Your Economy (No Politics)

[Bullwinkle]

Five Years Later: Risks Still Worsening
Market Views of Comstock Partners, Inc.
Thursday, June 9, 2005


We recommend that everyone read today’s (June 9, 2005) front-page article in the Wall Street Journal called “Side Effects: In Treating U.S. After Bubble, Fed Helped Create New Threats”. The article summarizes in a lucid and readable manner all of the imbalances created by the Fed’s efforts to prevent a deep and damaging recession following the bursting of the late 1990s bubble. We consider it significant that the writer of the article, Greg Ip, is said to have good contacts at the Fed, which apparently has used him in the past to disseminate information that they wanted known. We have repeatedly discussed this topic in our comments over the past few years, but have long believed that the serious potential consequences were being overlooked by the mainstream media. Now it appears that the discussion is out in the open, that there is widespread agreement that the structural imbalances really do exist, and that Greenspan, as we have long suspected, knows this as well.

The main disagreement now is whether these imbalances can be resolved gradually without serious damage or whether the rebalancing will be highly destabilizing to the U.S. and global markets as we believe it will. At today’s Congressional hearing, one senator specifically asked the Chairman about the Journal article. Greenspan answered that the Fed, following the bursting of the bubble, deliberately initiated a policy of massive monetary ease in order to prevent a damaging long-term deflationary recession. He felt that by doing that, the imbalances would correct in a gradual manner without dire consequences. He stated that they expected some positive and some negative results and that these expectations, both positive and negative, have essentially been met, with the economy having recovered without any serious inflation. He added that if he had to do it over he would do the same thing again. Significantly, though, he threw in the caveat that the imbalances and risks still exist and that the final outcome is still not known.

As for Greenspan’s prepared statement for the congressional committee, the media focused mainly on the first paragraph indicating that the economy was doing well, while virtually ignoring the remainder of the statement, which was all about the risks, including the low consumer savings rate, the massive trade imbalance, high oil prices, the evidence of increasing pricing power, the rise in unit labor costs, the unusual drop in long-term yields, the signs of froth in local housing markets, and the dramatic increase in interest-only loans.

While Greenspan feels that the problems will gradually work themselves out, a lot of outside observers are not so sure. While disaster has so far been averted and the “Maestro’s” reputation is still intact, the risks that existed when the policy of massive ease was initiated have only gotten worse, and threaten to keep doing so. This was clearly not supposed to happen. The Fed’s policy of raising rates is intended to head off inflation and cool the housing market, but can easily throw the economy back into recession at a time when consumers are facing heavy debt burdens. In our view the severe problems that the Fed created when it originally let the 1990s boom get out of hand are now even worse than they were over four years ago when the Fed first began to implement its extreme easy monetary policy January 2001. We thought at the time that there was no easy way out, and we still feel the same way today.

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