Sunday, February 24, 2013

Melloan: Asset bubble means we go through this again

George Melloan warns in the Wall Street Journal about the asset bubble created by the Fed:

We've learned a lot about asset inflation since that speech, but maybe not enough. The nearly 2,000-point rise in the Dow Jones Industrial Average since last June no doubt at least partly reflects asset inflation, since there has been very little in the economic or political outlook to justify it.

Midwest farmland prices were rising at a 13% annual rate last fall even after a summer of crippling drought. How could drought-stricken farms be gaining value so rapidly, other than through inflation generated by cheap credit? House prices also are climbing again in many areas, much as they were during the asset inflation of the 2000s. Those are the same houses that were on the down escalator not long ago. Call it "asset reflation."

Asset inflation often produces something called "wealth illusion," the belief that pricier asset holdings necessarily make one permanently richer. Illusions are dangerous. Eventually, painful reality intervenes.

We've been down this road before. Mr. Greenspan was cautioning himself as well as Wall Street in his AEI speech when he said, "we should not underestimate, or become complacent about the complexity of interactions of asset markets and the economy." After nearly a decade on the job, he knew the uncertainties of managing a fiat currency. He also knew that tightening the money spigots in boom times required the courage to face the political outrage that invariably results.

Seven years later, Mr. Greenspan would fail to heed his own warning. Urged on by his soon-to-be successor, Ben Bernanke, Mr. Greenspan would hold interest rates down too long, setting off a mid-2000s credit binge that sent assets soaring, home prices in particular. Congress developed a blasé attitude toward huge budget deficits, simply because Fed policy made them easy to finance. State and local governments overleveraged themselves. This was "irrational exuberance" indeed.

When the Fed finally tightened credit, the bubble burst, with a resulting stock-market crash, a vast wave of home foreclosures, public-sector pension funds in distress, and many state and municipal governments technically bankrupt. As Mr. Greenspan had feared, a crash in asset values did profound damage to the real economy. We are still living with it.

At least Chairman Greenspan understood the risks. It is not clear that Chairman Bernanke is aware that he has now set the Fed's asset-inflation machine on automatic pilot by promising near-zero interest rates well out into the future. The longer the policy continues, the greater the difficulty in climbing down from the debt mountain it is creating, particularly the rapidly rising national debt.

President Obama and Mr. Bernanke worsened the effects of the 2008 crash by adopting the same Keynesian antirecession measures—fiscal and monetary "stimulus"—that had failed before, most dramatically in the 1970s. Stanford economist and former Treasury official John Taylor recently argued persuasively on these pages that "stimulus" measures had retarded rather than speeded recovery.

Mr. Bernanke will have great difficulty letting go of the near-zero interest rate policy without severe consequences for both the Fed and the economy. The Fed's own economists recently warned that the Fed itself could lose as much as $100 billion on its vast portfolio when bond prices finally fall from their artificially elevated levels. Meanwhile, higher interest rates will cause the cost of financing government debt to skyrocket.

The Fed policy of quantitative easing is designed to rebuild the asset inflation edifice that collapsed in 2008. German banker and economist Kurt Richebächer provided some of the earliest warnings of the dangers. In his April 2005 newsletter, he wrote that "there is always one and the same cause of [asset inflation], and that is credit creation in excess of current saving leading to demand growth in excess of output."

The rising Dow is of course good news for savers, who have been forced into equities to try to find a decent return on investment. Thanks to Fed policy, "safe" 10-year Treasury bonds yield a near-zero or negative return, depending on whether you measure price inflation at the official rate or at higher private estimates.

Winners on stocks or land holdings should happily accept their gains as the best to be expected in a very unsettled financial environment. But they should also remember the 2000s, when so many people thought their newfound riches were real and cashed them in for yet more debt, such as home-equity loans.

They later had a rude awakening. The "wealth illusion" of asset inflation is seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction. Politicians smile in satisfaction and powerful Washington lobbies cry for more.

But an economy built on an illusion is hardly a sound structure. We may be doomed to learn that lesson once again before long.

Interesting letter to the editor in response to this column:


The next big bubble is growing right before our unseeing eyes: the bubble in Treasury debt. Unlike homes or farms, this "asset" can be produced from thin air by our which auctions it and the Federal Reserve which buys it. The Fed now holds $1.7 trillion in Treasury debt, comprising more than half its assets.  Holders of the other $9.9 trillion in Treasurys have been trained since infancy to consider this paper risk-free and super safe. They do not consider that settlement of these debts can be accomplished in only two ways: future taxes or currency devaluation. As Mr. Melloan alludes, the devaluation route has already been selected, though none dare speak its name.

What event might burst the Treasury bubble? A selloff by a major holder, a sudden spike in inflation, another federal fiscal crisis or an auction failure could trigger a Treasurys panic. The problem is that there's no place to which $9.9 trillion can quickly move. If the demand slackens, holders (including the Fed) will largely be stuck with the declining paper. The Fed could easily lose more than the $100 billion Mr. Melloan cites.

Steven Teeter

1 comment:

Anonymous said...

strong report and good points.



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Trollfest '07 was such a success that Jackson Jambalaya will once again host Trollfest '09. Catch this great event which will leave NE Jackson & Fondren in flames. Othor Cain and his band, The Black Power Structure headline the night while Sonjay Poontang returns for an encore performance. Former Frank Melton bodyguard Marcus Wright makes his premier appearance at Trollfest singing "I'm a Sweet Transvestite" from "The Rocky Horror Picture Show." Kamikaze will sing his new hit, “How I sold out to da Man.” Robbie Bell again performs: “Mamas, don't let your babies grow up to be Bells” and “Any friend of Ed Peters is a friend of mine”. After the show, Ms. Bell will autograph copies of her mug shot photos. In a salute to “Dancing with the Stars”, Ms. Bell and Hinds County District Attorney Robert Smith will dance the Wango Tango.

Wrestling returns, except this time it will be a Battle Royal with Othor Cain, Ben Allen, Kim Wade, Haley Fisackerly, Alan Lange, and “Big Cat” Donna Ladd all in the ring at the same time. The Battle Royal will be in a steel cage, no time limit, no referee, and the losers must leave town. Marshand Crisler will be the honorary referee (as it gives him a title without actually having to do anything).


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Donna Ladd of The Jackson Free Press will give several classes on learning how to write. Smearing, writing without factchecking, and reporting only one side of a story will be covered. A donation to pay their taxes will be accepted and she will be signing copies of their former federal tax liens. Ms. Ladd will give a dramatic reading of her two award-winning essays (They received The Jackson Free Press "Best Of" awards.) "Why everything is always about me" and "Why I cover murders better than anyone else in Jackson".

In the spirit of helping those who are less fortunate, Trollfest '09 adopts a cause for which a portion of the proceeds and donations will be donated: Keeping Frank Melton in his home. The “Keep Frank Melton From Being Homeless” booth will sell chances for five dollars to pin the tail on the jackass. John Reeves has graciously volunteered to be the jackass for this honorable excursion into saving Frank's ass. What's an ass between two friends after all? If Mr. Reeves is unable to um, perform, Speaker Billy McCoy has also volunteered as when the word “jackass” was mentioned he immediately ran as fast as he could to sign up.


In order to help clean up the legal profession, Adam Kilgore of the Mississippi Bar will be giving away free, round-trip plane tickets to the North Pole where they keep their bar complaint forms (which are NOT available online). If you don't want to go to the North Pole, you can enjoy Brant Brantley's (of the Mississippi Commission on Judicial Performance) free guided tours of the quicksand field over by High Street where all complaints against judges disappear. If for some reason you are unable to control yourself, never fear; Judge Houston Patton will operate his jail where no lawyers are needed or allowed as you just sit there for minutes... hours.... months...years until he decides he is tired of you sitting in his jail. Do not think Judge Patton is a bad judge however as he plans to serve free Mad Dog 20/20 to all inmates.

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Relax at the Fox News Tent. Since there are only three blonde reporters in Jackson (being blonde is a requirement for working at Fox News), Megan and Kathryn from WAPT and Wendy from WLBT will be on loan to Fox. To gain admittance to the VIP section, bring either your Republican Party ID card or a Rebel Flag. Bringing both and a torn-up Obama yard sign will entitle you to free drinks served by Megan, Wendy, and Kathryn. Get your tickets now. Since this is an event for trolls, no ID is required. Just bring the hate. Bring the family, Trollfest '09 is for EVERYONE!!!

This is definitely a Beaver production.


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Jackson Jambalaya is the home of Trollfest '07. Catch this great event which promises to leave NE Jackson & Fondren in flames. Sonjay Poontang and his band headline the night with a special steel cage, no time limit "loser must leave town" bout between Alan Lange and "Big Cat"Donna Ladd following afterwards. Kamikaze will perform his new song F*** Bush, he's still a _____. Did I mention there was no referee? Dr. Heddy Matthias and Lori Gregory will face off in the undercard dueling with dangling participles and other um, devices. Robbie Bell will perform Her two latest songs: My Best Friends are in the Media and Mama's, Don't Let Your Babies Grow up to be George Bell. Sid Salter of The Clarion-Ledger will host "Pin the Tail on the Trial Lawyer", sponsored by State Farm.

There will be a hugging booth where in exchange for your young son, Frank Melton will give you a loooong hug. Trollfest will have a dunking booth where Muhammed the terrorist will curse you to Allah as you try to hit a target that will drop him into a vat of pig grease. However, in the true spirit of Separate But Equal, Don Imus and someone from NE Jackson will also sit in the dunking booth for an equal amount of time. Tom Head will give a reading for two hours on why he can't figure out who the hell he is. Cliff Cargill will give lessons with his .80 caliber desert eagle, using Frank Melton photos as targets. Tackleberry will be on hand for an autograph session. KIM Waaaaaade will be passing out free titles and deeds to crackhouses formerly owned by The Wood Street Players.

If you get tired come relax at the Fox News Tent. To gain admittance to the VIP section, bring either your Republican Party ID card or a Rebel Flag. Bringing both will entitle you to free drinks.Get your tickets now. Since this is an event for trolls, no ID is required, just bring the hate. Bring the family, Trollfest '07 is for EVERYONE!!!

This is definitely a Beaver production.

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