American economy: Crisis to crisis, bubble to bubble

By Lim Say Boon

SINGAPORE: Just about now, there is probably nobody higher on the finance industry's pantheon of tribal "gods" than Alan Greenspan.

But history may not remember him quite as fondly if (and when) the big-spending beast he has created to avoid recession in the U.S. returns with a massive bill.

"Crisis to crisis, bubble to bubble" -- that might as well be the chant of U.S. policy-makers as they stir their potion to head off each impending spell of trouble.

Yes, the U.S. Federal Reserve will "save the day" (well to be more accurate, it will probably save the year) by tolerating -- no, maybe even creating -- another bubble.

Indeed, the Fed arguably did its fair share to create that last bubble -- the Nasdaq/Internet wassail on Wall Street -- to ward off another potential Evil Day some years back.

Remember how the Fed wittingly or otherwise fueled a nice little equities bubble beginning in 1998 when it cut interest rates and helped to bail out hedge fund Long Term Capital Management (LTCM). More on it later.

Well, last week, Greenspan delivered another 50 basis-point cut in the Fed Funds rate -- the fifth cut in as many months, taking 250 basis points off the Fed Funds rate. And with that, he engineered another surge in the U.S. markets. Yes, you read it correctly -- the word was "engineered".

The Fed may hate the public thinking of it as intervening in and supporting the equities market. But let me make none too fine a point about it: The Fed needs the equities markets to respond to its ministrations.

With no apologies for simplification, the chain of events works something like this: If the Nasdaq and the Dow continue on the downward path established since the second quarter of last year, U.S. households will suffer further damage to their already significantly reduced net worth. That is, the U.S. economy will suffer massive negative "wealth effect". And that, in turn, will further depress consumer sentiment, which has already been weakening generally.

There must be particular anxiety within the Fed that consumers do not become too gloomy because they hold the key to the old economy, and indeed, the whole economy!

Yes, the old economy -- the car makers, the builders and the retailers. And the old economy, in turn, is what is standing between the U.S. economy and a deep Internet-driven recession.

You definitely will not see the new economy heroes of yesterday doing much to help anybody -- not even themselves.

Computer production has fallen for four months in a row now. And semiconductor output has gone from 120-percent growth during the second quarter of last year to contraction of nearly 9 percent in the first quarter of this year.

Indeed, it is the traditional industries such as motor-vehicle assemblies, oil-drilling equipment and defense hardware that have been propping up stumbling industrial-production figures.

Now, there is nothing wrong of course with the Fed pumping up the old economy sectors to compensate for the disinvestment taking place in the new economy. But it puts the U.S. economy at great risk of stumbling from crisis to crisis.

Indeed, it starts to make U.S. economic management look a bit more like frantic fire-fighting than anything resembling coherent long-term strategy.

Well, think about it. Let us go back to my earlier point about that whopper of a financial catastrophe involving LTCM. That was in the autumn of 1998 -- as the world was experiencing the aftershocks of the Asian financial crisis.

Never mind that the United States hardly lifted a finger to help Thailand or Indonesia -- that is, outside the Washington- influenced International Monetary Fund's damaging "raise interest rates" and "tighten your belts till you turn blue" prescriptions. But that is another story.

Anyway, when the crisis reached U.S. shores, the Fed helped organize a private sector bailout of LTCM. Of course, it helped the private sector boot the ball into the net by cutting interest rates three times (by a total of 75 basis points) in late 1998.

Hmmm, is it just coincidence, or didn't both the Dow and the Nasdaq look like they were running out of steam just around the autumn of 1998? Yes, they were -- look back at your charts.

Indeed, the Nasdaq had eased back to around the 1,500-point level just about then. And the Dow had dipped from over 9,000 points to around 7,500.

But one morally hazardous bailout and a few interest-rate cuts later, both the Dow and the Nasdaq took off like frenzied bovines in Spain's infamous annual Pamplona bull stampede.

Less than three quarters later, the Fed had started reversing and hiking rates to dampen the "irrational exuberance" that it at the very least supported, if not even helped create.

And let us not forget why this exuberance was not particularly healthy or rational to begin with.

It wasn't really that it was inflationary -- but that it was feeding off and feeding a dangerous cycle of over-investment and spending. And in the process, it was pushing the U.S. economy deeper and deeper into current-account deficit territory.

So now that this over-investment phase -- yes, the Internet/technology bubble -- is unwinding, the Fed is seeking to once again postpone the Evil Day of reckoning. Yes, by cutting rates further, and pumping up the equities markets some more. So, we come full circle.

And happily for U.S. policymakers, there are massive global imbalances currently that play nicely into their hands -- at least for now.

Asia is still in a deflationary mode, with heaps of excess savings. And the Japanese look ready to bite the bullet on reforms that have long been demanded of them by the international financial community. But that would mean further depressing demand and boosting savings.

Meanwhile, the world continues to look to the U.S. economy as the main driver for international economic growth. So, Greenspan is happily obliging, by cutting rates and keeping Americans spending beyond their means. And in the process, Asian savings will continue to be funneled into the United States to fund its current-account deficit.

Meanwhile, the U.S. stock markets will rally ahead of the economic recovery that I had been predicting will emerge in the second half of the year.

Yes, U.S. investors will enjoy this while they can -- that is, until the next self-perpetuated crisis.

The writer is Director of OCBC Investment Research Pte Ltd. The views expressed in this article are his own. He contributed this article to The Straits Times.

-- The Straits Times/Asia News Network