Last week's blog post highlighted three episodes from the Greenspan era at the Fed - the Tequila Crisis, the LTCM Crisis and the "Citigroup Relief Act." All three of these episodes reveal the Greenspan Fed's ceaseless zeal to support Wall Street in any and all ways it could. These three interventions directly correspond with the NASDAQ's unprecedented rise from approximately 750 at the time of the Tequila Crisis, (early 1995), to over 5,000 in March 2000 and the aftermath of the climax run clearly inspired by the Citigroup Relief Act of November 1999. Put in purely mathematical terms, the NASDAQ rose approximately 46% per year for five straight years; bacteria in a petri-dish doesn't grow this fast! It was madness and doomed to a spectacular collapse. As evidenced by the three episodes discussed last week, a chief architect of the mindlessly irrational speculation fueling the NASDAQ's run was Alan Greenspan and the Fed.
A similar theme will be reviewed this week and next. We will review the actions of both Alan Greenspan and Ben Bernanke, and review their ramifications. In particular, the circumstances surrounding two events will be discussed:
- Part I: Greenspan's Irrational Exuberance Speech (05 DEC 1996)
- Part II: Ben Bernanke and the Taper Tantrum (19 JUN 2013)
In both cases, the Fed chairman attempted to be the sober kill-joy William McChesney Martin claimed every Fed chairman should strive to be. However, in both cases the Fed chairman ignominiously failed. The failure in the first case, (Greenspan's), led to the collapse of an enormous bubble in tech stocks and a subsequent slashing of interest rates. The ultra-low rates then fueled the terminal stages of an even larger housing bubble, which ended in an even more spectacular collapse than the bubble experienced just eights years before in tech stocks. The failure in the second case, (Bernanke's), is now being played out in the markets. If past is prologue - and it often is in markets - then things could get very interesting from here.
The Irrational Exuberance Speech
Some context is required to fully understand how badly Alan Greenspan fumbled the ball in the wake of his December 1996 "irrational exuberance" speech. Because of the enormous gains seen in the stock market, the NASDAQ in particular, asset bubbles had been a major topic of discussion for many years at the Fed. For example, at the September 24, 1996 meeting of the Fed's Open Market Committee, FOMC, Lawrence Lindsay commented,
"Everyone enjoys an economic party, but the long-term costs of a bubble to economy and society are potentially great.....As in the US in the 1920s and Japan in the late 1980's, the case for a central bank ultimately to burst that bubble becomes overwhelming. I think it is far better that we do so while the bubble still resembles surface froth, and before the bubble carries the economy to stratospheric heights." (1)
Whether Lindsey's comments prompted a reaction from Greenspan is impossible for anyone to know except Greenspan. However, not long after the FOMC openly discussed the dangers with an asset bubble getting out of hand, Greenspan gave one of the most remarkable speeches in the history of central banking - "The Irrational Exuberance" speech of December 05, 1996. The speech was officially titled, "The Challenge of Central Banking in a Democratic Society" - and was given to the policy wonks at the American Enterprise Institute. Greenspan asked the important question,
"How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions, as they have in Japan over the past decade? And how do we factor that assessment into monetary policy? We as central bankers need not to be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability....But we should not underestimate or become complacent about the complexity of interactions of asset markets and the economy. Thus, evaluating shifts in balance sheets generally and in asset prices particularly, must be an integral part of the development of monetary policy. (2) (emphasis added)
The speech - which was long even by Greenspan standards - and doubtless came at the end of an evening full of drinking, probably at an open bar no less! Most likely, the by now slightly sauced policy wonks of the AEI didn't realize the financial world shifting under their feet as the speech was being made. However, the financial markets surely did! Asian markets feel by several percent just a few hours after the speech. When markets opened in the US, they tumbled as well. (The speech was given on a Tuesday.) See the chart above for details on the market sell-off - noticeable but hardly earth-shaking.
Financial markets were clearly not taking kindly to Greenspan's speech. However, these same markets had been rising so rapidly that in meetings the Fed was comparing the US economy to the bubble economies of the US in the 1920's and Japan in the 1980's. Clearly, if the market was going up for sound and legitimate reasons, then a single speech, even from a Fed chairman, couldn't keep the market from resuming its ascent. However, if the market was on the cusp of developing into a full-fledged, economy-altering mania, then perhaps it was wise for Alan Greenspan to invoke the "McChesney Martin" mindset and ask market participants to sober up - even if it cost Greenspan some of his by then enormous popularity.
Basically, it came down to a test of wills between the market - clamoring for more of the Greenspan that gave them the Tequila Crisis bailout - and Greenspan - trying to provide the sobering market influence that McChesney Martin considered the Fed's most important responsibility. As events would prove, in this test of wills Greenspan folded - like origami. Soon after the "irrational exuberance" speech, Greenspan was preaching all the unparalleled virtues of the "new economy." As just one example among many, in a October 1997 speech to the American Bankers Association, Greenspan claimed the US was "witnessing the substitution of ideas for physical matter in the creation of economic value - a shift from hardware to software as it were." (3)
The fact that a PhD economist and purportedly sober central banker could give a speech to a conference of supposedly conservative bankers, and claim that ideas, removed from physical production, were the most valuable assets in the economy proves just how widespread the tech bubble mindset of the late 1990s had become. This bubble mindset had not spontaneously developed; by 1997 Alan Greenspan had done much to engender it and, as events would subsequently prove, would do even more to inflame it - right up until the point it all came crashing down. (4)
Concluding Remarks and Looking Forward to Part II
In next week's blog post, the example provided by Ben Bernanke folding in the face of a market confrontation will be discussed. This was the so-called "taper tantrum" of June 2013. What happened in the wake of Greenspan's failure to follow-up on the ideas expressed in the irrational exuberance speech are a matter of record;
- The tech bubble continued to grow until it ultimately collapsed.
- The Greenspan Fed, this time ably assisted by Ben Bernanke, slashed rates.
- The low-rates, along with Bill Clinton's central plan for housing, then fueled an even larger bubble in housing.
- When this bubble collapsed, the world banking system was brought to its knees.
What will be the ramifications of Ben Bernanke wilting in the market's glare prompted by the taper tantrum, #25 in the chart above? I am in no position to know, but it is interesting to observe that the NASDAQ low in October 2002 corresponds to its level in December 1996 when Greenspan delivered his irrational exuberance speech!
20 JAN 2019
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(1) Minutes of the Federal Open Market Committee, September 24, 1996. (See page twenty-five of the fifty-six page transcript). https://fraser.stlouisfed.org/files/docs/historical/FOMC/meetingdocuments/FOMC19960924meeting.pdf
(2) The Challenge of Central Banking in a Democratic Society, Alan Greenspan, December 05, 1996 https://www.federalreserve.gov/boarddocs/speeches/1996/19961205.htm
(3) Remarks by Alan Greenspan, "Technological Change and the Economy," The Annual Convention of the American Bankers Association, Boston, MA, October 05, 1997 https://www.federalreserve.gov/boarddocs/speeches/1997/19971005.htm
(4) In a speech at Boston College, a full four days before the NASDAQ peak, Greenspan claimed that the capital spending boom was still going strong and saw "nothing to suggest that these opportunities (for capital investment) will peter out any time soon." Remarks by Alan Greenspan, "The Revolution in Information Technology," Boston College Conference on the New Economy, Boston, MA, March 6, 2000 https://www.federalreserve.gov/boarddocs/speeches/2000/20000306.htm