Alan Greenspan: Mr. Creep

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As I will
explain in this report, Alan Greenspan and the Federal Reserve
System have now created a unique opportunity for tens of millions
of Americans to reduce their debt load. Most Americans won’t do
this, but maybe you will, assuming you have debt. Here’s how:
refinance your credit card debt, including any revolving credit
accounts with retail sellers.

The big consumer
news for the past two years has been on mortgage refinancing.
Falling mortgage rates have offered a tremendous opportunity.
I hope you took advantage of this before July 1: a fixed-rate
mortgage (not an ARM). But what most Americans don’t understand
is that another savings opportunity has been made available to
American debtors: a quiet, almost invisible refinancing boom in
credit cards.

You may have
seen TV ads for non-profit organizations that intervene to persuade
credit card companies to reduce the interest rate extracted from
borrowers. These non-profit outfits do well enough to pay for
TV ads. What few Americans know is this: you can skip the middleman.

The banks
that issue credit cards are in a price war. But only one card
company, Capital One, advertises heavily. "What’s in your
wallet?" is a great slogan. It’s working. Capital One also
claims to offer the lowest fixed rate: under 6%. This is far better
than the 18% or 24% that millions of Americans are paying.

The presence
of Capital One offers you a tremendous bargaining chip. Sit down
and write a letter to your credit card company. Request a reduction
in your interest rate. Explain to the credit card company or the
revolving-credit issuing company that you have seen Capital One’s
ads on TV, and you are thinking of switching. You’re thinking
of consolidating your debt with a Capital One card. This, I assure
you, will get the attention of the creditor. The creditor is profiting
at your expense. Ask for a new contract: a lower fixed rate for
all of your existing debt on the card.

Here is his
new option: he can get 0% from you after you switch cards and
pay off your debt to him, or he can earn a much lower rate by
offering you a permanent reduction. A creditor would rather receive
something than nothing. He will offer you a much better deal.
In the meantime, keep shopping on the Internet for low fixed-rate
cards that offer loan consolidation for your existing debt. The
ads are all over Google.

Get this
in writing: a permanent reduction to a fixed rate on all existing
debt on the card. The longer you have to repay at the new rate,
the better. If you don’t get the rate and time frame you want,
negotiate in writing or on the phone with the person who signs
the response letter.

The companies
are relying on the ignorance of existing borrowers who don’t know
that the companies are ready to negotiate lower rates with people
who threaten to pay off their loans by borrowing on a new card.
You are no longer ignorant. While rates are low, negotiate a better

Do not do
what so many Americans do; namely, expand your existing debt burden
because you can afford to after you receive lower rates. As I
will explain, Greenspan has created what I call a creepy recovery.
You can use it to reduce your overall debt obligation in preparation
for the great reversal in the economy.


Thirty years
ago, a pair of reporters with the Washington Post were
given a strategy by a tipster they called Deep Throat: "Follow
the money." The tipster was inside Nixon’s White House.

and Bernstein followed the money that had been used to pay G.
Gordon Liddy and the other Watergate burglars. The money trail
led them to the organization that had the most ill-selected yet
fitting acronym in American political history: CREEP (Committee
to Re-Elect the President).

As to why
CREEP spent the money on the break-in, no one is quite sure, except
for Liddy, whose lips are sealed on this issue (but no others).
Jeb Magruder recently stated that he heard Nixon over the phone
tell Attorney General John Mitchell to allocate the money, but
this has been denied by other Watergate researchers. If the break-in
was part of Nixon’s election-year strategy, it was wasted. Six
weeks later, the Democrats nominated George McGovern, who was
hopelessly behind right from the beginning.

There was
another political factor in 1972: the economy. In fiscal 1970
and 1971, the government had run back-to-back deficits of $25
billion, which back then were regarded as huge. (The good old
days!) The recession had led to a change in Federal Reserve policy
under Arthur Burns: monetary expansion. On Aug. 15, 1971, Nixon
had suspended gold payments to foreign central banks, i.e., "closed
the gold window." This enabled the Fed to continue to expand
the money supply without being bothered by the outflow of gold.
Nixon also unilaterally froze prices and wages, thereby creating
massive shortages, which no one in the administration blamed on
the controls. In short, he was exercising tyrannical powers familiar
in wartime. The Democrats in Congress rolled over and played dead.

Because 1972
was an election year, Federal spending soared. Every incumbent
president asks the Federal Reserve to make available sufficient
credit to sustain this spending and thereby stimulate the economy.
This is the Keynesian prescription for curing recessions. Nixon
had already announced on national television, "I am a Keynesian."
He was, indeed. But every president is a Keynesian in an election
year if he is running for re-election. He may call himself a supply-sider,
but the formula is the same: "deficits don’t matter"
+ "sufficient liquidity" = re-election in November.

We are coming
into an election year. The candidates are lining up. The Democrats
would prefer to run on the issue of the economy, since they fell
in line regarding Afghanistan and Iraq. Bush must go into the
election with a booming economy if he wants to be re-elected.
The war is not over, its expenses are soaring, and so is the government’s
deficit. But he, unlike our troops, can still dodge the bullet
if the economy is booming. Most voters are pocketbook voters.

like all Federal Reserve chairmen, knows where his bread is buttered
in an election year. The Fed knows what it has to do: inflate.
The Fed always becomes CREEP: the Committee to Re-Elect the President.


Because the
Fed was facing recession in mid-2001, followed by 9/11, it inflated
like mad. When the economy survived 9/11, the Fed put on the brakes
to avoid serious price inflation. But it has continued to expand
the money supply in the 6% to 8% range ever since.

announced and then got a series of reductions in the Federal funds
rate, the rate at which banks loan overnight money to each other.
It went from about 6% to 1%. But the economy still sputtered.
That’s because, as I have repeatedly said, the fall in the rate
was due more to the fall in demand for commercial and industrial
loans than it was to Fed monetary policy. Businesses reduced the
demand for credit. This has not changed.

a look at two charts published by the Federal Reserve Bank of
St. Louis.
The top chart shows overall bank lending. The figure
is rising sharply. The bottom chart shows commercial and industrial
loans. It is still falling.

If banks
are lending more money overall, yet loans to businesses are falling,
the conclusion is obvious: banks are lending to consumers.

Because interest
rates are falling, consumers are able to expand their overall
debt burden: principal owed. They are buying new cars and homes.
They are adding to their total debt obligation because they can
afford to carry this debt in their monthly budgets. All they care
about is the monthly budget. They assume that present rates will
stay low. They also assume that they will not get fired.

In this phase
of the business cycle — recovery — monetary inflation
is not producing much price inflation. Unemployment remains above
6%. Utilized industrial capacity is in the 75% range — low.
Price increases are unlikely with foreign competition high —
officially, about $500 billion a year in the red.

(I’m not
convinced that the payments deficit really is this large, or at
least very significant. This is because Americans actually bring
in slightly more money from their investments abroad than foreigners
take out from their investments in America. Each group will receive
about $280 billion this year. (See Table
1.9, “Income receipts from the rest of the world” vs. “Income
payments to the rest of the world
.”) This "balance of
extracted earnings" has been true for more than a decade.
This seems to indicate equality between foreign capital invested
in the United States and Americans’ capital invested abroad, since
arbitrage tends to equalize the rate of return. Warren Brookes
wrote about this inconvenient and unexplained fact back in 1991,
just before he died. The balance has remained amazingly steady
ever since. He concluded that the Bureau of Economic Analysis
was supplying incorrect figures regarding the value of capital
invested abroad. I am open to any other explanation. I assure
you that the BEA has not explained the anomaly, at least not to
me. I have tried, unsuccessfully, to get an explanation that is
in English.)

We are seeing
something unique in the history of America’s business cycles.
In the past, Fed monetary inflation has led businessmen into the
same forecasting error at the same time; namely, the illusion
that low interest rates were the result of increased thrift on
the part of investors. Businessmen then borrowed from banks and
started new projects. This was malinvested capital, given the
fact of the lack of additional thrift. Then, when interest rates
rose in response to price inflation, these projects became visibly
unprofitable, and businesses cut back, causing a recession.

This time,
businessmen are not deceived. They are reducing their borrowing.
They are laying off workers. It is consumers who are taking the
money and running. Businessmen look at the economy and say "I’ll
pass" to Greenspan. Consumers, concerned only about next
month’s payments, are gobbling up the new credit. They are adding
to their long-term liabilities because of the lure of short-term

forget about rising taxes and rising interest rates. They assume,
like the drunkards in Isaiah’s day, that things will always get
better. "Come ye, say they, I will fetch wine, and we will
fill ourselves with strong drink; and to morrow shall be as this
day, and much more abundant" (Isa. 56:12). They not only
refuse to save for a rainy day, they in effect sell the shingles
off the roof and spend the money.

election years are traditionally sunshine years. The Fed makes
it so. The question then arises: “What happens in the year following
the election?” Will the Fed put on the monetary brakes? If it
does, the economy will fall into recession. But if the Fed doesn’t
put on the brakes, it risks the return of serious price inflation.


If you are
borrowing for something that will probably increase your output,
then debt may be legitimate. For example, a debt for college education
might be wise if you are majoring in civil engineering (not much
competition from China or India), but not if you’re majoring in
sociology. But if you are borrowing to buy a consumer good that
will decline in value, debt is a lot riskier. The market value
of the asset may not be — probably will not be — as
high as the principal remaining on the loan. If you lose your
job, you could get trapped. You might even have to violate your
contracts and declare bankruptcy.

The economy
seems to be improving. Productivity is rising. But the reason
for the increase in productivity is not an increase in the supply
of capital. On the contrary, businesses are reducing their debt.
They are not borrowing to add to the supply of capital. Then where
does the additional productivity come from? Simple: from layoffs.
Businesses are firing marginal employees. This increases business
productivity, but at the expense of workers’ income.

The ISM (formerly
the National Association of Purchasing Managers) monitors manufacturing.
Things have picked up over the last two months. Previously, the
index was under 50 — recession level. Now it’s in the mid-50s.
But one negative statistic remains: employment.

But there
is an anomaly in the unemployment figures. It was revealed by
the figures for August, when businesses laid off 93,000 people,
yet unemployment dropped from 6.2% to 6.1%. How can this be?

Because of
how the Bureau of Labor Statistics defines "unemployment."
You might think that unemployment means "not having a job."
You would be incorrect. The
term is officially defined as follows:

persons are all persons who had no employment during the reference
week, were available for work, except for temporary illness,
and had made specific efforts to find employment some time during
the 4-week period ending with the reference week. Persons who
were waiting to be recalled to a job from which they had been
laid off need not have been looking for work to be classified
as unemployed.

If the number
of people, net, who get fired is lower than the number of people
who quit looking for work, then the unemployment rate falls.

estimate for August is that, while 93,000 workers got fired, 566,000
officially unemployed workers stopped looking for work, July/August,
thereby removing themselves from the ranks of the officially unemployed.

Thus, the
unemployment rate dropped. Whoopie!

Even with
a little help from 566,000 people who quit looking for work in
July/August, the unemployment chart from the final month of Bush
I’s term (7.3%) to August, 2003, looks bad for Republicans. This
chart is likely to be the center piece of the Democrats’ campaign
next year unless the figure drops substantially. Take a look at
the chart.
It makes the Clinton era look good.

So, we find
that in the midst of a poor labor market, American consumers are
loading up on debt. Their employers, in contrast, are repaying
debt and not replacing it. Psychologists call this phenomenon
"cognitive dissonance." I call it high-risk behavior:
grasshopper syndrome. The ants know better.

Here is my
point: debt should be a function of expected productivity. If
a person does not expect to increase his productivity, he should
not add to his debt except in cases of emergency. Adding to personal
debt in response to the interest rate-effects of a combination
of the Fed’s expansionist monetary policy and businessmen’s refusal
to borrow in order to add to plant capacity is what is sometimes
called "driving beyond your headlights." Millions of
Americans are doing this. They are putting the pedal to the metal.

To this scenario
add the resource-consuming effects of a war. This is Keynesianism
in operation: an attempted economic recovery based on (1) increased
government spending, (2) increased Federal deficits, and (3) increased
consumer spending by means of an increase in personal debt.

The grasshoppers
are out there, banjos on their knees. The ants are burrowing deeper.
The people who provide the tools of production that enable workers
to increase their output and therefore their real income have
decided that now is not a good time to invest. They look at the
American economy, even in an election year, and conclude:

yet." They not see ways of increasing business income by
using debt to add to productive capacity. Meanwhile, their employees
are running up personal debt.

It seems
to me that the decisions of businessmen whose capital is on the
line, and who are afraid to increase their indebtedness to the
banks, are more reliable indicators of the future of the economy
than people who borrow to buy new cars, even at a 0% rate.

It is no
surprise to me that the new book, The
Two-Income Trap: Why Middle-Class Mothers and Fathers Are Going
, has reached best-seller status in recent weeks.
If I could buy futures in just one book, that book would be my
choice for the next decade or two. The market for that book will
increase inexorably during my lifetime.


We are about
to enter an election year, November to November. This will be
the year of the CREEP. Greenspan & Co. will supply liquidity
to this economy, keeping rates down. Consumers will therefore
continue to malinvest their resources.

It is possible
that businessmen will get caught up in the credit-induced prosperity.
If they start to borrow, then the nearly free ride for consumers
will end. Rates will start back up: more demand. The Fed will
then have to decide: keep the boom going by increasing the rate
of monetary inflation (increase the supply of loanable funds)
or else allow rates to rise and thereby cut short the recovery.
Greenspan will cross that bridge when he comes to it. I think
it is safe to say that he will keep the boom going long enough
for statistics to remain as good as possible through November

The Keynesian
places faith in consumer spending, however this spending is motivated.
The monetarist places faith in the steady increase in the money
supply. The Austrian places faith in capitalists who put their
money on the line.

Right now,
corporate insiders are selling their shares to the mutual fund
managers who are acting on behalf of fund shareholders. Insider
sales exceed insider purchases by close to eight to one.

This tells
me that the present recovery is CREEPy. I am content to place
my excess funds elsewhere than the U.S. stock market.

24, 2003

North is the author of Mises
on Money
. Visit
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