Tuesday, October 2, 2007

Greenspan Speaks, I Listen

Today Alan Greenspan made several interesting comments: He stressed that longer-term inflationary pressures are rising, that agricultural price increases are not a mere short-term anomaly and that the potential costs of making a mistake in monetary policy are going up. In other words, watch out all you central bankers, if you cut rates too much you may end up with a big structural inflation problem in your hands. (Yes, this means you too, Mr. Bernanke). He also mentioned that measuring CPI inflation ex-food and energy is becoming increasingly less valid, but anyone who has been going to the supermarket in the past 12 mos. already knew that. Perhaps now that he has a bit more free time he pays closer attention to milk and cookie prices.

All of this may just be a "phantom Fed" condition for the ex-Chairman, like the person with an amputated hand or leg still "feeling" the lost limb, but I don't think so. His one true professional love has always been forecasting and that's why he was, on the balance, a successful Fed Chairman: he actually paid much closer attention to real business conditions instead of solely relying on Wall Street. What he is doing right now is forecasting the economy and doing so publicly - and for free! (Well, it does sell books).

But, all of a sudden, though everyone is listening to what he is saying, no one is paying attention. Gone are the days when Fed watchers would hang on his every phrase and punctuation mark to fathom his "real" thoughts. For example, he keeps on stressing that the US economy has a more than 33% and under 50% probability of going into a recession soon and has even recently raised this probability from a central 33%. The reason, he claims, is that 15% of personal consumption is a direct function of the wealth effect created by higher real estate and equity prices, chiefly through home equity loans and second mortgages. Since the rate of growth in US household net worth is flattening out, consumption is going to be affected - thus his recession probability predictions.

So, here is a chart of what Mr. Greenspan is talking about viz. household net worth (click to enlarge). The last data point is the second quarter of 2007, which is running at an annualized inflation-adjusted growth rate of 3.8%, which would have been even lower had it not been for shares going higher. The corollary is that if household wealth continues weakening - and it certainly was hit hard in the third quarter that just ended - then consumer spending will suffer, i.e. a recession.

Data: Federal Reserve

You would think that markets should be pricing this into their forecast for corporate earnings and adjusting share prices and risky debt accordingly, but no such thing is happening. Indeed, something else entirely appears to be at work: namely, a concerted effort to salvage household net worth (and thus consumer spending and the whole economy) by pumping share prices higher to mitigate lower real estate values. Call it manipulation, propaganda, convincing foreign "friends" to intervene with their (our) dollars... whatever. But this I can say, coming from my "stomach" where at least two decades of daily professional market experience resides: the probability of something out of the ordinary going on is more than 50% and less than 100%.


  1. I disagree with all conspiracy theory. It is used only when we do not have any sounded argument. And I believe that nobody has the power to move Wall Street for more than 1 minute. Now I agree the behaviour of Wall Street is really strange considering the economic facts. But it looks to me that investors have applied their historical experience of similar events and have largely discounted the "historical future". these times, wall street has anticipated cut in rates and rallied. Further more wall street looks to have already "passed" the valley of the bad economical statistics. I am worried by the fact that markets have not tumbled as usual, so for investor optimism, so for valuations and we are back today to a level which could be followed by a traditional bear market - corection of 20 % as it happenned each times before a recession

  2. At the top in 2000, program trading comprised about 15% of market volume. Since the August 2007 lows, this number has now skyrocketed to over 90%.

    I have no idea if this is true or not, nor how to find out/verify it. But I have a hard time believing that it is retail 'investors' who are driving the indexes to these highs.


  3. The government keeps making people feel invincible and instead of trying to cool things down they keep trying to play GOD and encourage silly speculation. There commitment to intervene at any cost keeps this game going until it doesnt and when it stops the decline will be worse than last time.

  4. "...nobody has the power to move Wall Street for more than 1 minute." - miju

    These are the developments in the past 4-5 years.

    1. Derivativization. Means that a smaller "lever" can move markets much more than before. No need to spend tens of billions - particularly if 3-4 houses account for 80% of all equity/equity equivalent derivatives trades.

    2. Program trading now accounts for anywhere from 40-80% of total volume, depending on the definition of what constitutes "program trading". This is not hearsay, look it up in NYSE's site. It means that if you properly push the appropriate "buttons", you can force program trading by others.

    3. The yen carry is another lever that can be used as a trigger to precipitate action in markets.

    4. The marketplace is now dominated by 4-5 huge houses. Easy to reach and maintain gentlemens' agreements amongst themselves. Retail investors are completely absent.

    5. I have seen manipulation close and personal and I know what it looks like, i.e. I can recognise the footprints it leaves behind. Some - not all - are present here.


  5. re: program trading
    Info at NYSE's site


  6. Could it be as simple as the money has no where else to go? The amount of money being pulled from the money markets is astonishing. Where do you put it? If this was correct, as soon as you see the markets calm down, the stock market could fall like a stone.

  7. BTW, i finally figured out how to post and now that I have I want to commend you on this blog. It's brilliant.

    Thank you so very much for taking the time.

  8. Dear Mr. Hellasious:

    "the probability of something out of the ordinary going on is more than 50% and less than 100%."

    In order to stay true to the subject matter and to remain consistent with "The Maestro", and I too agree that he is was a brilliant Fed Chairperson, I would suggest to you the the probability is only less than 101%.

    No offence intended.... ;-)


  9. Hello,

    I am a daily reader of your blog, and enjoy your writing.

    >I have seen manipulation close and personal and I know what it looks like, i.e. I can recognise the footprints it leaves behind.

    Would you please write a blog on some of the footprints? As individual investors, we would like to learn how to recognize trouble.


  10. This is the most frightening piece of information that I have read to date.

    Look at this Bloomberg excerpt:

    More than 65 percent of investors in mortgage-backed securities are struggling to find bids for their holdings, according to a survey of 251 institutions last month by Greenwich Associates, a Greenwich, Connecticut-based consulting firm. Among holders of CDOs, the figure is 80 percent.


    There is maybe $6 trillion in mortgage-backed securities outstanding. 65% of that amount would be $4 trillion.

    There is maybe $1.5 trillion in CDOs outstanding. 80% of that amount would be $1.2 trillion.

    We are probably very close to reaching a situation where there would be NO BID on these securities.

    Can someone tell me how the world financial system could even function with NO BID on $5 trillion in securities stashed in financial institutions worldwide?


  11. Can this last?

    That is the most impt qn...

    I hope it does!

  12. I think your gut will prove to be right, as, despite the hoopla of rate cuts, stock market rallies and such, nothing but the surface of things has changed.

    The ability of the PTB to avoid the day of reckoning time and time again has been more than a little impressive, but we are now at the point where deck chairs are being rearranged on the Titanic. And when we look back a year from now, the true colors of the financial/economic canvas that has been wrought, dark colors all, will be undeniable and dominant.

    In the meantime, the deflation monster continues to make progress.

  13. This isn't a technically erudite comment; sorry in advance.

    My mother just retired as a teacher after almost 40 years. She pointed out that her starting salary fresh out of college could buy 1500 meals a month if she were stingy enough. My present salary is a lot bigger than that, numerically. I'm lucky if I can manage 900 meals a month of the same size and nutritional value even if I were very stingy - and I've been working some time at it.

  14. Hellasious:

    re: Manipulation...can you comment on China vis a vis the Olympics and whether betting nothing untoward in the markets will happen before they are over is reasonable.

    Are the Chinese complicit in whatever pumping might be going on right now. And no, I am not a China basher, just curious from your POV.

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