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– Towards Liberty –
A COMMENTARY ON CURRENT EVENTS
– by Jarret Wollstein –
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WHY A 2006 "GREENSPAN RECESSION"
IS LIKELY
And how to protect yourself.
– 01-23-06 –
"The United States can be likened to Rome before the fall of the empire. Its financial condition is 'worse
than advertised,' [Walker] says. It has a 'broken business model'. It faces deficits in its budgets, its balance of
payments, its savings – and its leadership." – USA Today , Nov 15, 2005
At the end of this coming January, Alan Greenspan will end his
18-year career as Chairman of the Federal Reserve.
Although widely praised, Greenspan actually leaves behind a very
troubled U.S. economy. Many believe that – directly as a result of his policies – the
U.S. could fall into recession by the end of 2006.
Greenspan's appointed successor – Ben Bernanke, the current
chairman of the Bush administration's council of economic advisors – has also been widely
praised as a well-qualified, experienced professional who will "stay the course" and successfully
navigate the economy between the menaces of recession and inflation.
Unfortunately, there is also much reason for concern about
Bernanke, and particularly whether he is really committed to sound monetary policy.
In this article, I'll examine Greenspan's legacy, look at what we
can expect from Bernanke, and – most importantly – explain what this all means for our
economy and your investments in 2006 and beyond.
But first a few words about the crucial importance of the Federal
Reserve.
THE HUGE IMPACT OF THE
FEDERAL RESERVE
Created in 1913, the Federal Reserve ("Fed") is the most powerful
financial institution in the world.
Its decisions have a direct impact on the purchasing power of the
dollar, the value of your bank account, the cost of operating a business, and U.S. stock and bond
markets.
Officially, the Federal Reserve is the central bank of the United
States. Technically, it is privately owned by its member banks, but it operates under a government
charter.
Although the Fed is supposed to be politically independent, in
reality, it is controlled by the President of the United States, who appoints its seven governors,
and by Congress, which must approve them.
Since its inception, the Fed has become increasingly politicized.
While Greenspan's predecessor, Paul Volcker, refused to meet with the President at the White House
because it would appear 'too political,' Greenspan has met with presidents dozens of times at the
White House.
What's wrong with a politicized Fed? The problem is that the
political objectives of the White House and sound monetary policy are often in conflict. So a
politicized Fed can and has done enormous harm to our monetary system.
AN ENGINE OF INFLATION
The major role of the Fed is to regulate the U.S. money supply
and interest rates.
In general, the greater the money supply and the lower the
interest rates, the more money is available for spending and investment as well as growth and
economic activity.
There are three ways that the Fed controls the money supply:
#1. Purchasing U.S. government securities with money created
out of thin air. Typically, the Fed buys securities from its regional banks, who in turn purchase
securities from other banks throughout the country. The more the Fed buys, the larger the money
supply and the higher monetary inflation.
#2. Setting the discount rate – the interest rate that
the Fed charges on loans it makes to banks. The lower the discount rate, the more money banks have
available to lend out, and – generally – the lower the interest rate on borrowing
throughout the economy.
#3. Setting the reserve requirement, the proportion of money
deposited that banks must keep on hand and not lend out. The higher the reserve requirement, the
less funds banks have to lend and the higher the interest rates on loans.
By its very nature, the Federal Reserve (like other central banks
around the world) is biased in favor of inflation. Indeed, since the last gold backing for the
dollar was removed in 1971 under the Nixon administration, there is no limit to how much the Fed
could inflate the dollar – which is now a currency backed by nothing but faith in the U.S.
government.
The Feds' ability to manipulate the money supply and inflation is
limited by many factors outside of their control, including U.S. and global demand for money,
consumer spending, and savings.
When the Fed miscalculates and creates too much or little money,
or sets the interest rate too high or too low, the result has been severe economic problems. As
economist Anna J. Schwartz explains:
"The United States has experienced three major price inflations
since 1914, and each has been preceded and accompanied by a corresponding increase in the rate of
growth of the money supply: 1914 to 1920, 1939 to 1948, 1967 to 1980."
"Since 1914 an actual decline of the money supply has occurred
during only three business cycle contractions, each of which was severe as judged by the decline in
the output and rise in unemployment: 1920 to 1921, 1929 to 1933 [the Great Depression], 1937 to
1938.
"The severity of the economic decline in each of these cyclical
downturns, it is widely accepted, was a consequence of the reduction in the quantity of money,
particularly so for the downturn that began in 1929, when the quantity of money fell by one-third."
(Anna Schwartz,"Money Supply," The Concise Encyclopedia of Economics).
Millions of people throughout the world were financially harmed or
even ruined by these huge mistakes by the Fed. Now, as you are about to see, we could well be the
verge of another major recession.
GREENSPAN AND THE FED
Although Alan Greenspan has been widely praised for his "wise"
stewardship of the Fed, his 18-year tenure as chairman has actually been a period of great economic
turmoil and problems including . . .
- The stock market bubble of the 1990s
- the 2001 dot-com crash
- the 2002 telecom crash
- a major recession in 2002-2004 (no doubt made worse by 9/11)
- the current housing bubble
Look at the impact of just one of these events: Between March 2000 and
March 2001, the NASDAQ declined nearly 80 percent in value, and the DOW declined nearly 25 percent, wiping
out $4.6 trillion in value, according to Business Week (3-26-01).
One of Greenspan's most notable "accomplishments" has been to
massively inflate the U.S. money supply.
Since Greenspan became chairman of the Fed in August 1987, he has
expanded the U.S. money supply by over $5 trillion – more in 18 years than during the
previous 90 years.
This enormous sum of money, created out of thin air, resulted in
huge price increases in two areas:
- the stock market (particularly the tech-heavy NASDAQ) and,
- urban real estate.
In March 2000 – just before the 1990's stock bubble burst –
some NASDAQ stocks were selling for hundreds of times earnings.
During the same period, real estate prices in parts of New York
and San Francisco went up more than 500 percent in seven years – one of the biggest inflationary
bubbles in U.S. history, thanks at least in part, to Alan Greenspan's Fed.
Another problem with the massive inflation created by the Fed has
been the destruction of the value of savings, which in turn has sparked enormous debt.
"Under Greenspan, the U.S. has gone from the world's
largest creditor nation to the world's largest debtor nation."
Why save when your money will be worth much less a few years from
now?
Under Greenspan, the U.S. has gone from the world's largest
creditor nation to the world's largest debtor nation. Indeed, the main pillar
propping up U.S. growth is the huge influx of money invested by foreigners, particularly by Chinese
and Japanese central banks.
The $64 billion question is: "What happens when foreigners stop
propping up the dollar?"
Unfortunately, we will soon know the answer, because that has
already started to happen, with foreign investment slightly down for 2005.
THE REAL GREENSPAN CONUNDRUM
When Greenspan realized a few years ago that soaring deficits and
the artificially-low interest rates he had fostered for political reasons, were creating
unsustainable, and potentially catastrophic financial bubbles, he had no choice but to increase
interest rates in an attempt to head off out-of-control inflation.
But the Federal Reserve faces a seemingly intractable dilemma:
If the Fed stops raising interest rates, the dollar will quickly resume its fall, aggravating
inflation and further discouraging savings and both domestic and foreign investment. That in turn
will lower economic growth and ultimately cause living standards of millions of Americans to
decline.
However, if the Fed continues to increase interest rates,
that will make nearly everything you buy more expensive, including food, energy, cars, etc. That
will curtail consumer spending (which constitute 2/3 of our entire economy).
Higher interest rates on mortgages, credit cards and other
expenditures could put millions of consumers – who are living paycheck-to-paycheck – at
risk of bankruptcy.
So no matter what the Fed does now, it is difficult to see how
recession can be avoided in 2006 or 2007. We may well see the return of '70s-style "stagflation"
– simultaneous inflation and recession.
The only "good news" is for Greenspan. Since his term ends this
coming January 31st, 2006, his successor – not Greenspan himself – will get blamed for
the recession.
WILL BERNANKE DO BETTER?
Greenspan's successor, Ben Bernanke, has promised to continue
Greenspan's policies and "stay the course." But that's hardly good news. How will "staying the
course" solve America's very serious economic problems caused by that very course?
As Bill Bonner of Agora Financial explains: We are
"neck-deep in the foul brine of excess debt, depleted savings and bubble-like asset prices. And yet
Ben Bernanke wishes to emulate these same reckless policies that created this mess."
In fact, we can expect even more monetary inflation under Bernanke
than we had under Greenspan.
Bernanke is an ardent fan of inflation, who once joked that one
way to make sure people have enough money to spend is to print it up and throw it out of
helicopters.
As The Daily Reckoning explains . . .
"[Bernanke] is the guy who said we control the printing presses and we will run them as fast as
we have to. He's the guy who says it doesn't matter if the United States has the biggest trade
deficit ever."
This doesn't bode well for an economy already reeling under
massive monetary inflation and debt.
Further, unlike Greenspan, who didn't have the arrogance to think
he could micromanage the finances of 280 million Americans, Bernanke has declared his intention to
"fine tune" the entire monetary system.
That could include "propping up the stock market," financed by
– you guessed it – even more monetary inflation and debt.
While Bernanke can't be blamed for Greenspan's inflationary
policies, he can be blamed for promising to continue and expand them. This is opposite of what we
should be doing.
Rather than "staying the course" – which is headed straight
for a massive inflationary recession – we need to reverse that course, end monetary inflation,
and gradually raise interest rates to market levels.
While that would undoubtedly cause pain in the short term, it is
the only way to avert a massive inflationary recession, which could wipe out all savings and even
the dollar itself.
FINANCIAL DANGERS AHEAD IN 2006
In our next issue, we will provide an in-depth look at what we expect will
happen in the U.S. economy and investment markets in 2006. Here, in brief, is a summary.
In 2006 we expect . . . :
- interest rates to increase 30% to 50% (including 7% mortgage rates),
- the "official" rate of inflation to top 6% (and the real rate to be 12% or higher),
- housing prices to decline in many bubble markets, at least in inflation-adjusted dollars, if not in absolute
dollars,
- equity markets to fall at least 5%,
- foreign investment in the U.S. to sharply decrease,
- commodity prices to soar to new, record highs, and
- gold to break $570 an ounce.
SURVIVING THE COMING GREENSPAN RECESSION
Cut expenses to the bone. Unless you are independently wealthy, you will soon find yourself caught
between sharply rising prices and stagnant or falling income.
Gasoline prices are up over 80% during the past year. Heating oil and
natural gas prices are expected to be up 50%+ nationwide this winter.
High oil prices also mean higher prices for virtually everything you buy
this winter. Cutting expenses is going to be a matter of economic survival for most families.
If you own a property in a bubble market, consider selling. With prices already starting to fall, you
can maximize your profits by selling now.
There is no reason to sell your primary residence if you can afford
payments and other expenses, and don't plan to move soon. However, to maximize your profits, you
need to sell soon.
At best, another round of monetary inflation will delay the housing
bust by a year or two. However, since this is unpredictable a crash could occur at
any time.
Stay out of most stocks. Rising interest rates, inflation and taxes, coupled with falling consumer
spending will cause many stocks to plummet.
Particularly avoid stocks connected with homebuilders, such as Toll
Brothers and Pulte, and bank and S&L stocks, which will fall when the home market goes south.
Stocks most likely to buck the trend are commodity stocks, excellent
mining stocks, and premier tech stocks. However, even in the case of these stocks, you need to sell
quickly if they experience an unexpected downturn.
Keep 50% of your spare dollars in cash, cash-equivalents, and precious metals.
That includes CDs, precious metals, and strong foreign currencies, like the Swiss franc and New
Zealand dollar.
We expect precious metals to rise sharply next year. Gold recently
broke $520 an ounce, and platinum broke $1,000. Look for much higher prices as inflation heats up.
You can set up foreign-currency checking and CD accounts at many major
banks, including Everbank in Florida, www.everbank.com
Diversify your investments outside the U.S. especially into Asian stocks (other than China) and
Latin American stocks.
Although a "Greenspan recession" now seems inevitable in 2006 or 2007,
by taking prudent action you can still protect yourself and emerge from the recession, more wealthy and secure than
before.
To view back issues of Jarret Wollstein's Towards Liberty, Click here.
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