Danger time for America

I just read an excellent article from The Economist, dated 12 Jan 2006. The author makes the assertion that our Alan Greenspan Economy is in a much less healthy state than popularly assumed.

Now in his final days as Fed Chairman and eager to pass the batton to the “Helicopter man”, Mr. Greenspan is currently receiving incessant praise for masterfully guiding our economy through the last 18 years—even during difficult times. The article then points out that these tributes are probably premature, as our past economic stability has come at a great cost… Alan's policies helped to create bubbles that he was unwilling to target, and he would feed them until they popped. He would then try to minimize the pain of the fallout by creating new bubbles that required the same fuel (low rates and liquidity). With that said, Mr. Greenspan has now created multiple coexisting bubbles and the largest economic imbalances in American history...

Here are a few snippets from the article:

“Mr Greenspan's departure could well mark a high point for America's economy, with a period of sluggish growth ahead. This is not so much because he is leaving, but because of what he is leaving behind: the biggest economic imbalances in American history.”

… “the Fed's policies of the past decade look like having painful long-term costs.”

“ But the main reason why America's growth has remained strong in recent years has been a massive monetary stimulus. The Fed held real interest rates negative for several years, and even today real rates remain low. Thanks to globalisation, new technology and that vaunted flexibility, which have all helped to reduce the prices of many goods, cheap money has not spilled into traditional inflation, but into rising asset prices instead—first equities and now housing. The Economist has long criticised Mr Greenspan for not trying to restrain the stockmarket bubble in the late 1990s, and then, after it burst, for inflating a housing bubble by holding interest rates low for so long (see article). The problem is not the rising asset prices themselves but rather their effect on the economy. By borrowing against capital gains on their homes, households have been able to consume more than they earn. Robust consumer spending has boosted GDP growth, but at the cost of a negative personal saving rate, a growing burden of household debt and a huge current-account deficit.”

“Part of America's current prosperity is based not on genuine gains in income, nor on high productivity growth, but on borrowing from the future. The words of Ludwig von Mises, an Austrian economist of the early 20th century, nicely sum up the illusion: “It may sometimes be expedient for a man to heat the stove with his furniture. But he should not delude himself by believing that he has discovered a wonderful new method of heating his premises.”

… “there is a limit to their willingness to keep accumulating dollar reserves. Chinese officials last week offered hints that they are looking eventually to diversify China's foreign-exchange reserves. Over the next couple of years the dollar is likely to fall and bond yields rise as investors demand higher compensation for risk.”

“When house-price rises flatten off, and therefore the room for further equity withdrawal dries up, consumer spending will stumble. Given that consumer spending and residential construction have accounted for 90% of GDP growth in recent years, it is hard to see how this can occur without a sharp slowdown in the economy.”