The National Investor

Friday, May 7, 2004

Yesterday, Federal Reserve Chairman Alan Greenspan gave his second strong condemnation of the size of the federal budget deficit in the past couple weeks. Speaking via satellite to a gathering of bankers in Chicago, he warned that the soaring deficit represents a major obstacle to America’s long-term financial health. Notably, Greenspan said he was more concerned about this than both the trade deficit and the high level of household debt. Both of these others, he said, could be “corrected by market forces.”

The central banker trotted out all the various reasons for his concern over Washington’s out-of-control spending, and propensity to promise everything to everyone. “We have legislated commitments to our senior citizens,” Greenspan said, referring to the massive entitlement programs politicians must one day deliver on, “that, given the inevitable retirement of our huge baby-boom generation, will create significant fiscal challenges in the years ahead.”

True enough. But what “The Maestro” conveniently overlooked in his comments was the fact that one major market force does indeed have the power to rein in the federal government’s spendthrift ways.

That market force is the Greenspan-led Fed itself.

A couple weeks ago, Greenspan appeared before the Joint Economic Committee of Congress. There, he also waxed philosophical about the nation’s budget woes, similarly warning of dire consequences for the markets and economy down the road if Washington is unable to rein in its spending.

There, though, he was not able to get by with talking about what, in effect, is but a symptom of a more fundamental problem. Most notably, Congressman Ron Paul (R-TX,) who most always is able to make Greenspan squirm at such gatherings, hit the nail on the head in pointing to the Chairman himself as the enabler of not only the federal government’s free-spending ways, but the one man who could stop such behavior.

Dr. Paul, as many of you know, is one of the precious and, unfortunately, very few real statesmen who have been elected to Congress in recent memory. As both a libertarian and an advocate of sound money (as Greenspan himself once was) Paul regularly grills the Fed chairman over his wild inflation of our monetary base; often, Paul uses Greenspan’s own past speeches and articles against him in this regard.

This time around, Congressman Paul pointed out that the Congress would have much less room to run staggering deficits were it not for the fact that the Greenspan-led Fed has been drowning us in a rising sea of dollars. He has created so many of them, in fact, that there are sufficient quantities to go around to enable everyone to take on more and more debt—including Uncle Sam. To guarantee that long-term rates don’t move higher in spite of his wild monetary inflation, he has further arranged for Japan and China to join in the fun. Thus, it is the Fed itself that has completely removed any need for the government (or anyone else, for that matter) to spend within its means.

Once upon a time, as Paul stated to a Fed chairman who seemed to have a “when is this session going to end?” look on his face, we had a central bank that was not so wildly inflating the volume of our fiat currency. In those days, if the federal government deficit began to move too high, the “punishment” came in the form of the so-called bond market vigilantes trashing U.S. government debt, and pushing market rates higher. One way or another, there was a cost for the government’s behavior; even if it didn’t always pay attention right away.

Now, though, Greenspan is enabling anyone and everyone—including Uncle Sam—to borrow and spend way beyond their means. In so doing, he and his compatriots at the central bank have removed responsibility from consumers and investors alike, and have led one and all into a false sense of security. Take on all the debt you want, because it’s cheap. The rising value of your home will bail you out (if not allow you to borrow more money for stuff you don’t need next year.) If you’re an investor, pile back into stocks; the Fed will make sure sailing remains smooth. Etc., and etc.

Nobody else can be blamed for this, since nobody else has had the ultimate power to change it as does the Fed.

I wish Dr. Paul had been able to similarly quiz—and take to task—Greenspan yesterday, when he added the following in his comments to the bankers in Chicago:

“Has something fundamental happened to the U.S. economy and, by extension, U.S. banking, that enables us to disregard all the time-tested criteria of imbalance and economic danger?” Greenspan asked. Answering his own question, the Fed chairman said, “Regrettably, the answer is no. The free lunch has still to be invented.”

You could have fooled me!

Following its Open Market Committee meeting of this past Tuesday, the Fed kept interest rates at their “emergency” low level of 1 percent on the federal funds rate. Sure, the F.O.M.C. engaged in more word games to try to “sedate” the bond market, as an incredulous Bill Gross, manager of the largest bond portfolios known to man for PIMCO, quipped. Yes, it took another grudging, baby step towards eventually raising short-term interest rates. But make no mistake: the Fed STILL does not intend to do so unless it has a gun placed to its head, and without being virtually dragged into the move(s).

The Maestro has money managers like Gross and a growing number of economists increasingly nervous. Even the bond market vigilantes aren’t quite as sedated as Greenspan and his cohorts hoped would be the case. As of today, the yield on the Treasury’s 10-year note has now risen a full percentage point from where it stood following the F.O.M.C.’s last meeting in March. More and more—especially when you look at the Bank of England raising rates and the European Central Bank remaining on hold yesterday—you can easily get the picture of a Federal Reserve that is so far “behind the curve” that when it finally is forced into raising interest rates, the economy and markets will be wrecked.

Should we consider the venerable central banker as having become addled perhaps because 17 years into his job he’s punchy and confused? Should we wonder at his ability to read and grasp the news headlines, showing that—even by the government’s screwy figures—consumer prices have risen at a 5% annual clip so far in 2004? Should we merely poke fun at Chairman Greenspan, likening him to a preacher railing about temperance from the pulpit while he has a bottle of Jim Beam concealed in it for after the congregation heads home?

The bottom line, folks, is this: Greenspan really isn’t nuts. He can read a CPI report. He can read of how rapidly real estate is rising in some areas for no reason other than speculation and “flipping” of properties, encouraged by his policies. It’s not that he can’t see these things; the kinds of things that have “bubble” and “crash” written all over them. Simply put, though he will rail against the excesses and irresponsibility he himself has fostered, he just can’t do anything to change it all.

He dares not utter the simple fact that his central bank has no choice but to keep the monetary spigot wide open, and—for as long as the markets let him get away with it—keep interest rates near rock-bottom, so as to keep “the recovery” from coming to a dead stop. As I write in this month’s issue of The National Investor in an item entitled “Underwriting Exuberance,” a fractional reserve banking system as leveraged and deep in hock as is ours can follow no other course of action, no matter how loony—and ultimately doomed—it appears to Gross and others. The implications for the markets—including commodities—are fairly clear, as I detail therein.

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