Posts Tagged ‘Alan Greenspan’

How are central bankers going to deal with asset bubbles?

Sunday, July 12th, 2009

Prior to the Global Financial Crisis (GFC), central bankers tend to adopt the ostrich’s mentality to asset price bubbles. Alan Greenspan, the chief architect of this school of thought believes that central bankers should only target price stability and price inflation with their interest rate levers. Greenspan argued that since it is impossible to know when bubbles will burst, it is impossible to intervene at the right moment (we heard of another twist to Greenspan’s argument- one can never know whether it’s a bubble until it bursts).

What about Australia? As we reported in What should the RBA do?, the RBA, regardless of whether it believes asset price bubbles are dangerous or not, do not have the mandate to prick them,

The masses have not given the RBA the mandate to spoil the asset price inflation party. Although, Ian Macfarlane acknowledged that asset price bubbles can be very dangerous for the economy, his hands were tied. Elsewhere, Coalition opposition politicians were toeing the populist line by demanding that Glen Stevens (the current head of the RBA) be grilled more frequently in order to pressure him against hiking interest rates.

This ostrich mentality of central bankers is strongly criticised by the Bank for International Settlement (BIS). As we wrote before in Bank for International Settlements (BIS) warning on stimulus spendings, the BIS is the

… only international body that had correctly anticipated the global financial crisis (GFC) and warned of another great depression back in June 2007, when they released their 77th annual report (see Bank for International Settlements warns of another Great Depression).

The BIS is dubbed as the central banker of central banks. Its chief-economist, William White, whom we believe is from the Austrian School of economic thought, warned central bankers repeatedly of impending global financial disaster and implored them to re-think their strategy as early as 2003.

Greenspan and White stood at opposing sides. It seemed that Greenspan’s views held sway among the central bankers. He was dubbed as the “Maestro” and was celebrated as the world’s greatest central banker. No one in the world of central banking dared to openly criticised Greenspan, except for William White of the BIS. Since Greenspan was a member of the board of directors of the BIS, he was technically White’s superior. Greenspan had the upper hand until…

… until the GFC erupted and the financial world order came close to collapse in 2008. And so, Greenspan is dis-credited today. White’s theory gained ascendency. As this article reported,

The group of the 20 most important industrialized and emerging nations, which is now left with the task of cleaning up the wreckage of the crisis, apparently faces less academic problems. At the London G-20 summit in April, the group decided to promote a crisis-prevention model based on White’s theories.

They want to introduce what might be called his hoarding model, which calls for banks to build up reserves in good times so that they can be more flexible in bad times. The central banks, according to White, must actively counteract bubbles and exert stronger control over the financial industry, including hedge funds and insurance companies.

As an adviser to German Chancellor Angela Merkel’s group of experts, White helped to shape the basic tenets of the new order. And the 79th annual report of the BIS, published in Basel last week, also reads like pure White. It lists, as the causes of the crisis, extensive global imbalances, a lengthy phase of low real interest rates, distorted incentive systems and underestimated risks. In addition to improved regulation, the BIS argues that “asset prices and credit growth must be more directly integrated into monetary policy frameworks.”

What does this imply for investors?

It means that any investments and investment strategy that depends on ever rising asset prices to work will no longer work in this new global financial order. To put it bluntly, in this new financial order, the Reserve Bank of Australia (RBA) will not let property prices balloon as it did over the past 10 years. As the RBA governor Glenn Stevens said (as reported in this Bloomberg article),

 Australian central bank Governor Glenn Stevens said policy makers must be cautious about cutting interest rates too far because that may encourage some borrowers into debt they can?t afford.

?It is the intention of current monetary policy settings to lower debt-servicing costs, assist efforts to reduce leverage and support demand,? Stevens told a conference in Townsville, Australia, today. ?It would be counterproductive, though, if further reductions in interest rates induced a large number of marginal borrowers into debts they could service only at unusually low interest rates.?

This is just an example of a sea-change in thinking among central bankers.

Jimmy Rogers: ‘Abolish the Fed’

Sunday, March 16th, 2008

Recently, one of our readers, alerted us to a video interview of Jimmy Rogers at CNBC. He was the contrarian who was famously right on the commodity bull market several years ago. That interview was conducted a few days ago, after the 400+ point rise in the Dow Jones after the Fed announced a US$200 billion liquidity injection and for the first time, lend Treasury bonds in exchange for mortgage bonds. Both Jimmy Rogers and Marc Faber (see Marc Faber: Bernanke Policy Will ?Destroy? U.S. Dollar) are contrarians who are influenced by the Austrian School of economic thought. However, both of them differ in style. Marc Faber is more of the intellectual/philosopher style whereas Jimmy Rogers is more of the straight-talking street-smart style.

Jimmy Rogers’ first reaction to the 400+ point rise was,

You see what it did to the stock market. You see what it did to your friends at Wall Street. But it is not good for America. It is not good for the 300 million Americans. It is not good for the world. This man Bernanke goes from bad to worse.

Jimmy Rogers was asked, why was a 400+ point rise not good for American? Basically, the reason was because of the huge amount of money being injected into the financial system, which will eventually result in inflation, depreciating dollar and ultimately cause a worse recession. We agree with Jimmy Rogers, as we said before in November 2006 at How will asset-driven ?growth? eventually harm the economy?,

Indeed, as we mentioned in our previous article, The Bubble Economy, this is exactly what the Federal Reserve is currently doing to the US economy. In 2001, when the US economy was faced with a threat of recession, the Federal Reserve embarked on an expansionary monetary policy (aka ?printing money?) in an attempt to prevent it from happening. We believe this policy does not prevent a recession?it merely postpones it, in which the upcoming one will be more severe instead.

Even if Bernanke succeeded in ‘preventing’ a recession by re-inflating the economy with another bubble, it will set the stage for an even bigger recession in the future.

As Jimmy Rogers said, by collecting mortgage bonds in exchange for Treasury bonds, the Fed is getting involved in a “landlord business,” by collecting ‘rents.’ Are they going to get involved in a car loan and credit card business next? What the Fed did was akin to ‘printing’ money, which was what they did in the 1970s. Then Paul Volcker came to crush inflation with crippling high interest rates (see Peering into the soul of Ben Bernanke for a mention of Paul Volcker).

Jimmy Rogers is still bullish on the commodities, no matter what happen to the dollar. With the monetary printing press running at full speed, it will exacerbate the commodity price inflation even more. Jimmy Rogers reckoned that Japan made the same mistake (by cutting interest rates to zero) and “18 years later, they are still trying to solve the problem.” As pointed out by one of the interviewers, the Fed did not technically ‘print’ money by lending Treasuries in exchange for mortgage bonds.

So, Jimmy Rogers was asked, what will he do if he is in Bernanke’s shoe?

I would abolish the Federal Reserve and resign.

That provoked some laughter. He was asked, how would that help the 300 million Americans?

We wouldn’t have anybody printing money. We don’t have inflation in the land. We don’t have a collapsing US dollar. We will start to have a sound currency again. And we start to get rid of inflation. Inflation is not good for the world. No country in the world has succeeded by debasing its currency. That’s what this man is trying to do. He is trying to debase the currency as a way to revive America. It has never worked in the long term.

However, Jimmy Rogers was asked for a “real solution” to solve the current problem. His response was this:

What is so wrong about a recession? It can cost you more to prevent a recession than have a recession… Recessions are good. They clean out the excesses and [we] start out from a sound foundation and then you go again. It is like a forest fire… nature invented forest fires to clean out the undergrowth so that the forest can then revive and grow from a sounder foundation.

We agree with Jimmy Rogers on this (see What causes economic booms and busts?).

Regardless of a recession, how can an investor make money out of this market? Jimmy Rogers’ recommendation is to “buy agriculture” where investors are going to profit in 2, 3 or 5 years. By “agriculture,” he meant agricultural commodities like cotton, wheat, sugar and so on. He specifically favoured commodities themselves more than stocks of commodity producing businesses. The Chinese Yuan, Japanese Yen and Swiss Franc are his favourite currencies. Shorting investment bank is another possibility.

But wouldn’t shorting investment banks deepen the rot in the financial system?

Jimmy Roger’s reply is:

Wait a minute! Why is it the end of the world if an investment bank goes bankrupt? … If you bail out every investment banks, that is not capitalism- that is socialism for the rich. Why should two or three hundred million Americans suffer so that we can bail out two or three investment banks?

What about more or better regulations on the investment banks?

More regulations? You want Alan Greenspan and Ben Bernanke? These are the guys who got us into this situation. They are supposed to be regulating the banking system for the past 50 years. These are the guys who let it all happen. I don’t want more regulations. Let the market regulate it. If xyz needs to go bankrupt, let them go bankrupt. I promise you, that will send a very straight signal and you will have a lot of self-regulation when these guys start to go bankrupt.

Regulations will not solve the problem. Instead, it will introduce more problems.

When it comes to China, what about their inflation problems? To Jimmy Rogers, at least the Chinese government is more honest about their inflation problem. The American government, on the other hand, is denying that they have an inflation problem. Thus, the EU, Chinese, Norwegian and Australian central banks are doing a better job. Ben Bernanke, on the other hand, is “pouring gasoline into the fire.”

At this point, the interview was cut off.

Will the US dollar collapse?

Tuesday, December 12th, 2006

As we mentioned in The ABCs of hedging, the first step in hedging our investments is to subject our portfolio to ?war-games,? where we work out how it may perform under various economic what-if scenarios and come up with strategies to counter the unfavourable outcomes.

Today, we look at one possible scenario?the decline (or collapse) of the US dollar.

Lately, we are again hearing that central bankers are murmuring about diversifying their foreign reserves away from the US dollar. Does it mean that there is an imminent liquidation of their US dollar reserves? Well, this is not the first time they murmured about it and it is definitely not in their (including the Federal Reserve?s) interest to see a collapse of the US dollar. The Chinese, with their US$1 trillion of reserves, would not want to see their stockpile of US dollars to lose significant value. The same goes for the Japanese and the oil-rich Middle-Eastern nations. The US too, would not want to see their dollar collapse as that would result in soaring inflation in their homeland. Therefore, we do not expect mass selling of US currency reserves by central bankers in the near term.

On the other hand, it is open knowledge that the status quo is unsustainable. This morning, we heard that Alan Greenspan (the former US head of Federal Reserve) warned investors in a business conference in Tel Aviv to expect a few years of dollar weakness. He further said that is imprudent to hold everything in one currency. This prompted a further slide of the US dollar against the Euro. The US has the dubious honour of having the world?s greatest trade deficit. If not for the fact that the US dollar is (maybe ?was? is the more appropriate word) the world?s reserve currency, the US would be consigned a banana republic long ago. The world cannot lend to the US indefinitely. Sooner or later, they will demand a pay back. The moment they decide that the US will not and is unable to repay its debt, what will happen to the US dollar? What will happen to the global financial system when that happens?

Thus, this situation is akin to an individual owning the bank money. If he owes the bank a million dollars, he is in trouble. But if he owes the bank a billion dollars, the bank is in trouble?if he goes bankrupt, a large portion of bank?s loan portfolio will be wiped out, rendering the bank insolvent. The US owes the rest of the world so much money that they cannot afford to let the US go ?bankrupt.? But the rest of the world knows that sooner or later, the US will go ?bankrupt.? (Of course, a country cannot be bankrupt in the same way as individuals do because there is always the option to print money to remain solvent. But the end result will be just as horrible?hyperinflation.) What can be done?

We are all living in a precarious situation. We shudder to think of the day when a black swan event happens. On that day, whoever owns gold will have a lot of friends.


How to secretly rob the people with monetary inflation?

Sunday, December 10th, 2006

Quite some time ago, we had learnt that Alan Greenspan, the former US head of the Federal Reserve, had a sign at his desk that said, ?The Buck Starts Here.? While we are not sure of the truth to this, we know that at the very least, the statement itself is true (and funny as well)?the Federal Reserve has the power to create US dollars out of thin air. Since the world is running on fiat currency system, this arrangement is an accepted order of things globally. While we are not pointing a finger at anyone, we cannot help but feel disturbed by the ethical implication of this arrangement.

Suppose someone of great counterfeiting skill forged a million dollars. Who is the first to benefit? Obviously the forger because he can now spend the fake money on whatever he likes. The shopkeeper who receives the forger?s fake money will benefit next as his income increases. As the fake money spread throughout the economy, the money will pass from hand to hand in the forms of incomes and expenditures, raising the prices of goods and services along the way. Who will suffer most? The last person who receives the fake money because by the time he does so, price would have already risen.

Now, let us look at the situation in Shanghai as an example?see our previous article, Cause of inflation: Shanghai bubble case study. (Please note that we are not pointing a finger at the Chinese authorities?this is a universal problem that applies to every country in the world.) Clearly, there are some people who unfairly benefit and some who loses out. When central banks print money, the commercial banks are usually the first in the queue to receive them. The next to receive the money will be the companies and businesses that receive the money in the form of loans through the fractional reserve banking system. As that money made its way into the various classes of assets (e.g. properties and stocks), there will be some who strike it ?rich? as they sell their assets at inflated prices. As we said before in Speculative fervour in the Chinese stock market, the proliferation of ?success? stories of those who achieve their wealth through their ?investment? is testament to this phenomenon. Those who ?made? money will no doubt spend them, thus adding to the aggregate demand of the economy and bidding up prices. The end result is price inflation. Who are the last ones who will receive the money? The common people on fixed salaries and who do not own any ?assets? will have to bear the brunt of price inflation. In Shanghai, the rural migrants are one of the most susceptible groups. What is the end result of this? A redistribution of wealth from the last ones in the queue to the first one in the queue! Usually, the latecomers are the most vulnerable members of society.

Thus, monetary inflation always brings about false illusions of prosperity in the beginning. In reality, if left unchecked and unrectified, will be harmful to society in the end.