Frederick Sheehan is the author of Panderer to Power: The Untold Story of How Alan Greenspan Enriched Wall Street and Left a Legacy of Recession (McGraw-Hill, 2009).
"China in Midst of 'Greatest Bubble in History'", Bloomberg told readers on March 17, 2010. That was the opinion of certain experts interviewed by the news service. One expert held the opposite view: "'People making comments about bubbles possibly don't have all the facts,' HSBC Holdings Plc Chief Executive Officer Michael Georghegan said in Shanghai today. Regulators are in control of the banking industry, and have the ability to curb lending as needed, he said."
Aside from the bubble question (which the experts answered), it is the rationale behind Georghegan's chipper comment that deserves attention. "Regulators are in control" seems low on the list to assure clientele. Even though Georghegan is persuaded, investors should be skeptical. What follows is a review of instances when trusted regulators were a good reason to panic.
On September 4, 1929, Roger Babson advised a gathering in Wellesley, Massachusetts to "pay up their loans and avoid margin speculation at this time because a 'crash' of the stock market was inevitable." This was the New York Times summary in its September 6 edition under the headline "Babson Predicts 'Crash' in Stocks."
Forever known as the "Babson Break," stocks fell 3% after the ticker relayed Babson's warning. This was two days after the Dow Jones Industrial Average peaked at 381, which would remain the top until 1954. The Times quoted the most celebrated economist of the time, Irving Fisher: "Stock prices are not too high and Wall Street will not experience anything in the nature of a crash." The persistence of celebrated economists to miss monumental shifts is, or should be, expected.
Alexander D. Noyes, sometimes called the "dean of American financial journalism," cautioned Times' readers that Babson's counsel might be outdated. There are "numerous other considerations now which must nowadays modify ideas about the future. One is the power and protective resources of the Federal Reserve."
There were some inside the Fed who thought differently. In 1928, Carl Snyder of the New York Fed wrote: "Owing to the abundance of credit, in excess of what appears to be about the maximum possible growth of trade, there came a heavy expansion of bank investment.... [P]artly in consequence of the abundant credit, [we have seen what] appears to be the greatest building boom which this country has known in 60 years..."
By the fall of 1929, plans were or had been drawn for five buildings ranging in height from 80 to 150 stories in New York. The "protective resources of the Fed" were no better (or worse) in 1929 than in 2008.
Investors are better off trusting their own judgment than the motivations of government authorities. In the same September 6, 1929, "Babson Break" edition of the Times, a column with the title "Action by Board Doubted" reported the "total of broker's loans by member banks of the Federal Reserve System took another jump... [to] a new peak of $6,354,000,000. Treasury officials indicated that they did not expect any radical step by the Federal Reserve Board at this time to curb the speculative movement."
This instance of an inflated stock market accompanied by a blank stare from the government is known, in contemporary parlance, as the "Greenspan Put," now superseded by the "Bernanke Put." Speculators, in 2010, as in 1929, must decide whether the "power and protective resources of the Federal Reserve" have put a floor on the stock market's price even though it was (and is) floating on borrowed money.
Such calculations aside, there was another story in the Times' "Babson Break" issue that warned the mind of the market was that of the village idiot. The article, "Brokerage Office Set Up On Pebble Beach Golf Course," reported: "Golf enthusiasts who are following the course of the national amateur championship at Pebble Beach, Cal., may watch the stock market while keeping up with the play. A temporary brokerage office, housed in a tent...has been established by the firm of E.F. Hutton & Co.... The temporary office has had a lively bit of business from the crowd following the players and from some of the players, too, many of whom are ardent followers of market quotations."
In 1966, when the Federal Reserve was ceding monetary policy to the Johnson administration, the business editor of the New York Times calmed readers: "Luckily, the Government has the ability and the wisdom not to let inflation break into a gallop as has happened recently in other countries." The inflation rate was 3.3% at the time and rose to 6.1% in 1969. The Times, in its high-minded trust of Washington, did not stoop to consider the authorities might be looking after their own interests. Secretary of Defense Robert McNamara was lying about the financial burden of Vietnam, where the troops deployed were to double (from 184,000) in 1966. The Johnson administration would not consider a major tax increase and the budget deficit rose from $1 billion in 1965 to $25 billion in 1968.
As every schoolchild knows, political independence of the Federal Reserve does not include its unstated mandate to plug Treasury deficits. In late 1965, Federal Reserve Chairman William McChesney Martin had told the Federal Reserve Open Market Committee "I cannot believe that all periods of prosperity float on constantly rising levels of credit or that one can ignore credit quality." Martin's intentions may have been parsimonious, but McNamara's War demanded expansion. Bank credit rose at a 7.2% rate in December 1965 and by 15% in April 1966. At Martin's 1970 White House farewell dinner, he told the assembled: "We are in the wildest inflation since the Civil War."
As goes inflation, so go bonds. Americans who trusted the "ability and wisdom" of the Federal Reserve were scarred. In 1969, Institutional Investor published a front cover story, "The Death of Bonds." Prices of long-term Treasuries fell 14% from the end of 1966 to 1969. Stock investors wished they hadn't. After rising for 17 years, the Dow Jones Industrial Average reached a peak of 995 on February 9, 1966. The Dow was 777 on August 12, 1982. These numbers do not reflect inflation's toll on purchasing power. Consumer prices tripled over the 16-year period.
This brings us to the present and to a regular columnist in the New York Times, Greg Mankiw, professor of Economics at Harvard University, past chairman of President George W. Bush's Counsel of Economic Advisers, and so on. On December 23, 2007, Mankiw outdid Irving Fisher: "The truth is the current Fed governors, together with their crack staff of Ph.D. economists and market analysts, are as close to an economic dream team, as we are ever likely to see.... The best Congress can do now is to let the Bernanke bunch do its job."
The Federal Reserve governors had spent 2007 in a daze; 2008 would show their policy was to panic, overreact to meltdowns the Fed had fostered, and disguise their market manipulations.
Anti-authoritarianism is often simple common sense. Returning to China, the country suffered one of the worst inflations of the twentieth century during the 1930s and 1940s. (In good measure, this was inflicted by the United States. See "America's Beggar-Thy-Neighbor Policy" under "Articles" on the Aucontrarian.com website.)
The Chinese press, controlled by Chinese Communists in 1949, blamed inflation on "Kuomintang agents" and "unscrupulous speculators." (It never changes.) Prices for necessities - rice, bean oil, firewood, soap - were rising daily when the Communists demanded trade be conducted in the new People's Bank note. In June 1949, a New York Times correspondent spoke to a merchant in Nanking who would not touch the paper currency: "Communist currency may be backed by rice, but you can't hold rice. It spoils. A gold bar is always a gold bar."
Frederick Sheehan writes a blog at www.aucontrarian.com