So, what does the stumbling Chinese stock market have
to do with Greenspan?
Greenspan was the driving force behind deregulation
which 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 U.S. manufacturing plants are dismantled
and air-mailed 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 which 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 percent. 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 non traditional 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 today) which “fell by 16.6 percent, the most
since 1994” (Bloomberg) and you get 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 back-draft 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 stiff from their
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."
That 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 yesterday 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 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 more than 11 percent for the last six years ensuring that we will
eventually face a cycle of agonizing hyper-inflation.
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 BT 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.” (Wickipedia)
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 market to move back to more adequate risk
pricing and maybe forego 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’ve 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 United States where personal
and mortgage debt has increased by more than $7 trillion in
the last six years! This is not an issue that can be
resolved by a meager 10% 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.
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 400-point somersault is just the
first sign that Greenspan’s Goldilocks’ economy is
cracking at the seams.
LINK: Information Clearing House