Greenspan Got It Right (again)!!

I have been saying this for quite a while that the only goal for the Bush administration's economic policies (other than focusing on national security) is to bankrupt the United States of America.

Alan Greenspan did not "explicitly" said what I though, but I think he is close enough without bashing Mr. Bush's economic policies.

With interest rates going up, looming of a new oil crisis, and historical twin deficit figures, economic policy makers have very little room to react if a recession occurs. Not to mention that Americans are experiencing one of the lowest saving rate period in their entire economic history.

Economic growth much depends on a nation's saving rate (both public and private savings). In today's America, most people are living on credit. The new definition of wealth is "how much cash flow an individual has" rather than "how much asset an individual owns", and people ignore their liabilities, as long as they can sustain their life-style with enough cash flow. Most Americans nowadays live on pay-cheque by pay-cheque, without much savings in their bank accounts, and do maintain balances on many of their bills (i.e. credit cards, cell phones, etc.).

What could happen if interest rates start to go up (i.e. to 6% or 7%), where high oil prices trigger new waves of inflation while the stock and real estate bubble burst at the same time??

The consequences will be high inflation rate together with high debt servicing cost due to high interest rate, where national income will decrease dramatically with the burst of the real estate and stock bubbles. Many households will go bankrupt, and with higher investment cost, private companies and many potential investors will hold back their investments. Unemployment will begin to soar, where businesses will have to outsource jobs and/or downsize their companies to control costs as revenues decrease. If things go bad enough, the American economy could experience very similar consequences to some Asian countries during the Asian economic flu in the late 1990s, where too many bad debts (caused by too many household bankruptcies) cripple the banking system (however, I still believe that the American banking system is nowhere close to where the Asian banks were, and the current real estate bubble in the United States is no where close to where those Asian countries were at before September 1997.)

With the current record twin deficits, the American government can do very little with such a collapse. High deficit in the current account shows that the World is financing Americans' consumption (and that explains how it is possible that many Americans are living on credit - money they don't have, because they are borrowing foreign capitals). When economic bubbles burst, the Greenbag will drop, and foreign capitals will leave America for other economies that can provide better return of investment (or a better shelter for the recession). In other words, the world will stop financing Americans' "over spending" life-style. Such a phenomenon could lead to a very painful recession, where GDP growth will be lowered with consumption and investment decrease dramatically. In addition, with the retirement of baby-boomers, more individuals will depend on social security and many pension investment funds will no longer become available for the economy as investment capital. With higher demand in Medicare and Medicaid, the government will have their budget tied up with health care spending. Even if the government is willing to issue more bond, foreign investors may hesitate to invest into the government bond. Hence, even the US government may not be able to "spend themselves out of the recession", and a potential recession could be worse than many could predict.

Anything could trigger such a scenario, and one potential issue could be the avian flu.

The avian flu can shut down all international trade within weeks if a pandemic broke out. This could be "the trigger" to burst the stock and real estate bubble in the United States, and could lead to many other problems mentioned above (a ripple effect).

As Keynes wrote that much of the economy is driven by "the animal spirit", current bubbles in the American economy is exactly driven by this force - unpredictable and irrational behaviours.

I am sure that Paul Krugman will make his comment some time next week on this issue. Just keep your eyes open!!

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Greenspan warns on deficits

By JEANNINE AVERSA

Friday, August 26, 2005 Updated at 2:03 PM EDT
Associated Press

JACKSON, Wyo. — Creeping trade protectionism and bloated budget deficits pose a risk to the United States' long-term economic vitality, Federal Reserve chairman Alan Greenspan said Friday.

“Developing protectionism regarding trade and our reluctance to place fiscal policy on a more sustainable path are threatening what may well be our most valued policy asset: the increased flexibility of our economy, which has fostered our extraordinary resilience to shocks,” the Fed chief said in a speech to an economic conference.

Maintaining economic flexibility is especially important, Greenspan said, to deal with what he called some of America's current economic imbalances: the swollen current-account trade deficit, which surged to a record $668 billion US last year, and the housing boom.

Mr. Greenspan also expressed concern in his speech about what will occur with the ending of the recent sustained period of low interest rates and low risks for investors.

“History has not dealt kindly with the aftermath of protracted periods of low-risk premiums,” he said in his remarks.

Rising stocks and home prices have made households feel more wealthy and has helped to support consumer spending, a key ingredient of the economy's good health. But Mr. Greenspan sounded a stronger note of caution that people shouldn't count on that paper wealth, which can evaporate if economic conditions deteriorate rapidly.

“What they perceive as newly abundant liquidity can readily disappear,” he said. “Whether the currently elevated level of wealth-to-income ratio will be sustained in the longer run remains to be seen.”

Low interest rates have powered the booming housing market. Home sales have hit record highs four years in a row and house prices are surging. In previous speeches, Mr. Greenspan has warned of “froth” and “speculative fervour” gripping some local housing markets.

If U.S. home prices were to suddenly fall or if interest rates were to rise rapidly, some local housing markets, homeowners and lenders could get clobbered.

“Greenspan is giving individuals ample warning that they need to take that into account,” Allen Sinai, chief global economist at Decision Economics, said in an interview.

He and others believe Mr. Greenspan was strengthening his warning about the booming housing market. But they didn't believe he was signalling a new concern about the development of a national housing price bubble. Instead, they said, he seemed to be stressing his oft-stated worries about bubbles in local markets.

Stock prices and home prices are factors that Fed policy-makers are increasingly needing to consider when setting interest-rate policy.

“Our forecasts and, hence policy, are becoming increasingly driven by asset price changes,” Mr. Greenspan said.

During the high-flying stock market days of the 1990s, the Fed chief famously questioned whether Wall Street investors were engaging in “irrational exuberance.” Despite the warning, stocks continued to soar. In 2000, the stock market bubble began to burst and wiped out trillions of dollars in paper wealth.

Mr. Greenspan said that “fear of change” is behind stalled international trade negotiations and the hesitancy of Congress and the White House to “face up to the difficult choices that will be required to resolve our looming fiscal problems.”

In the past, Mr. Greenspan has urgently called on policy-makers to shore up social security, saying a big wave of baby boomers starting to retire in 2008 will put massive strains on the system and, if not fixed, could imperil the overall economy as well.

On other issues, Mr. Greenspan said the economy thus far seems to be weathering reasonably well the run-up in energy prices over the last two years.

Mr. Greenspan gave his speech at a conference titled The Greenspan Era: Lessons for the Future.

The Fed chief, who has steered the world's largest economy through both smooth and choppy economic waters for 18 years, plans to step down in just five months.

Mr. Greenspan's appearance at the annual Fed conference, which is attended by other Fed policy-makers, economists, academics and central bank officials from around the world, is expected to be his last as Fed chairman.

Looking back over his tenure, Mr. Greenspan said a key hallmark of his approach to monetary policy-making has been preparing for a wide spectrum of economic outcomes: from the most likely to the most unlikely.

The Fed's worry in the summer of 2003 about the remote threat of deflation — a widespread decline in prices that can severely harm the economy — prompted the Fed to keep cutting short-term interest rates, Greenspan noted.

“Given the potentially severe consequences of deflation, the expected benefits of the unusual policy action were judged to outweigh its expected costs,” he said.

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