“Don’t look, Edward.”
The instruction came from Elizabeth, directed at her youngest son. We were driving through the Bois de Boulogne, a notorious hangout of extravagant prostitutes.
“Besides, they’re not what you think they are. They’re disgraceful. Sordid. Some of them are men dressed up as women.”
Of course, Edward craned his neck to look even harder. And so do we crane our necks today…to take a better look at a counterfeit. That is also what makes financial history so entertaining, after all; it is like the Bois de Boulogne – full of jackasses and imposters. Alan Greenspan will go down in it, of that we are certain. He will be remembered as the greatest central banker since John Law. Mr. Law invented modern financial bubbles. Dr. Greenspan perfected them.
In the early 18th century, John Law was on the lam in France, after having killed Beau Wilson in a duel in England. France was broke, thanks to the grandiose spending of Louis 14th. A clever rake, Law proposed to solve the Regent’s financial problems with a novel monetary system, based on a new national bank – the Banque Generale – and a new currency backed by the future profits from Louisiana. Anyone who had set foot on the banks of the Mississippi at the time would have known that there was little easy money to be had in that savage place. But almost no one had seen it, so they could imagine all sorts of fantasies – even that they’d get rich panning for gold there.
At first, of course, Law’s project was a great sensation…by 1720 he was the richest man in the world…women threw themselves at him, and France even gave him a title – the Duc d’Arkansas. Here again, a little travel would have put the kibosh on the whole enterprise. Even today, you could be an Archduke of Arkansas; people would still laugh at you.
It didn’t take long before Law’s adventure blew up; his bank and his money sank into the bayou mud. Law was forced to flee angry mobs in Paris, and went to Venice, where he died, disgraced, nine years later.
Today’s news tells us that Alan Greenspan is still invited into polite society. His gives speeches. People clap and want their photographs taken with him. Still, Dr. Greenspan’s big, yellow moon seems to be waning.
But neither the Bois de Boulogne nor the former Fed Chairman is the subject of today’s pensee, just the point of departure. The period of low inflation and rising asset prices – known by economists as “The Great Moderation” – is over. Inflation rates are rising all over the world; people are rioting over food; truckers are blocking roads to protest high fuel prices; credit is harder to come by. Today, the subject of the following 400 words is: what next?
After you take out spending on the necessities, reported London’s Daily Mail , “families have less to spend on themselves than at any time for 17 years.” Discretionary spending, that is, things you buy after you have paid for food, housing, heat and council tax, is at its lowest level since 1991. In America, too, staggering increases in personal, mortgage, and public debt have wiped out the accumulated savings of 6 generations. Prove it to yourself by simply dividing the U.S. government’s “financing gap” of $57 trillion by the number of households in the United States. You will get about $500,000 per family, far more than what the average family has in assets.
What was it about The Great Moderation that left such sour disappointment? The answer is simple: it was a counterfeit.
“There are principally two different kinds of spending…” wrote the late Kurt Richebacher. “One kind is on goods and services from current output, adding to the gross domestic product. The second kind is spending on existing property, land, buildings, plant and equipment, and all sorts of paper assets (such as stocks, bonds, mortgages, and so on)…”
Keynes explicitly classified the two components in the money supply as “industrial circulation” versus “financial circulation.” The distinction is important; it is like the difference between a woman and a female impersonator. They may be alike in almost every respect, except the essential ones.
Many overseas markets – including China, India, Russia, and Brazil – have enjoyed real booms. They’ve built factories. They’ve built highways and airports. Wages have gone up. GDPs have risen. People are better off in those countries than they were 10 years ago. That’s why they have been such good investments; it’s also why we continue to recommend them. If they continue to grow, their citizens can expect not only to be as rich as Americans one day – but to be richer.
But the boom in the United States was not an economic boom; it was a financial bubble; and all bubbles explode. In the typical financial bubble – from Tulipmania of the 17th century to the Wildcat Bank Bubble of 1837 – asset prices blow up and speculators lose money. Then, speculators wipe the dust off their faces, poorer but wiser, and people get back to work. But the bubbles of recent years have had something that previous bubbles lacked – the support of the world’s largest, most powerful central bank…and a currency as faithless as its custodians. This was largely the contribution of Dr. Alan Greenspan and now, his protégé, Ben Bernanke. They made the world safe for bubbles.
The result was more and bigger bubbles than ever before.
“One bubble may be an accident,” noted a columnist in the Financial Times , “but two in the space of a decade beings to look like carelessness.”
After the bubble in tech shares blew up in 2000-2001, another bigger bubble – in residential property – took its place. It was aided and abetted by coincident bubbles in mortgage derivatives – notably in the sub-prime area – and in the financial industry, generally. The popping of those bubbles is what has dominated the financial headlines for the last year. It is also what has ended the “The Great Moderation.”
But those bubbles were the result of neither accident nor carelessness. Fed governors have callouses on their hands to prove it. When one bubble popped, the Fed and other central banks pumped up another. Today, they are still pumping – with money supplies soaring all over the world (in the United States, the latest figure put money growth about 5 times the GDP growth rate)…and the Fed’s key lending rate at less than half of the rate of consumer price inflation. More bubbles are inevitable. And now the swelling goes where it is most unwelcome – into oil, commodities, gold and emerging markets.
The trick has turned against the tricksters. These new tide of liquidity doesn’t lift up the U.S. economy the way it did when it was going into stocks, housing and finance. Instead, this new tide pushes up consumer prices…while assets sink, entire families drown, and Dr. Greenspan’s reputation washes up like an empty, plastic bottle.
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