Back to the Nineties
From the perspective of my macro Credit analytical framework, history’s greatest Credit Bubble advances almost methodically toward the worst-case scenario. After more than two decades, the Bubble has gone to the heart of contemporary “money” and perceived safe government debt. The Bubble has fully encompassed the world – economies as well as securities and asset markets. And we now have the world’s major central banks all trapped in desperate “nuclear-option” “money”-printing operations. Moreover, serious cracks at the “periphery” of the global Bubble now feed “terminal phase” Bubble excess at the “core.” Indeed, “hot money” finance exits faltering periphery markets to play Bubbling king dollar securities markets. Euphoria reigns. In many ways, the Bubble that gathered powerful momentum in the Nineties (with king dollar) has come full circle.
Alan Greenspan was interviewed by the Financial Times’ Gillian Tett at the Council on Foreign Relations, October 29, 2014:
Greenspan: “In 1775 we printed a whole bushel full of continentals. And one of the fascinating things about that period is the fact that for the first year or two there was very little evidence that they had any effect on prices. Meaning that that paper currency circulated with the same value as specie (gold and silver). There is an extraordinary lag which exits between actions of that type and consequences. Now, eventually a continental was not worth a continental. But it took a long while, and I think that we’re looking at very similar things now. This again is human propensity. One of the things that I used this book (“The Map and the Territory”) to write was to develop a concept of how do you shift from a system where everybody is acting rationally – which is what all our models basically said – to one where reality is where people are acting intuitively, various different types of forms. Irrationality is in many respects systematic – you can model it. And indeed I show in many cases why for example fear is demonstrably a much stronger force than euphoria… This is the type of thing that I think we’ve got to understand. And one of the reasons why I say, as a conclusion in this book, that the non-financial parts of our economy behave very well. They are highly capitalized, and essentially it is a financial system which is totally divorced – a different function than the type of things we do in the non-financial area. One (the financial sector) has to do with the allocation of savings into investment. That is where “animal spirits” really run wild. And we have to understand that better than we do now. This is the reason why – everybody knew there was a Bubble in 2008 but, to my knowledge, nobody - even when we knew on a Monday morning that Lehman was going to default - did we get the reactions right away. It took several days before the whole system broke down. If you can’t forecast something like that what good is forecasting.”
Gillian Tett: “Do you regret not having pricked the Bubble in, say, 2005?”
Greenspan: “No. Because of by then – one of the things I conclude in the book is that pricking the Bubble – short of collapsing the economy – doesn’t do anything. We tried at the Fed, for example, in 1994. We raised the Federal Funds rate by 300 basis points –which is a huge amount in a short period of time. We went up 50 basis points, 75 basis points. And we did slow what was - we can call it an incipient rise in the Dow, for example. It stabilized. And we thought we got a previously unachieved safe landing. And so we started patting ourselves on the back, and low and behold as soon as we stopped tightening the Dow took off again. And the reason is that markets are very complex. The markets observing the fact that 300 basis points did not disrupt the economy changed the equilibrium level of the Dow Jones Industrial Average from here to there (raising his hand higher), and the markets just took off. There is no evidence of which I’m aware of where central banks have incrementally tightened. The only occasion where we actually saw something is when Paul Volcker’s Fed hit in late-1979 and early-1980 - put a clamp on the economy. And it’s only by bringing the economy down that you could burst the Bubble. And that is very bad news in a sense that – the only place where incremental tightening actually defuses Bubbles is in econometric models. And that’s because they are mis-specified.”
I have a weekly chronicle of the Great Credit Bubble going back to 1999 ready to do battle against historical revisionism. I began my “blog” in 1999 in part because I had witnessed profound changes in finance, policymaking and the markets that were going completely unreported and unanalyzed. Today’s out-of-control global Bubble arose from the Nineties Bubble in U.S. Credit and asset markets. And no one played a greater role in nurturing the Bubble than Alan Greenspan.
Greenspan remains impressively sharp. Interestingly, he has become a fan of gold. He doesn’t see the euro monetary experiment succeeding. Greenspan is clearly concerned about the current stance of monetary policy and “fiat” currencies. That he would raise the issue of our nation’s terrible experience printing “Continentals” is fascinating. That he would point responsibility to “human propensity” is incredible. Greenspan has expended considerable energy absolving himself of responsibility, in the process revising history. I’ll attempt a few clarifications.
Greenspan states that “everybody knew there was a Bubble in 2008.” As someone that studied, chronicled and warned of the Bubble, I recall things quite differently. Will everybody have known it was a Bubble in 2014? And, actually, wasn’t it perfectly rational to participate in stocks, bonds and asset markets – even on a leveraged basis – during the Nineties and right up to 2008, with the Fed (and Washington policymaking) manipulating, intervening and backstopping finance and the securities markets? Is it not similarly rational to speculate in stocks, bonds, corporate Credit and derivatives today? I would strongly argue that rational responses to government-induced market distortions are instrumental to major Bubbles.
Greenspan was the father of contemporary “activist” central banking. His market assurances and “asymmetrical” policy approach were godsends to speculative markets. An aggressive rate collapse and yield curve manipulation (stealth banking system bailout) were instrumental in fostering historic expansions in both non-bank “Wall Street finance” and leveraged speculation. It’s easy these days to forget the scope of the Nineties Bubble that inflated under Greenspan’s watch.
The S&P500 returned 429% during the decade of the Nineties. The Nasdaq Composite gained almost 800%. Total system (non-financial and financial) debt doubled during the decade to $25 TN. The Asset-Backed Securities (ABS) market expanded 525% to $1.3 TN. Securities Broker/Dealers assets surged 320% to $1.2 TN. Rest of World holdings of U.S. financial assets jumped $3.7 TN, or 370%, to $5.64 TN. Corporate (non-financial) borrowings surged 141% during the decade to $9.319 TN.
If not for the spectacular Nineties Bubble I seriously doubt Bernanke would have become a leading figure. He was brought into the Fed in 2002 when the scope of the post-Nineties Bubble landscape came into clearer view. Bernanke had the academic creed the Fed would adopt as it took central bank “activism” to a whole new level of experimentation. In the name of fighting the scourge of deflation, the Greenspan/Bernanke Fed fueled a reflationary mortgage finance Bubble that left even the Nineties Bubble in the dust.
I’m compelled to amend a few of Greenspan’s comments. Yes, the Greenspan Fed did raise rates 300 basis points between February 4, 1994 and February 1, 1995. But the Fed had previously cut rates 600 basis points – from 9% in October 1989 to 3% by September 1992 (in the end slashing 300 bps in seventeen months).
I certainly concur with Greenspan’s comment that “markets are complex.” I simply don’t buy into Greenspan’s attempt to distance the markets’ propensity for destabilizing “animal spirits” from “activist” government policymaking. Government actions repeatedly throughout the decade backstopped the markets and resuscitated the Bubble. There was the extraordinary use of the U.S. Treasury’s Exchange Stabilization Fund as part of the 1995 Mexican bailout. There was the Federal Reserve orchestrated bailout of Long-term Capital Management. There were scores of (Washington-based) IMF bailouts. There was the February 1999 “Committee to Save the World,” with Greenspan on the cover of Time magazine positioned in front of Robert Rubin and Larry Summers.
In some key ways, these days it’s Back to the Nineties. King dollar is again flourishing, fueled by Federal Reserve “activism” coupled with faltering Bubbles around the globe. U.S. securities markets are once again bolstered by the perception that policymakers will guarantee marketplace liquidity and quash incipient crises. And, importantly, the Bubble is again being dangerously fueled by an underlying source of finance that is both unrecognized and unsustainable.
Back in 1999, there was absolutely no doubt in my mind that the system was in the midst of a historic Bubble. At the same time, the bull story was compelling (in contrast to today): the “technology revolution,” unprecedented productivity gains, robust growth, globalization, contained inflation and newfound confidence in astute policymaking. There was the collapse of the Soviet Union, European integration and the rise of Capitalism around the globe. But there was as well one major unappreciated problem: The underlying finance encompassing the world’s reserve “currency” was unsound.
GSE assets were up $1.27 TN, or 280%, during the nineties (to $1.72 TN). Notably, GSE holdings increased an unprecedented $150bn, or 24%, during 1994. I can state confidently that the incipient U.S. Credit, securities and speculative Bubbles would have been suppressed had the GSE’s not been there to backstop increasingly speculative markets. Without the GSEs, the 1994 bursting of the bond/derivatives Bubble would have been a major problem (and an invaluable learning experience for market participants and policymakers). Operating as quasi-central banks, GSE assets increased $112bn in 1997, $305bn in 1998 and $317bn in 1999.
To this day, there is no recognition of the profound role the GSE backstop played in distorting markets and promoting risk-taking and speculation. Including GSE MBS, total GSE securities increased about $2.7 TN during the nineties, providing the key source of system Credit underpinning the Nineties Bubble. The Technology and stock market Bubbles burst in 2000. The “miracle” U.S. economy fell into recession. Instead of running budget surpluses and paying off all federal debt (part of the bullish view at the time), deficits returned with a vengeance. By 2002, the U.S. corporate debt market was in crisis. Enter Dr. Bernanke.
There is still little appreciation for the how GSE Credit fueled the securities markets, housing prices, the real economy and government receipts throughout the Nineties. These days, there’s a similar lack of understanding for how almost $3.6 TN of Federal Reserve Credit has stoked securities markets, the real economy and Federal receipts. The view in the Nineties was that the GSEs didn’t matter – “only banks create Credit.” The view today is that QE-related Federal Reserve “money” just sits there inertly on the U.S. banking system’s balance sheet.
We’re at a critical juncture in the global Bubble. Serious cracks have developed at the periphery. The Russian ruble sank another 8.0% this week (two-week decline 10.5%). The Ukrainian Hryvnia dropped 10.5%. The week saw the Brazilian real fall 3.2%, the South Korean won 2.3%, the Colombian peso 2.0%, the Malaysian ringgit 1.7% and the Chilean peso 1.7%. The Iceland krona, Romanian leu and Hungarian forint all lost about 1%.
Last week saw the Bank of Japan’s Kuroda (after a 5 to 4 vote) shock the markets with a major boost in QE. This week, with various reports of serious dissension within the Governing Council, Mario Draghi emerged from committee policy discussions more determined than ever to push through with his Trillion euro increase in ECB holdings.
I struggle believing Kuroda and Draghi are driven by domestic considerations alone. I am not alone in discerning an element of desperation. Their aggressive measures have definitely thrown gas on the king dollar fire. And the week saw further acute pressure on commodities markets. King dollar and sinking crude helped incite crisis dynamics for Russia’s currency. The Russian central bank spoke of the ruble under attack from “speculative strategies” and “threats to the nation’s financial stability.” Putin on Thursday claimed “politics prevail in oil pricing.” By Friday, there were reports of Russian tanks again entering Ukraine.
In Back to the Nineties-type analysis, emerging markets contagion now seems to gain momentum by the week. This week’s ruble collapse certainly seemed to pull down the vulnerable Brazilian real. The sinking real then tugged at Colombian and Chilean pesos – and even the Mexican peso (trading at a 15-month low early Friday). EM bonds also showed some vulnerability. After beginning the week at 12.1%, Brazilian 10-year (real) yields traded to almost 13% Friday morning (closed the week at 12.56%). Venezuela yields jumped 232 bps to 18.50% (high since March ’09). Other EM markets were hinting at contagion vulnerability. The Turkish lira declined 1.6% this week, as Turkish 10-year yields jumped 17 bps to 8.61%. Turkey’s major equities index was hit for 3.25%. On the back of a Moody’s debt downgrade, South Africa’s currency lost 2.1%, while bond yields rose 11 bps (to 8.0%).
European equities popped somewhat on Draghi but posted another unimpressive week. Notably, Spanish stocks were down 3.4% and Italian stocks were hit for 3.5%. And with German yields down another 2.5 bps to a record low 0.815%, bond spreads widened in Spain (11bps), Italy (6bps) and Portugal (9bps). It’s worth noting that Italian CDS rose four basis points this week to 132bps, up 46 bps from September lows (only 9bps below the “panic” 10/16 close).
Meanwhile, U.S. equities bulls just love (Back to the Nineties) king dollar. Scoffing at global crisis dynamics, those seeing the U.S. as the only place to invest are further emboldened. And, no doubt about it, “hot money” flows could further inflate the U.S. Bubble. Speculative flows (underpinned by Kuroda and Draghi) have surely helped counter the removal of Federal Reserve stimulus. Yet this only increases systemic vulnerability to de-risking/de-leveraging dynamics. At the end of the day, it’s difficult for me to look ahead to 2015 and see how the household, corporate and governmental sectors generate sufficient Credit growth to keep U.S. asset prices levitated and the Bubble economy adequately financed. Perhaps this helps explain why - with stocks at record highs, the economy expanding and unemployment down to 5.8% - 10-year Treasury yields closed Friday at a lowly 2.30%.