effect of a practical joker who, late at night, switches a road
sign that says "Detour" to one that says "70."
If the police
caught him, he would be given a jail sentence.
the effect of Alan Greenspan’s policy of monetary expansion — in
1987, in 1995, and 2001. In each case, the interest rate was sending
a signal: "Detour." In each case, he switched signs. Then
he provided the liquidity necessary to legitimize the sign.
is, each time he did this, capital was redirected from "Caution:
Washout Ahead" to "70 Miles per Hour." He kept the
stock market from falling, but he filled the highway with care-free
drivers who put the pedal to the metal and pushed the cruise-control
This is what
the Federal Reserve has done every time there have been signs of
a recession, from 1930 to the present.
This is official
policy. Every time the FED follows the familiar scenario, the public
learns a lesson: "There is a floor below which my investment
portfolio will not fall." In recent years, this has become
known as the "Greenspan put."
A put is a
contract to supply a capital asset to a buyer at a fixed price over
a specific time period. So, if the price falls below the contract
price, the holder of the put makes money. He can sell the underlying
asset for the higher price allowed by the contract.
holding lots of stocks, a put lets him insure his position against
a serious fall in the stock market. Most of what he loses in the
stock market he will re-gain with his put.
put" was the investment world’s term for a way to keep investors
from losing too much money in a market meltdown.
with this puts-for-all policy is the means of securing it: monetary
inflation. It produces a constant upward ratchet of consumer prices.
gave a speech to a group of trainees in an inner-city job search
program. I told them about my first job. It paid a dollar an hour.
To let them
know what this income was worth in 1957, I went to the site of the
government’s Bureau of Labor Statistics.
I used the site’s
Inflation Calculator to see what I would have to earn today
to match $1. It turns out to be $7.25.
In 1957, my
employer paid $30 a year to Social Security. I did, too. That was
a total of $60, or today’s equivalent of $435. Today, for a person
working 40 hours a week for 50 weeks, that’s 2,000 hours, times
$7.25 = $14,500. (This year, I will pay $14,400 into Social Security.)
The combined Social Security taxes on $14,500 is $1,798. On top
of this will be a Medicare tax: two times 1.45%, or a total of $420.
I was a lot
better off financially in 1957 than today’s entry-level worker is
today. That is an unstated cost of the Federal Reserve System’s
FAITH IN THE PUT
cycle is the product of this sign-switching. This has been known
for over eight decades, but only to investors (few) and economists
(fewer) who are aware of the Austrian School of economics’ monetary
theory of the trade cycle. Ludwig von Mises pioneered this explanation
back in the early 1920s, in the second edition of his book, The
Theory of Money and Credit.
that it is interest rate manipulation that is the heart, mind, and
soul of central banking. Central banks lower the rate of interest
so that businessmen will invest in job-creating capital. The businessmen
are lured into a false belief, namely, that investors have saved
money, thereby making this money available for investment by businesses.
But the underlying reality is that investors are not the source
of money available for capital investment. The central bank is.
bank, unlike investors, does not restrict consumption in order to
make money available to businesses. So, businessmen are lured into
a false assessment regarding the willingness of investors to postpone
consumption for the sake of future returns. The injection of new
funds adds to the demand of all goods, but initially, this demand
is confined mainly to capital goods. Demand is from people who are
willing to borrow money, either from commercial banks or the government.
is now chasing the existing supply of goods, especially capital
goods. Business costs will soon begin to rise, thereby calling attention
to the false signal in interest rates, when the central bank expanded
the money supply.
boom phase of the monetary expansion, capital markets boom or, if
they had been falling, reverse. Greenspan reversed the 22% one-day
decline in October, 1987, by means of fiat money. He created the
stock market boom of 1995—2000 with fiat money. He created
the stock market reversal of 2000 with fiat money. He created the
housing bubble, too.
The booms were
accompanied by falling interest rates. Falling rates accompanied
the capital boom. It did this because of switched signs and a fiat
money policy to back them up.
a Russian psychologist who conducted a famous experiment. He would
ring a bell when he fed a group of dogs. They would salivate when
the smelled the food. Then, after he trained them to associate food
with the bell, he found that they would salivate when he rang the
bell, even when he gave them no food.
two decades, lower rates have meant "Greenspan put." Whenever
he rang the bell by announcing a lower federal funds rate, investors
bought stocks. This made them money because the FED supplied sufficient
fiat money to force down other rates. In the supply and demand for
money, more money lowered the market price of loans — temporarily.
got investors to salivate whenever the FedFunds rate was forced
down by (say) half. When it was forced down from 6.5% (mid-2000)
to 1%, (mid-2003), investors grew confident about buying stocks
never lost confidence. Prices soared after 1995.
So, when the
FED ceased inflating heavily after 2002, and the FedFunds rate slowly
but surely increased by .25 percentage point eight times a year,
investors did not lose confidence in the boom. The boom had a floor.
It had a Greenspan put.
chairman in 1987. He was thought to be a closet gold standard economist.
His reputation as a man who was hostile to inflation preceded him.
He never ceased delivering verbal warnings against price inflation.
But the ratchet of fiat money never ceased.
with the reputation of being committed to fiat money. His 2002 speech
in which he playfully described the FED as a helicopter filled with
paper money made him "helicopter Ben."
This was an
indication that he stood ready at all times to extend the Greenspan
put policy. Stock market investors breathed a sigh of relief when
he was sworn in as Chairman of the Board of Governors in February.
Lo and behold,
the FED immediately adopted a policy of stable money. The adjusted
monetary base, which had been chugging along in an upward direction,
Then the FED
stopped hiking the FedFunds rate. It peaked at 5.25%.
and financial media commentators do not seem to understand is that
the FED influences the FedFunds rate by monetary policy. It does
not merely announce a rate; it announces a rate and then supplies
money to establish it.
By the time
the FedFunds rate peaked at 5.25% on June 29, the FED had stabilized
the monetary base for over five months. Its subsequent announcements,
the FED announced an unchanged rate.
stocks, like Pavlov’s dogs, salivated. No more rate hikes! The FED
would not threaten the capital markets with a tight-money policy.
They started buying shares.
In the meantime,
the price of silver and gold peaked on May 12, and were heading
down by June 29. They continued down.
metals are inflation indicators. These markets were saying, "the
Bernanke put is a myth."
I had warned
about this in mid-March.
I had warned that the precious metals were close to a peak.
to look at the money supply statistics. These statistics are screaming
"Tight money! Tight money!" They are screaming, "No
more put." But investors refuse to grasp what is happening.
The FED has reversed course, just as it did under Paul Volcker in
not ringing Greenspan’s bell. He is ringing Young’s bell.
Roy Young was
Chairman from 1927 to 1930. After the 1928 death of Benjamin Strong,
the leading FED figure as president of the New York FED, the FED
moved toward tight money. Its decision-makers were convinced that
the stock market had become a bubble. They wanted to cool the stock
market. They did.
in the Great Depression fell even below the 1% rate. T-bills were
under .25% in 1932. Down, down, down went rates after 1930. Corporate
profits, stocks, housing, and employment followed rates over the
cliff. Only T-bonds went up.
constant, since it was not a free market commodity. The Treasury
bought it at $20/ounce. Then, in 1934, gold went up by 75%, when
the government hiked its price from $20 to $35. Thus was born the
myth of gold as a deflation hedge. It is not a deflation hedge when
it is not a commodity with a government-guaranteed price floor.
The FED is
not going to announce a FedFunds rate hike because the FedFunds
rate is artificially high. T-bill rates are now lower than the FedFunds
rate. The yield
curve has inverted.
are not signs of a Bernanke put. On the contrary, they are signs
that the economy is slowing down and will continue to slow down.
Corporate profits will follow.
The stock market
bulls have been trained well by Greenspan. They hear the bell: "No
more FedFunds rate hikes." They salivate. They buy.
Shedlock is a market bear. So am I. On October 15, he posted a report
on real estate, "Kool Aid and Krispy Kremes." Here, Kool-Aid
hearkens back to the mass suicide of "Rev." Jim Jones’s
cult in 1978. He had them drink poisoned Kool-Aid, which they did,
knowing it was poisoned.
Much of this
report is a reprint of a remarkable letter from a real estate specialist,
Mike Morgan, who is well-known in financial media circles. Morgan
Do you remember
my analogy of housing to donuts? A year ago I said this was like
the room of 1,000 donuts. Even if they are warm Krispy Kremes,
how many can you eat? Three? Maybe four? And even if you come
back the next day, and the donuts are now half price, how many
can you eat? Same thing with housing. We only have so many people
in the US. But builders built houses like donuts. They sold houses
to non-users. They sold houses to the greedy masses that bought
multiple houses to flip. Now we have the inventory, but there
are not enough people to occupy these homes. Moreover, with interest
rates rising and mortgages becoming tougher to obtain, we have
less and less people that can buy these homes, even if they want
This is the
supply/demand problem facing housing builders, who are described
by Morgan as already having swallowed the Kool-Aid.
a piece on this in Barron’s. He is getting calls from all
over the country. The bubble is popping.
Developer — Asked me to resell 132 units that they had sold a
year ago for an average of $400,000 a unit. All of their buyers
have notified them that they will not close. Unfortunately, even
a year ago in the heated market these units were only worth about
$250,000. Now, the units will not command more than $175,000 .
. . if they’re lucky.
Agent — She sold 10 of the 132 units I just mentioned to her friends,
family, banker and co-workers. They’re all going to walk away
from their $40,000 deposits, so they don’t lose $250,000. The
developer will be stuck with 132 units that are not worth what
it cost to build them.
Then he comes
to a case that he thinks is a yellow flag to the housing market
— This one really hurts, and this is the next wave of the massive
tidal wave hitting this industry. As surfers know, the third set
is the biggest. This homeowner purchased her home for $390,000
plus $15,000 in closing costs. It is now worth maybe $300,000.
Their interest-only ARM is scheduled for refinancing. The bank
told them they need to come up with additional cash to cover the
drop in equity. But they don’t have the $75,000 the bank wants.
And even if they sell for $300,000 and clear $280,000, they can’t
pay off their $390,000 mortgage balance. You see, their mortgage
was 100% and it was interest only. They are going to walk away
from the house and give it to the bank.
if they are lucky, will sell the house for $300,000 less commissions
and expenses. Maybe they will net out at $280,000. The math is
simple. The bank, at best, will lose at least $110,000 on a $390,000
mortgage. That’s a 28% loss . . . IF they can sell at $300,000.
Back to the donuts. Maybe they can sell a few of these homes at
market prices, but as foreclosures mount, prices will drop further.
is really pessimistic about what is about to unfold. This is
going to affect the entire economy, he says.
tidal wave will affect all aspects of our economy. Some banks
will fail. Other banks will suffer the worst liquidity crisis
since the Depression. And there is no way to stop this wave.
I am not yet
persuaded that the entire economy is this much at risk. That is
because I think housing is less volatile than the stock market.
People have to live somewhere.
is liquidity. Every year, around 18% of Americans move. In a falling
housing market, home owners will not be able to sell their homes
at today’s prices. They will not want to admit that they made a
mistake by not selling in 2005, but when they are transferred, they
will have to sell unless they can afford to buy a home and keep
their old one, which I recommend as a buy/sell strategy.
The FED has
switched signs for so long that investors now believe the signs,
not the underlying roadways.
The sign that
says "falling rates" has meant "economic boom"
for so many decades that most investors have forgotten that "falling
rates" can mean "collapsing economy," as it did,
rung the FedFunds bell: no more rate hikes. The salivating victims
have rushed in to buy stocks. But the bell doesn’t signify what
it did under Greenspan.
call them Greenspan’s putzes.