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Tuesday’s market meltdown;
Greenspan’s “invisible hand”
Mike Whitney
Online
Journal
Thursday, March 1, 2007
Tuesday’s stock market freefall has Greenspan’s
bloody fingerprints all over it. And, no, I’m not talking
about Sir Alan’s crystal ball predictions about the impending
recession; that’s just more of his same circuitous blather.
The real issue is the Federal Reserve’s suicidal policies
of low interest rates and currency deregulation which have paved
the way for economic Armageddon. Whether the Chinese stock market
contagion persists or not is immaterial; the American economy is
headed for the dumpster and it’s all because of the cunning
former Fed chief, Alan “Great Depression” Greenspan.
So, what does the stumbling Chinese stock market have to do with
Greenspan?
Greenspan was the driving force behind deregulation that keeps
the greenback floating freely while the Chinese and Japanese manipulate
their currencies. This gives their industries a competitive advantage
by allowing them to consistently underbid their foreign rivals.
Big business loves this idea, because it offers cheaper sources
of labor and allows them to maximize their profits. It’s been
a disaster for Americans though, who’ve seen their good paying
jobs increasingly outsourced while US manufacturing plants are dismantled
and airmailed to the Far East.
Greenspan has been the biggest champion of deregulation; it’s
another way he pays tribute to the Golden Calf of “free trade,”
the god of personal accumulation.
Tuesday, the Chinese got whacked with their own stick. By keeping
the value of their currency down, they spawned a wave of speculation
that inflated their stock market by 140 percent in one year. When
the government threatened to tighten up interest rates the stock
market went into a nosedive and the overall index got a 9 percent
haircut in a matter of hours. If they had been playing by the “free
market” rules, rather than pegging their currency to artificially
cheap greenbacks they could have avoided inflating their stock market.
As it happens, the rumblings in the Chinese market sent tremors
through the global system and triggered a 416-point loss on Wall
Street; the biggest one day slide since 9-11. Now the world is watching
nervously to see if the markets can recuperate or if this is just
the beginning of America’s great economic unwinding.
Wednesday’s revised numbers of GDP are not encouraging. The
Commerce Dept. revised their original data from a robust 3.5 percent
GDP to a paltry 2.2. The economy is shrinking faster than anyone
had anticipated. Also, durable goods plummeted beyond expectations
and the real estate market continues to swoon. Troubles in the sub-prime
market are spreading to nontraditional loans as more and more over-leveraged
homeowners are unable to make their monthly mortgage payments. (By
the end of December 24, sub-prime mortgage lenders had already gone
belly-up.) Greenspan’s empire of debt is bound to come under
greater and greater pressure as volatility increases.
On Monday, the National Association of Realtors (NAR) reported
a 3 percent jump in the sales of existing homes, but it was all
hogwash. The housing industry has joined the media in trying to
conceal what’s really going on by showering the public with
cheery talk of a recovery. Don’t believe it. Go to their website
and you’ll see that “year over year” January sales
were down by a whopping 290,000 homes. Add that tidbit to “new
home sales” (announced yesterday) which “fell by 16.6
percent, the most since 1994” (Bloomberg) and you get a bird’s-eye
view of an industry teetering on the brink of collapse.
Greenspan pumped the housing bubble so full of helium; we’ll
be feeling the backdraft for a decade or more. Still, the gnomish
ex-Fed master had the audacity to stand in front of the cameras
and say, “We have not had any major, significant spillover
effects on the American economy from the contraction in housing.”
Really?
Apparently, Greenspan hasn’t taken note of the skyrocketing
rate of foreclosures or the growing number of people on public assistance.
It’s doubtful that one notices the struggles of the working
stiffs from his manicured sanctuary in the Aspen foothills.
It’s not just the housing market that’s buckling from
the expansion of debt, but the stock market as well. The Associated
Press reported last week that “Investors are borrowing at
a record pace to sink into the stock market, and the trend is raising
concerns on Wall Street about what might happen if a major correction
occurs . . . The amount of margin debt, which is how brokers define
this kind of borrowing, hit a record $285.6 billion in January on
the New York Stock Exchange. Such a robust appetite, amid a backdrop
of complacent market conditions, could leave investors badly exposed
if major indexes are snagged by a market decline. Some could find
themselves forced to sell stock or other assets to meet what’s
known as a margin call, when a broker effectively calls in the loan.”
The last time margin debt was this high was at the height of the
dot.com bubble in March 2000. We all know how that turned out; the
bubble burst taking with it $7 trillion in savings and retirement
from working class Americans.
It all could have been avoided if there were prudent and enforceable
regulations on margin debt. Of course, that would have been a violation
of the central tenet of free market exploitation: “There shall
be no law inhibiting the unscrupulous ripping-off of the American
people.”
Margin debt is a red flag that the market is over-inflated by speculation.
When the market hits a speed bump, like Tuesday’s, the fall
is steeper than normal, because panicky, over leveraged investors
start scampering for the exits. This probably explains much of what
happened on Wall Street after the sudden decline in the Chinese
market.
The problems facing the stock market will soon play out whether
or not we recover from this “dress rehearsal” for disaster.
America’s huge account imbalances and the massive expansion
of personal (mortgage) debt ensure that there’s more trouble
ahead.
The real problem is deep, systemic and difficult to understand.
It relates to basic monetary policy which has been tragically mishandled
by the Federal Reserve. A healthy economy requires that the money
supply not exceed the growth of real GDP, otherwise inflation will
ensue. The Fed has been cranking up the money supply at a rate of
over 11 percent for the last six years, ensuring that we will eventually
face a cycle of agonizing hyperinflation.
More worrisome is the fact that the world is about to face a global
liquidity crisis for which there is no easy solution. See, the Fed
loans money to the banks by buying government debt. Then, the banks,
through the magic of “fractional banking,” are then
able to multiply the amount of money they loan out to their customers.
In other words, the loans exceed the amount of the reserves by a
considerable margin.
Grasping the magnitude of this phenomenon is the only way to appreciate
the storm that lies ahead. This excerpt may shed some light on the
issue:
“In the 1970s the reserve requirements on deposits started
to fall with the emergence of money market funds, which require
no reserves. Then in the early 1990s, reserve requirements were
dropped to zero on savings deposits, CDs, and Eurocurrency deposits.
At present, reserve requirements apply only to “transactions
deposits” -- essentially checking accounts. The vast majority
of funding sources used by private banks to create loans have nothing
to do with bank reserves and in effect create what is known as “moral
hazard” and speculative bubble economies.”
“Consumer loans are made using savings deposits which are
not subject to reserve requirements. These loans can be bunched
into securities and sold to somebody else, taking them off of the
bank’s books.
“The point is simple. Commercial, industrial and consumer
loans no longer have any link to bank reserves. Since 1995, the
volume of such loans has exploded, while bank reserves have declined.”
(Wikipedia)
That’s why we should not be surprised when we discover that,
although there are currently $3.5 trillion in bank deposits in the
USA, the actual reserves are about $40 billion.
This system works fairly well unless there’s a major market
meltdown or a run on the banks, in which case people will quickly
find that there are, in fact, no reserves. Even this would not be
a concern if the Fed had not increased the money supply by leaps
and bounds while, at the same time, fueling the housing bubble through
obscenely low interest rates. Now, millions of homeowners will be
facing default on their loans, the banks will be stretched to the
max, and the stock market will begin to falter.
Something’s gotta give.
Last week, in Davos, Switzerland, German banker Max Weber warned
the G-8 Summit, “If you misprice risk, don’t come looking
to us for liquidity assistance. The longer this goes on and the
more risky positions are built up over time, the more luck you need
. . . It is time for financial markets to move back to more adequate
risk pricing and maybe forgo a deal even if it looks tempting .
. . Global liquidity will dry up and when that point comes some
of this underpricing of risk will normalize. If there is much less
liquidity around, people will not go into such high risk.”
It is unlikely that Weber’s advice will be heeded. The United
States has grown addicted to “cheap money” and ever-expanding
debt. The Federal Reserve will keep greasing the printing presses
and diddling the interest rates until someone takes away the punch
bowl and the party comes to an end.
There have been plenty of warnings, but they’ve all been
brushed aside with equal disdain. In a recent article on Counterpunch.org,
(“Lame Duck”), Alexander Cockburn refers to a report
published by the Financial Services Authority (FSA), “a body
set up under the purview of the British Treasury to monitor financial
markets and protect the public interest by raising the alarm about
shady practices and any dangerous slides towards instability.”
The report “Private Equity: A Discussion of Risk and Regulatory
Engagement” states clearly: “Excessive leverage: The
amount of credit that lenders are willing to extend on private equity
transactions has risen substantially. This lending may not, in some
circumstances, be entirely prudent. Given current levels and recent
developments in the economic/credit cycle, the default of a large
private equity backed company or a cluster of smaller private equity
backed companies seems inevitable. This has negative implications
for lenders, purchasers of the debt, orderly markets and conceivably,
in extreme circumstances, financial stability and elements of the
UK economy.”
The problem is even worse in the US where personal and mortgage
debt has increased by over $7 trillion in the last six years! This
is not an issue that can be resolved by a meager 10 percent correction
in the stock market. The reaction on Wall Street to the sudden downturn
in China demonstrates the fragility of the market and presages greater
volatility and retrenchment.
<!--[if !supportEmptyParas]-->
We should expect to see bigger and more destructive market fluctuations,
as investors get increasingly skittish over bad economic news and
weakness in the dollar. Tuesday’s 416-point somersault is
just the first sign that Greenspan’s Goldilocks’ economy
is cracking at the seams. <!--[endif]-->
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