The Great Deformation (67 page)

Nor was the Microsoft mispricing an isolated error. None of the great free market creations of the 1990s technology revolution escaped the
mania. Intel's dominance of advanced semiconductors and microprocessors stood shoulder to shoulder with Microsoft's accomplishment in software. Intel's powerful technology edge was reflected in the massive growth of sales and profits it recorded during the span between 1990 and 2000: annual revenues grew from $4 billion to $34 billion, and its net income climbed at a 32 percent annual rate to $10.5 billion.

Yet the Greenspan bull market capitalized these sterling business results as if they were the financial equivalent of the second coming. Intel's stock price rose seventy-five-fold during the course of the decade, and in no small part because its PE multiple reached 48X earnings by the time of the 2000 peak. Consequently, its market cap soared to $500 billion, compared to only $10 billion in 1990, once again showering punters with previously unimaginable windfall gains.

Needless to say, this half-trillion-dollar gain on the stock of an already large and maturing company was unimaginable by the lights of prior history. Its 48X valuation implied that its net income would reach $100 billion by fiscal year 2010. In point of fact, Intel's net income in fiscal year 2010 was only $11.5 billion, meaning that during the decade after 2000 its earnings grew at only a 1 percent annual rate.

Two recessions, the rise of competition from Korea, Japan, and Taiwan, and the law of large numbers all played a role in bending Intel's financial performance toward the flat line after the turn of the century. In the process of economic reality setting in, Intel's $75 stock price cratered to $17 per share by the fall of 2000, thereby shrinking its market cap by about $400 billion.

THE $2.7 TRILLION BUBBLE THE MAESTRO COULDN'T SEE

At the time the thundering dot-com collapse was gathering momentum in April 2000, Chairman Greenspan would have none of it. Asked during a meeting of the Senate Finance Committee that month whether an interest rate increase would prick the stock market bubble, he responded: “That presupposes I know that there is a bubble … I don't think we can know there has been a bubble until after the fact. To assume we know it currently presupposes that we have the capacity to forecast an imminent decline in [stock] prices.”

Rarely have the words of a high official been so thoroughly mocked by the unfolding of real-world events. During the next eighteen months, the dozen highflyers of the stock market, mentioned above, experienced nearly a 75 percent average decline in shareholder value. This meant that $2.7 trillion of market cap vaporized just among these highly visible corporate majors. That staggering loss constituted the core of more than $7 trillion in market cap decline for the stock market as a whole.

Contrary to the maestro's Senate Finance Committee testimony, Greenspan and his monetary politburo did not need a crystal ball to spot the impending flameout. The mounting danger of a market crash was palpable, but the Fed obstinately refused to even assess the evidence that was plainly displayed in its rearview mirror.

The explosion in the market value of the highflyers had no historic precedent, not even during the stock mania of 1929. In fact, the parabolic rise in the market value of these big companies was just plain preposterous, and meant that a meltdown of historic proportions was waiting to happen.

Only forty months elapsed between the worried message of Greenspan's “irrational exuberance” speech and the unaccountable bubble blindness conveyed in his April 2000 testimony. During that period, the market cap of the dozen highflyers reviewed above grew from $600 billion to $3.8 trillion. In that ascent, the known laws of economic value creation were grossly violated.

There is simply no plausible circumstance on the free market in which the true value of giant companies like these can increase sixfold in such a brief interval. This outbreak of irrationality, therefore, was not merely a curiosity on the margin, nor was it a flash in the pan signifying nothing of lasting import. In fact, it was decisive evidence that the financial markets had been fundamentally unhinged by the Fed's continuous money printing and pandering.

The maestro might have reviewed the fate of these dozen highflyers before plunging into the lunacy of 1 percent interest rates and the housing bubble which followed. Needless to say, there was no reason to believe that $2.7 trillion of equity value could have just gotten “lost” on the free market.

The evidence as to its ultimate fate soon arrived and it was unequivocal: the big-cap highflyers at the very center of the first Greenspan stock market boom never experienced even a dead-cat bounce. Instead, they remained at their lows throughout the 2002–2006 period when the Greenspan Fed was busy transplanting bubble finance to neighborhood real estate markets throughout Main Street America.

In fact, as of twelve years later in 2012, four of these companies have disappeared and those which remain have a combined market cap of $850 billion. In the final reckoning their share prices did not grow to the sky; the market value accruing to shareholders of this legendary dozen highflyers has actually grown at only a 2.5 percent rate over the last sixteen years.

Neither the Greenspan Fed nor the mad money printers of the Bernanke era which followed ever leveled with the American public about the sobering truth evident in the saga of these highflyers; namely, that there is no such thing as effortless, instant riches on the free market.

THE PERVERSE UNTRUTH OF BUBBLE FINANCE:

HONEST SAVINGS ARE NOT NECESSARY

The Fed might have been better advised to dissect the bubble's deflation, not promote a new one. It would have found that the Greenspan stock market mania had led millions of investors to embrace the instant riches of stock market gambling, when the very paragons of that mania—the dozen highflyers—have produced only a 2.5 percent compound price appreciation over the last sixteen years.

Yet, instead of coming clean and embracing sound money policies which would have induced the American middle class to revert to frugal living and saving for retirement, the thrust of Fed policy since the dot-com crash has been to perpetuate the lie. Accordingly, the massive baby boom generation that desperately needed to save has remained enthralled to the financial delusions that the Greenspan Fed foisted on the public.

Unfortunately, this wrong-headed policy has not only made the Federal Reserve a hostage of Wall Street, but it also has warped and deformed the very foundation of the nation's economy. Having fostered a bull market culture of stock gamblers during the 1990s, the Fed simply broadened the casino's offerings after 2001 to include housing, real estate, and derivatives.

By so doing, it kept the party going for a spell, but in the process implanted the most pernicious possible error in the workings of the American economy; namely, the belief that savings out of current income is unnecessary and even counterproductive because higher savings would allegedly reduce consumption expenditures and the rate of GDP growth.

Under the Fed's new prosperity management régime, by contrast, the buildup of wealth did not require sacrifice or deferred consumption. Instead, it would be obtained from a perpetual windfall of capital gains arising from the financial casinos. In this manner, the historic laws of sound finance were mocked by the nation's central bank: households would grow steadily richer, even as they enjoyed the luxury of borrowing and consuming at rates far higher than the sustainable capacity of their incomes. The bull market culture had now totally deformed the free market.

CHAPTER 17

 

T
HE PERIOD BETWEEN GREENSPAN'S ARRIVAL AT THE FED IN 1987
and the dot-com crash in early 2000 brought a remarkable change in the finances of American households. Bubble finance supplanted the old-fashioned habits of savings and frugality. At the center of this transformation was the soaring value of household investments in stocks and mutual funds, which grew from just under $2 trillion to nearly $13 trillion during this time period.

There had never been a wealth gain anywhere close to this magnitude, even during the Roaring Twenties. And there was good reason for this: such massive leaps in wealth defy sustainable economics.

During the twelve years of the Greenspan stock market mania, for example, the value of stocks and mutual funds held by households grew at a 17.5 percent compound rate compared to an average nominal GDP growth rate of only 5.7 percent. Obviously, the implication that stock market wealth can grow permanently at three times the rate of national output growth is not plausible.

Common sense is enough basis to reject that proposition on its face. But a simple exercise in compound math surely underscores its absurdity. Household investments in stocks and mutual funds had amounted to about 40 percent of GDP in 1987, but had climbed to a record 130 percent by the bubble peak in 2000. Had stock valuations continued to rise at three times the growth of GDP for another twelve years, household stock and mutual fund investments would have reached nearly 500 percent of GDP.

Such extremes were never even remotely approached during the Japanese stock mania of 1989 or the Chinese moon shots of 2007. The Green-span Fed was thus heading down a blind alley, dragging Main Street straight into harm's way.

THE COST OF THE GREENSPAN STOCK BUBBLE:

DESTRUCTION OF MAIN STREET THRIFT

By the turn of the century, household finances were clearly on an unsustainable path. The Greenspan Fed's bubble finance deluded Main Street America into believing it was far wealthier than was actually the case, inducing households to radically reduce their savings out of current income. Indeed, the change in savings and spending behavior was so extreme that it is a key hallmark of the financial deformation emanating from the Greenspan Fed.

Between 1955 and 1980, the household savings rate fluctuated narrowly in a band between 7.5 percent and 10 percent of disposable personal income. On average, it posted a benchmark of about 8.5 percent over these two and a half decades. Even as late as 1986, the year before Greenspan took over the Fed, the savings rate had clocked in at the bottom of its historic range at 7.6 percent.

From the time that the Greenspan Fed embraced its régime of easy money and Wall Street pandering after Black Monday, however, the savings rate of American households dropped below its historic range and headed steadily downhill. By 1993 it slipped to 5.8 percent, followed by an even lower 4.6 percent rate in 1997. It then plunged to a never-before-recorded low of 2.5 percent during the six quarters ending in December 2001.

This headlong retreat from the historical norm for household savings could not have occurred at a worse time. By 2001, the first cohort of the giant baby boom generation was just a decade from retirement, and 75 million more boomers were queued up right behind it.

The clear and present danger, therefore, was that the bubble wealth stored in 401(k) and mutual fund accounts would prove to be illusory or could not be extended for another decade. In that event, the Greenspan Fed's drastic error of supplanting the thrift habit of the American people with central bank–manufactured bubble wealth would have grave implications for the long-term future of the American economy.

As it happened, the post-2000 collapse of the stock market bubble did not awaken Main Street America to the fact that it had been stranded high and dry by the Fed's bubble economics. The nation's monetary central planners refused to let financial reality break through, no matter how deep the hole resulting from the dot-com crash. And, in fact, the hole in household balance sheets was deep. By the end of 2002, the value of household investments in stocks and mutual funds had declined by 42 percent from the $13 trillion dot-com peak, and now stood at only $7.4 trillion.

This massive cratering of household wealth should have been a clarion call for drastic revival of thrift, since fully 50 percent of the 1987–2000
Greenspan bubble gain in stock and mutual fund holdings had been vaporized by the market correction. Yet after only a brief, anemic rebound to the 3–4 percent range, the savings rate cratered again, falling to virtually zero by the time of the 2008 financial crisis.

The reason was not mysterious. After the dot-com crash the Fed conducted what amounted to an extended Charlie Brown and Lucy gambit with the American public. Time after time, the public was tricked into believing that the Fed's latest and greatest new financial bubble obviated the need to curtail consumption and begin to save for a fast approaching era of baby boom retirement.

Consequently, the fundamental ailment of the American economy as it entered a new century—too much consumption and not enough savings—went unaddressed by the very central bank responsible for this condition. Moreover, the Fed's indifference with respect to the extended collapse of household savings was a signal to Wall Street that the low-interest-rate party could be extended indefinitely.

DO NOT BE TROUBLED: THE SAVINGS FUNCTION HAS BEEN OUTSOURCED TO CHINA

The American savings deficit was transparent after the turn of the century, but the Fed flat-out didn't care. As detailed in
chapter 15
, Greenspan and his monetary central planners had a glib answer: do not be troubled, they admonished, the Chinese have volunteered to handle America's savings function on an outsourced basis.