It’s tough being a contrarian these days. All the investments I used to write about, in the happy knowledge that I would be the only one tipping them, have come over all mainstream. Only three years ago a fund manager told me that I was making a fool of myself persisting with “the gold thing.” Today everyone’s buying gold and everyone’s tipping it. The same can be said of silver, of base metals, of oil (we haven’t heard much from the back-to-$40-crowd recently), of Japan (which has made the cover of almost every investment magazine in the UK already this year) and this month even of soft commodities – a year ago no one knew what they were, now half the world appears to be spread betting on the sugar price.
On the plus side I am still hanging on to one opinion that puts me in something of a minority – the view that Alan Greenspan’s legacy to America, as he prepares for retirement at the end of this month, is a truly horrible one. Greenspan’s many fans say that in his 18 years at the helm of America’s Federal Reserve he has presided over a low inflation era of astonishing prosperity and stability. But is this really true?
The answer is that it depends how you look at it. Greenspan has prevented any huge crises actually taking place on his watch so for that you could applaud him. However what his preventative actions have also done is pretty much guarantee that a serious crisis will take place on his successor’s watch, something I’d say isn’t quite so praiseworthy.
The fact is that Greenspan’s polices over the last few decades have created vast and unsustainable imbalances in the economy. In response to every single problem – the 1987 crash, the collapse of LTCM, the tech crash of 2000 and the corporate scandals of the early part of this century – he has cut interest rates and kept cutting them.
But keeping rates this low – while it has averted obvious disaster – has had a nasty effect on the way the US economy sustains itself. Low interest rates mean more people borrow more money, and the Americans have been borrowing in some style.
Last year four out of ten new homebuyers in the US put down no deposit at all; in the last 18 years mortgage debt has jumped from $1.8trn to $8.2trn; consumer debt levels have quadrupled in the same time period; the average US credit card debt per family now stands at well over $8000; and last year the savings rate in the US actually turned negative. Government debt has soared at the same time – as Bill Bonner, author of Empire of Debt points out – more government debt will have been issued during the 8 years of the Bush administration than in the 200 years before that all put together.
All this debt has – as Alan Greenspan presumably intended – spurred asset prices and consumer spending upwards, something that has kept the economy moving ahead nicely in GDP growth terms (consumer spending has been the main driver behind the US economy for years now) and that has boosted asset prices to their current levels.
But no one can borrow and buy forever. Even Greenspan knows that. Last year he warned that periods such as this often end in tears: as soon as people get nervous, he said, risk premiums go up, asset values go down and debt is liquidated with major losses being made all round along the way.
So here’s the question: is anyone nervous yet? Well if they aren’t, they should be. The rate of growth in the US economy has slowed significantly, house prices are coming off the boil fast (in Southern California house sale volumes in December were their worst of 4 years and in San Francisco prices actually fell 2.6% between November and December), and, while most are still in denial about it, inflation is rising.
It may not show up in the final numbers, skewed as they are towards things that are falling in price, but let’s not forget that the costs of fuel, of heating, of services, of health care and of education are all rising fast (annual tuition costs at Princeton have just gone up by nearly 5% to $42,200 a year). Combined with the fact that real wages went down last year for the second year in a row, and it’s little wonder that much of America is feeling the pinch.
The number of bankruptcies in the US hit a record level last year and that was in a period of apparently splendid growth. Indeed according to Merrill Lynch’s misery index (which takes into account GDP growth rates and interest rates as well as budget and trade deficits) the US has the worst of the G7 economies.
It’s no good saying, as the bulls do, that all these imbalances have been with us for years and they haven’t caused crisis yet so they won’t now, because they will. The levelling out of house prices in particular spells very bad news indeed. Houses are far more widely owned than stocks, so a fall in house prices will hit consumption hard (as it already has in the UK), something that is very likely to cause an economic downturn which will in turn send corporate profits tumbling.
And corporate profits are vital to the health of the stock market: they soared last year but the market barely budged so what will happen to stocks when they stop rising or even fall?
Disaster may not come to the markets immediately of course – Greenspan’s successor Ben Bernanke has some room to do his own spot of rate-cutting if he feels the need – but I’m not sure that’s a risk I’d like to take with my money. I’m still steering well clear of American investments and I wouldn’t be surprised if Greenspan, as he heads off to a new world of $150,000 a pop after dinner speaking engagements, was too.
First published in The Sunday Times, 29/01/2006