June 17, 2004
Alan Greenspan sat through his confirmation hearings this week, giving the Senators complete assurance that all is well in the economy, and inflation is completely under control. His customary cautions were temporarily omitted. The word he chose to describe the amount and timing of necessary interest rate increases in the future was "measured." The market translates this term in its most favourable context.
One might say, with kindness, that Greenspan wants to keep his job. This is barely credible, given his age and the length of his public service. One might suppose that he is a victim like the war prisoners, his head placed in a sack, or that snarling attack dogs are straining to bite his face. But this is unlikely, unheard of as it is in Washington, DC.
One could suppose he begins to suffer the effects of age, smiling gently and calmly in the sweet breeze of senility. More likely he has caught Potomac Fever, which has as its major symptom, an overflow of optimism reminiscent of the What-Me-Worry Alfred E. Newman character of Mad Magazine, whose idiotic grin suggests a blissful ignorance, with a complete disdain for the factual aspects of worldly reality.
Potomac Fever is contagious, easily caught during a total submersion under the unholy waters of the military-industrial complex. Its victims are seen issuing orders for military contracts with neither the constraint of financial prudence nor any pre-requirement for practical utility. They say they are acting in the best interests of America, where the consumers must have jobs. They think the most reliable way to create jobs is to spend, spend, and spend more on military hardware, the means to kill in many masks of mass murder; to continue spending without looking at the disastrous treasury deficits it causes. They say the stock markets must be supported, and the voters must have no reason to growl. It is an election year.
Alan Greenspan is doing his part, not saying anything that might betray an impending disaster. He has successfully consoled the markets, and the Senators have promised that he will receive his reward with little delay. He smiles up at the circle of Senatorial faces from his central table, but the smile surely cannot last far along corridors that lead to lunch. Once out of sight of the circling press corps, the beads of perspiration surely must stream down his back, because he knows the horrible truth.
Recently the respected senior US military officer, General Myers, reported to a Senate Committee that the US was "looking into the abyss." He referred to the US military involvement in Iraq and to the sordid situation in the Middle East generally. Greenspan might have used the same words, but did not. It is an election year, and he has agreed to continue to serve Bush and company. Others however, are leaving with a nauseous gut full of disgust, caused by a constant cuisine of corporate cupidity that cancels the customary concern, completely incautious in fiscal matters and clean of any concern for character.
It is difficult to avoid a polemical tone in writing of Greenspan's appearance before the Senate confirmation Committee. The reason becomes clear when we look at the present financial and economic situation in the US today. The Federal debt approaches US$7.25 trillion. It increases at the rate of US$500 billion per annum. At one percent interest, the annual service cost is US$72.5 billion. When the Federal Reserve raises the interest rate a quarter of a percent, the service costs on the public debt increase by US$18 billion per year. The return on the US ten-year bond now nears 5%. At this rate, the service cost on the full Federal debt comes to US$363 billion per year. Almost half of this amount is paid to foreigners, who now hold large amounts of US bonds, bills and notes; this portion of the interest paid on the public debt is not considered as circulating inside the domestic US economy, though much of it may be used to buy US assets.
The US is presently engaged in a record level of budget deficit, over US$500 billion per year, which means there is a large shortage of the funds required to meet the daily domestic demands of the American people, caused largely by a desire to adopt the role of international policeman. The shortage of money is met by borrowing, selling new paper regularly to trusting investors, governments and institutions. The proceeds of the new borrowings must be used to service the existing debt. What is left is used to meet the US budget. It is important to keep in mind that there is no significant exchange of actual currency or certificates; the reality is that there is a vast worldwide vacuum in the fertile and far-flung fields of international finance. But the fields are fatuously fallow, filled only with virtual numbers transferred between virtual accounts and held as bits of low magnetism in computer memories.
This form of financing is much like a Ponzi scheme, in which today's bond sales are used to satisfy yesterday's bond buyers. Tomorrow's bond sales will be used to satisfy today's bond buyers. Since the proceeds of the bond sales are also needed to first cover the existing debt and interest due, and only then can it be applied to the budget, it is easily seen that the amount of the bond sales must constantly increase. This is true whether there is ever a future ability to pay, or whether there are now sufficient assets to cover a potential default.
In a previous era an intent to repay the borrowed capital was strongly implied as a fundamental part of the bond sales contract, and further, that there was a determination to retire the US public debt in the near future or as soon as possible. This is obviously no longer the case, not only because the large annual deficit is programmed to extend for decades into the future, but because the rate of increase in the amount of routine bond sales indicates the present level of borrowing is unsustainable.
The 'full faith and credit' standing that is offered as a virtual surety behind US bonds has changed from a guarantee that the public debt will eventually be paid, to a vacuous promise that although the public debt admittedly cannot be repaid, the bonds will be redeemed with interest as they mature. The huge public debt looms overhead indefinitely, growing ever larger and more threatening.
Greenspan is also very aware of the dangers of the US trade deficit, which now has grown to almost US$50 billion per month, and the annual total will almost certainly approach US$600 billion in the coming year, and will continue its high growth rate for the coming years.
The US is thus buying more foreign goods than it is selling to the world's markets. At this high level of trade imbalance, one wonders how long the trend can continue before there are serious consequences. Many economists and the IMF (twice) have warned of the twin dangers of the US trade deficit and the budget deficit, which combined exceed US$1.2 trillion per year. On earlier occasions Greenspan mentioned these problems, but not now. It is an election year.
The US economy is primarily a consumer economy. The level of retail sales reported each month is closely watched as an indicator of the health of the economy. The consumer is the key, and the financial health and confidence of the consumer is a constant concern of the Bush administration. If the consumer cannot find sufficient funds or credit for further foolish flings of fashion, it is a threat to the entire system, and so the consumer's income and creditworthiness is closely monitored, by the administration, the Federal Reserve, and by investors generally.
The price of gasoline has increased, and this has diverted a portion of the consumers' disposable income from less necessary items, such as savings and investment. This is a threat to the enormous 401(K) pension program that is heavily invested in the stock market and government securities. Approximately half of the home mortgages in the US are of the adjustable rate type (ARM's), which allows the lender to increase the interest rate if the base rate set by the Federal Reserve is increased. If the consumer is forced to make higher payments on the mortgage, there is less to spend on retail sales items, and this number, reported monthly, will tend to fall.
The retail sales numbers are reported only after a period of delay, today's numbers reflecting retail sales in the month of April. Because there is also a delay in the implementation of a consumer's order to reduce or suspend the level of his 401(K) contribution, typically allowed only at the end of the next quarter, the gasoline squeeze will not be reflected in the level of share sales for another three or four months. The same delay occurs in the case of the adjustable rate mortgage, where the monthly payment is not increased until the beginning of the next quarter.
One should not expect to see the effects of the present inflationary pressures, on prices the consumer must pay, for two or three months, perhaps more. It is now the middle of June, and a drop in retail sales for this month will not be reported until around the middle of August. There may be no significant drop that is reported until after the November election date. The same delay is true for the increase in interest rates as applied to adjustable rate mortgages. Greenspan and the Federal Reserve are aware of the large debt being carried by the homebuyer, which is now close to US$18 trillion, around half of which is of the ARM variety.
Greenspan does not want the consumer to face increased costs from the adjustable rate mortgage, so the base rate is likely to be held constant until its effect will not be felt until after November. For this reason, one should not expect a rate increase until after June 30, and then only a quarter of a percent, so that the consumer will not feel the pinch until November 1st, the beginning of the last quarter, and the reduction in retail sales will not be reported until January 2005.
While he asserted the level of inflation was not presently problematic, Greenspan did admit there were uncertainties, like the price of oil, which might create problems. The market is consoled, many commentators stating that the price will fall to the US$30/bbl range "by the end of the year." Others state confidently that previous fear of the deleterious economic consequences of high oil prices was unfounded, that the US economy is now so strong that it can withstand higher oil prices indefinitely.
The propaganda of past decades was that the price of oil was determined by a traditional competition between buyers and sellers, known in economic terms as demand and supply. This view is patently false, as previously argued on this web site. Oil producers are free to price their oil as they please, since they are not dependant on oil sales for economic survival. They can demand a high price, and if it is not met they can wait until the supplies of those who are willing to sell at lower prices are out of stock.
Oil buyers must meet the price demanded or seek alternative energy sources. It is thus appropriate for Greenspan to touch, however lightly, on the price of oil as a potential threat. He knows that the price of oil is a very influential inflationary factor, not only because the consumer must divert cash from other sectors of retail spending in order to pay more for gasoline and mortgage, but also there are the other increased costs the consumer must absorb; transportation costs for every item of commerce, including airline fares, heating oil, and electricity. All these costs are inflationary factors, as Greenspan knows. He looks into the abyss every day. But not on confirmation day, when the press is present. It is an election year.
For the moment, however, Greenspan exhibits a customary confidence before the Senate committee. He does not look down into the abyss, but exudes the quiet competence the market has come to admire and respect. His remarks must be taken in the context of the current background situation. Greenspan realizes there is nothing that can be done to relieve the disastrous political scene so long as Bush-the-Second is in the presidential office.
Greenspan is aware that the financial future of the US is doomed, that current political policies and activities are unsustainable. Greenspan also knows there is no point in unnecessarily creating market drama, tension that would certainly invite a panic and accelerate the pace of the inevitable decline. While others leave the scurrilous Bush administration, he remains at his post, responsibly accepting his portion of blame.
If he were more forthright than ambitious, he would resign. While history will not absolve him of his complicity, it will at least note that he opposed the fiscal insanity that has destroyed the US, beginning with the surreptitious and still secret response to Russia during the Cold War, and especially those activities now evident that were carried out during the presidential years of Ronald Reagan, George Bush I and II.
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