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Posted 7/21/2003
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What the Fed really wants: more inflation
Fed Chairman Greenspan's testimony before Congress last week signals that the Fed would prefer we head to a new era of rising prices.
By Bill Fleckenstein
A cloud of obfuscation has always hung over our Fed chairman's oratory. It's not that Alan Greenspan can't speak in "for-two-cents-plain." It's that clarity does not serve his purpose. Hiding behind rhetoric, he has deflected the criticism of those who would question his infallibility. In this week's Contrarian Chronicles, we'll dissect that rhetoric to expose a "maestro" of manipulation, not monetary policy.
All hail the price-to-tone ratio
Last week, folks cheered the arrival of a new yardstick in tech land. New-era types like to use the word "metric" to calibrate how businesses are doing. That's because those businesses they talk about don't have such mundane things as earnings. That's why a hue and cry went out to buy Applied Materials (AMAT, news, msgs) last Tuesday, because the "tone" of its presentation at the Semicon West conference that day came across as better. So, you can expect to see a new "metric" for arm-waving stocks, the price-to-tone ratio.
Alan G. went up the Hill; bonds came tumbling after
Away from stocks, the hue and cry out of bond land last Tuesday was a one-syllable "sell," on the back of Greenspan's fool-on-the-Hill testimony (much more about this in a second). As to what precipitated the selling, there are two interpretations. Bulls will ascribe it to an improvement in the economy, noted by Easy Al. But that also points up a comment I was making recently in my daily column, that the Fed was in a box. It was in trouble either way: If the economy started to come back and bonds got hit, that would impinge on housing, hurting the economy. If the economy didn't come back, it goes without saying that this would be bad.
Meanwhile, the bearish interpretation is that folks who had leveraged themselves on fixed income -- financial institutions, hedge funds and believers in Fed Governor Ben Bernanke's "put" (i.e., his remark a few months back about how the Fed could just crank out the printing press as needed) -- have been trapped for a while now. Greenspans testimony, for whatever reason, tipped the boat over, and we had an accident. Either way, my conclusion is that the "refi" bid in the economy is now history. There's not going to be a capital-expenditures pickup. The economy is soon to be hitting on fewer cylinders. Of course, it will do even worse when the stock market decides to re-tank.
Last Tuesday was an important day in fixed-income land because it put an exclamation point on the fact that the bond market had previously exhausted itself. Folks who wonder how markets can go down when everything looks so rosy should consider the recent 10-point drop in the bond market. Once people have made their bets, and particularly if they've done so in a leveraged fashion, anything can take the market down, and it's damned difficult to put Humpty-Dumpty back together again.
2, 4, 6, 8, whaddya do? Accommodate:
Now on to the innards of Greenspan's testimony. Because I am tired of reprising the utter drivel of this man, I had not planned to discuss his speech this week. I changed my mind after reading what he had to say, which just blew me away. Early on, he was predictable enough: "The FOMC stands prepared to maintain a highly accommodative stance of policy for as long as it's needed to promote satisfactory economic performance." Of course, satisfactory economic performance is to be determined by Greenspan -- who can't distinguish a bubble from a bust.
From there, he hinted at what was to come: "Policy accommodation aimed at raising the growth of output, boosting the utilization of resources, and warding off unwelcome disinflation (my emphasis) can be maintained for a considerable period without ultimately stoking inflationary pressures." Translation: The Fed is so good, it can not only tell the difference between these two, but can make sure that we get only welcome disinflation, not unwelcome disinflation.
We can peg inflation
Or, said differently, if disinflation, i.e., the lowering of the inflation rate, is unwelcome, the Fed will somehow magically pick the right level of inflation (though Greenspan chose to keep us in the dark as to whether that's 2%, 3%, 4% or 5%, or clue us in on how he came by his powers of omniscience). So, he has basically dropped the pretense of the Fed's deflation-preventing crusade to expose its true colors -- the desire for more inflation. (Of course, what the Fed really wants is asset inflation and more speculation.)
Toward the very end of his speech, when praising the Fed for bringing down the rate of inflation, Greenspan let the cat out of the bag completely: "We face new challenges in maintaining price stability, specifically to prevent inflation from falling too low (the emphasis is mine)." Read that again. It's a seminal event in the history of that great inflation machine, the Fed. Let the record show the Fed believes its goal is not maintaining price stability but rather making sure inflation runs at a high-enough rate. To repeat, the Fed now deems itself capable of picking the right rate and engineering things perfectly to that level.
An ode to indebtedness
Oh, but there's more. Greenspan went on to crow about welcome speculation (vs. the unwelcome kind) in the financial markets, giving a tip of the hat to what's been happening in bonds and junk bonds: "Moreover, strong inflows to corporate bond funds, particularly those specializing in speculative-grade securities, have provided further evidence of a renewed appetite for risk-taking among retail investors." So Gordon Gekko had it wrong. It's not "greed is good" but "speculation is good." Or, in the parlance I've invented for this week, "welcome" speculation is good.
Speculation, of course, led him to opine on the housing market: "Households have been able to extract home equity by drawing on home equity loan lines, by realizing capital gains through the sale of existing homes, and by extracting cash as part of the refinancing of existing mortgages." Once again, he recognizes that we've got all this leveraging up in housing, and that, too, is welcome in his book.
Why no capital spending? The boss is scared
Shifting to the slump in capital spending (a fly in the ointment of his little scenario), he turned to a rather novel concept to explain the problem away: "But as yet there is little evidence that the more accommodative financial environment has materially improved the willingness of top executives to increase capital investment. Corporate executives and boards of directors are seemingly unclear, in the wake of the recent intense focus on corporate behavior, about how an increase in risk-taking on their part would be viewed by shareholders and regulators (the emphasis is mine)."
Well there you go, folks. Capital expenditures are being held back by regulatory concerns, and/or by chieftains' concern about alienating their shareholders. These are the same guys who grant themselves stock-option packages across the board and don't give a damn about what the shareholders say -- and now Greenspan is using that as an excuse? Anyone with a basic understanding of economic history knows that capital expenditures are not picking up because we had the biggest bubble in the history of the world. In the aftermath of a bubble, as history has shown, capital expenditures usually remain pretty soft for a decade, because it takes that much time for the prior misallocation of capital to be purged.
Inflation-indexed incompetence
But no matter. Blind to his prior errors, Greenspan ended by reaffirming his commitment early in the speech: "The FOMC stands ready to maintain a highly accommodative stance of policy for as long as it takes to achieve a return to satisfactory economic performance." He has demonstrated for years that he cannot judge what "satisfactory" is. He lurches from crisis to crisis borne of his own incompetence, making them bigger each time.
Despite my outrage at his wrecking of the economy and the financial system, I am glad of one thing: Greenspan has finally made it crystal-clear that the Fed's goal is to be an engine of inflation. Since it was a successful engine of inflation even when it claimed that it wasn't, we can only guess at what the inflation rate's going to look like in the future.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column for TheStreet.com's RealMoney. At the time of publication, he held short positions in Applied Materials and Intel and long positions on put options for Intel. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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