In a recent interview with CNBC, former Federal Reserve Chairman Alan Greenspan indicated that the recent highs of the Dow Jones Industrial Average and its impressive 10-day performance were not indicative of “irrational exuberance.” However, shortly after his remarks, the Dow experienced a drop of 25 points, marking its first loss since March 1.
Reflecting on his past, during the late 1990s stock market bubble, Greenspan raised concerns about irrational exuberance on December 5, 1996. While addressing the American Enterprise Institute, he posed a critical question:
“How do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions, as they have in Japan over the past decade?”
Greenspan elaborated, stating, “We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs, and price stability. However, we should not underestimate or become complacent about the complexity of the interactions between asset markets and the economy. Consequently, assessing shifts in balance sheets and asset prices should be a crucial component of monetary policy development.”
Despite his reservations regarding rising stock prices back in 1996, Greenspan persisted in injecting liquidity into the financial system, resulting in the Dow soaring from 6,437 at the time of his speech to an astonishing peak of 11,722 by January 14, 2000.
Pushing the Envelope
In the wake of the stock market crash from 2000 to 2002, during which the Dow plummeted nearly 40 percent, Greenspan once again escalated money supply in the economy. This time, the influx of capital infiltrated not just the stock market but also the realms of real estate, oil, and gold. Following the 2008-09 financial crisis, the Federal Reserve’s expansionist policies continued under Ben Bernanke, who inherited the fallout from Greenspan’s earlier decisions.
To rectify this situation, Bernanke had to adopt even more aggressive tactics than Greenspan, adding $2.25 trillion to the Federal Reserve’s balance sheet and currently inflating at a staggering rate of over $1 trillion annually.
Had he still been in charge, Greenspan would have likely been horrified at the sheer scale of Bernanke’s intervention. Fortunately for Greenspan, he is no longer at the helm. However, much like his predecessor, Bernanke will leave an even greater dilemma for the next Fed Chairman, expected to be current Vice Chair Janet Yellen, who has shown a preference for even looser monetary policies. One can only speculate on the unconventional measures she may deploy to maintain stability.
In Cyprus, depositors are facing a “stability levy,” a move we hope does not set a precedent in the United States. However, in times of crisis, unexpected actions can become a reality.
Price Distortions and Risks Ahead
The pressing question remains: Can Bernanke postpone another stock market crash until he exits his position?
This may hinge on whether Greenspan’s assertion that the surge in stock prices is free from irrational exuberance holds true. It is also plausible that a stock market frenzy may prolong itself to lengths unimaginable to anyone with sound judgment and integrity. Time will ultimately reveal the outcomes.
For now, it’s clear that Bernanke is fully committed to sustaining inflated asset prices during his tenure. The present-day approach of the Federal Reserve appears less focused on recognizing the shifts in balance sheets and asset valuations, and more on perpetually inflating the balance sheet to drive asset prices higher.
Nonetheless, inflation is not an endless phenomenon; prices will eventually correct, revealing the distortions caused by Federal Reserve policies. Numerous financial landmines are already in place, including Ten-Year Treasuries yielding a mere 1.96 percent and a Dow nearing 14,500, with 70 percent of stocks bought on margin.
It is probable that further distortions will unfold before any corrections take place. We anticipate that the spectacle will be nothing short of extraordinary while it persists.
Sincerely,
MN Gordon
for Economic Prism
Return from On Price Distortions and Landmines to Economic Prism
