtedly coming, and that it would be painful.
Finally, with Friday's speech, Greenspan has come full circle. He's totally repudiated his previous views. It appears that he now knows that his statement that "our strategy of addressing the bubble's consequences, has been successful" is wrong.
I speak to a lot of people, and I've learned something remarkable: Evidently many, many investors are aware that "something is wrong" with the stock market, and they plan to sell "soon," but they think that they can get out in time.
Even those who've already lost money in the 2000 Nasdaq crash seem to have no fear. They're certain that they'll be "smarter" this time around, and get out fast when they see the warning signs.
I just spoke to an investor recently who said, "I can't sell now with the market down. I'll sell in a couple of months when the market is up again." Gulp. What if the market doesn't come up again?
Look at the graph on the right of the DJIA for the last year. It's as addicting as a roller coaster ride. It even looks like a roller coaster ride.
This leads to an obvious apparent logical contradiction. We know that "getting out in time" is a zero-sum game, and that only a few people will actually succeed at doing that. Therefore we know that most of the people who believe they can get out in time will not be able to do so. It therefore follows that the next collapse won't take four years, as it did in 1929-1933, but will occur so quickly that almost all investors will be unable to react in time.
Thus, the most likely scenario appears to be a one-day crash of 50-75% of the stock market's value. It will occur so quickly, that few will be able to react. This might happen today, next month or next year, but now there's no doubt that it will happen, and apparently even Greenspan now realizes it. We're going to return to the bankruptcies and the homelessness of the 1930s.