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Free Lunch: Myths of the Greenspan Era

Federal Reserve Chairman Greenspan’s imminent retirement has become the largest love-fest since Woodstock. Alas, we cannot avoid adding to the chatter. Besides, how many Fed Chairs will retire in our lifetimes? Perhaps we can act as a counter-ballast to all the accolades and bon mots. Now would be as good a time as any to discuss some of the myths and misunderstandings of the Alan Greenspan era:

Myth 1 Greenspan whipped inflation: This is the most pervasive-yet-easiest to disprove Fed Chair legend. As the nearby chart of long term interest rates reveals, inflation spiked in the late 1970s. Paul Volcker became Fed Chair during that period of ugly stagflation. He aggressively changed the way the Fed attacked inflation, and the U.S. has been enjoying the fruits of his labor ever since.

Myth 2 Greenspan’s flexibility met all challenges: Flexible? Hardly. The Fed Chair’s response to every challenge has been the same: inject more liquidity into the system. That’s why Money Supply has risen so dramatically over the past 18 years (M3 included), and why rates are down to unnaturally low levels. To be considered flexible, you would need more than one move in your bag of economic tricks.

Myth 3 The Plunge Protection Team: After the 1987 crash, traders claimed the market “mysteriously” managed to stop its sickening fall. While others have laid this myth to rest previously, let’s go right to the source of this one. The Dow had dropped from 2,400 to almost 2,200 on Friday, and then plummeted to almost 1,600 on Black Monday. A 33% peak-to-trough drop is no sign of an invisible hand: That’s a massive, capitulatory distribution which exhausts sellers. That correction brought out bottom-fishing fools and heroes alike – no Plunge Protection Team necessary.

Myth 4 The Greenspan Put: While the concept of the “Put” is alive and well, I do recall a recent 78% plunge in the Nasdaq. As of Big Al’s 2^nd to last day as Chairman, the Nasdaq was still down close to 60%. If that’s the kind of capital destruction that exists with the “Put,” its really not worth all that much. Indeed, the brutal crash makes it kinda hard to argue that the Put is – or ever was – alive and well.

Myth 5 Greenspan as Economic Sage: We laid this fable to rest in 2004 (Ignore the Cheerleader-in-Chief).

One has to wonder why so many acolytes believe you can get something for nothing. Yet Greenspan’s legacy is based on the Free Lunch: easy money, and lots of it. Yet I recall the very first lesson in Economics: “There is no Free Lunch.”

Much of the Greenspan myth is actually the result of his fortuitous timing: He started his gig as head honcho 5 years into the biggest Bull Market in history, and even before the crash, his reputation had been cemented.

Despite the saying, people still confuse a bull market with genius.

Monday, January 30, 2006 | 03:30 PM | Permalink | Comments (16) | TrackBack (1)
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Comments

Re Greespan put...........
It is not that there is in fact a put....the issues is that mkt perceives there to be one...this has created enourmous complacency, so when the risk aversion trade starts and the mkt realizes that there is no greespan put, it will be far worse than otherwise.

Posted by: pjfny | Jan 30, 2006 3:44:24 PM