“Yet, under the placid surface, there are disturbing trends: huge imbalances, disequilibria, risks -- call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it.
I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change
So I think we are skating on increasingly thin ice. On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb markets, with damaging volatility in both exchange markets and interest rates. We had a taste of that in the stagflation of the 1970s -- a volatile and depressed dollar, inflationary pressures, a sudden increase in interest rates and a couple of big recessions.”
Paul Volker, Washington Post -- April 10, 2005
http://www.washingtonpost.com/wp-dyn/articles/A38725-2005Apr8.html
“The structure of our economy will doubtless change in the years ahead. In particular, our analysis of economic developments almost surely will need to deal in greater detail with balance sheet considerations than was the case in the earlier decades of the postwar period. The determination of global economic activity in recent years has been influenced importantly by capital gains on various types of assets, and the liabilities that finance them. Our forecasts and hence policy are becoming increasingly driven by asset price changes.
The steep rise in the ratio of household net worth to disposable income in the mid-1990s, after a half-century of stability, is a case in point. Although the ratio fell with the collapse of equity prices in 2000, it has rebounded noticeably over the past couple of years, reflecting the rise in the prices of equities and houses.
Whether the currently elevated level of the wealth-to-income ratio will be sustained in the longer run remains to be seen. But arguably, the growing stability of the world economy over the past decade may have encouraged investors to accept increasingly lower levels of compensation for risk. They are exhibiting a seeming willingness to project stability and commit over an ever more extended time horizon.
The lowered risk premiums--the apparent consequence of a long period of economic stability--coupled with greater productivity growth have propelled asset prices higher. The rising prices of stocks, bonds and, more recently, of homes, have engendered a large increase in the market value of claims which, when converted to cash, are a source of purchasing power. Financial intermediaries, of course, routinely convert capital gains in stocks, bonds, and homes into cash for businesses and households to facilitate purchase transactions. The conversions have been markedly facilitated by the financial innovation that has greatly reduced the cost of such transactions.
Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”
Alan Greenspan, Jackson Hole, Wyoming Aug 26, 2005
http://www.federalreserve.gov/boarddocs/speeches/2005/20050826/default.htm
These guys are talking about the same thing and the thing that I have been pounding my head against the wall about here on this Board-- really to no avail and at the cost of being viewed as a doom ‘n gloomer--since I first began posting last Christmas.
There are tremendous imbalances in the world economy at present which on the one hand have had the effect of firing up asset values all across the board but which on the other hand are unsustainable over the long run. Both Volker and Greenspan see the situation clearly enough. What is really, really of concern is that both of them see no likelihood of policy action to forestall a coming crisis. The crisis will be a crisis of “confidence”. Volker posits “an event or combination of events” as the trigger. Greenspan, in his much more nuanced and oblique way references “ any onset of increased investor caution” arising from …..what? Probably “an event or combination of events”.
Both men, and Donner, too, see market values today, including equities, bonds and real estate, as incorporating a greatly elevated degree of “confidence” or “animal spirits”.
I think Greenspan’s comments in particular are pretty chilling. You really should read his entire comments. Weeding through the Greenspan-speak, what he says, basically, is that: a) we really don’t know what the hell is going on; b) we have no effective simple monetary tools to deal with what we don’t know is going on; c) our most recent experience has shown that we can survive the financial collapse of markets (1987, Tech Stock Meltdown etc.) without experiencing undue adverse effects in the real economy; d) our job is not to pamper investors or the international financial community but to assure some balance between monetary stability (inflation) and unemployment in the “real economy”; e) we are mildly amused at investors willingness to swallow an amazing amount of risk without demanding risk premiums, BUT WE ARE NOT WORRIED ABOUT IT AND WE DO NOT PLAN TO DO A DAMN THING ABOUT IT; f) if we stay “flexible” enough we will be able to ride out the next surely coming crash in real estate, bond, equity, and exchange markets without too much damage to the real economy – too bad for those wacky investors who are going to get killed when “events or a combination of events” ultimately transpires; g) our job is to have enough bullets ready in the gun to deal with the aftermath of the surely coming financial and real estate market meltdown – i.e., don’t expect any halt in our “measured” pace of rate hikes any time soon; h) rest assured that we will rush to support the real economy with needed liquidity when the time comes after the next market collapse – that is our MO and it worked real well after the last couple of collapses.
Investors should take heed. I believe one of the reasons that risk premiums are so low right now is that many players, including the Chinese and Japanese central bankers, are convinced that the Fed will play the role of buyer of last resort when “an event or combination of events” occurs. That is, they believe that the Fed will enter the bond markets in a big way to prevent a collapse of prices as interest rates rise unchecked because of that durned “event or combination of events” that zaps “confidence” and “animal spirit” leading to escalating risk premiums and associated plummeting valuations in the markets. Reading Greenspan’s remarks I think you have to conclude THAT IS NOT THE PLAN AT THE FED. The plan is to pick up the pieces after the blood is spilt. Whose blood? Why that would include the Chinese, the Japanese, all those other foreign investors and, oh yes, all the ERs, ER Wannabes, Rs and R wannabes, like you and me, that’s who. And Mr. Greenspan, and his successor whoever that is going to be, won’t shed a single tear over what is going to happen to us. And the real economy is going to go merrily along its way. The problem of too much liquidity in the system will evaporate in a very rapid meltdown. One day it will be there, the next day it will be gone. Balance will be restored to the financial system – the hard way as far as investors are concerned but the easy way as far as the Fed is concerned. Consumers will continue to consume – the Fed will see to that. No recession. No depression. Inflation will be “well contained” and unemployment won’t budge an inch. GDP growth will be at a sustainable pace. Productivity – that golden nostrum for all that ails – will continue to improve. Corporate profits will continue to hit their “consensus” targets this quarter. All will be well in the real economy. All that will be missing is investors over-priced capital investments – gone to rising risk premiums. The best part of it is the Chinese and Japanese will be stuck with the bill, along with all those unfortunate domestic investors who have their retirement portfolios parked in over-priced long-term financial assets and real estate. I guess the Fed will just consider that as “collateral damage”, an unfortunate side effect of sticking it to the foreign investors and re-establishing balance here at home. Oh well, there’s always safety net programs like Social Security to take care of the casualties.
Now, I know, I know. The laptops are just heating up all over the place as many of you are leaping to be the first to condemn this post as the ranting of a crazed gloom ‘n doomer who has finally gone over the edge into total mental derangement. Save your breath. I am prepared for that and I am quite immune to it. I am posting this simply because I think there are some really good, honest, hard-working people reading these posts who may be in a quite vulnerable situation. Also, it’s raining here in DC on this Saturday morning and I can’t do any yardwork!
I know there are a lot of people here who are very put off by my lengthy posts. I apologize for that but it’s because these are very complex issues and I am not a good communicator. I wish I could articulate in the short, brilliant bursts which is so characteristic of this Board. But after some practice I must conclude that I am not very good at that. Sorry. 
Don’t take my word for this admittedly downbeat view of the future. Read Volker and Greenspan and come to your own conclusions. Folks, the handwriting is on the wall. Volker, Greenspan, Donner and others can read it quite clearly. I have advised my family and others to take measures to protect their hard earned savings. I, like Volker or Greenspan, cannot tell you when the “event or combination of events” is going to take place. It might be tomorrow, or next week, or next month, next year, or three years from now. But it is surely on the way. I agree wholeheartedly with Greenspan’s observation that “history has not dealt kindly with the aftermath of protracted periods of low risk premiums”. This is Greenspan’s own quirky and inimitable way of warning you to take cover.
There are those here that will advise riding the storm out. 4% SWR and FIRECALC and all that. A decline of 20% to 30% in the market value of their portfolio is no biggie to them. Think long term. Asset allocation will protect and immunize you. Modern Portfolio Theory-- diversify and hold through thick and thin. The market has never failed to reward those that have the faith to persevere through adversity. CONVENTIONAL WISDOM. That’s ok for some folks – young ERs and ER wannabe’s with a sizable portfolio cushion, a working spouse and the option of going back to **** with a long way to go in retirement and old farts praying for one more good year can afford to ride the wave of price volatility over a considerable period and come out whole at the end or dead, as the case may be. They have the legs to carry them through. God bless ‘em. But a 20% to 30% hit to the portfolio for someone like me at the brink of retirement with only a small cushion in the portfolio and lingering health issues precluding the likelihood or opportunity of returning to **** constitutes a very big biggie. It would put off my retirement, possibly for a long time. And I’m not sure I am going to be able to put off retirement for very much longer. As I have described in previous posts, I have a high and dry portfolio that is concentrated in cash and short to intermediate term Gov’t bonds that I believe will survive the coming acceleration of risk premiums in the market. So my retirement is going to remain on track “event or combination of events” , or, no “event or combination of events”, either way.
I realize I have used very strong language, perhaps shocking to some, to describe the problem as I see it. But I am not ranting. I realize my apocalyptic view is hard to swallow for many people given the benign nature of the economy and the markets right now. All is calm and the sunsets are beautiful. If you want the warm, fuzzy and optimistic take on growth and stability stretching out to the unbounded horizon check out any Lawrence Kudlow article or tune in to CNBC any afternoon. It’s there and it is well articulated based on the economic facts on the ground. Just keep this in mind – a good many people in the “finance industry” cannot and will not tell you what they really think. They would be fired and/or lose their client base, probably both. Wall Street and its professional flack class is compromised. They proved that in the 1990’s. You will never, never get the straight stuff from them. They are trying to make a buck and you can’t get rich in that business by urging caution. Don’t worry, be happy! is their permanent mantra.
Personally, I feel as prepared as I can possibly be, short of selling my residence and renting for a while, to weather the storm I see coming down the road. I feel no urgent need to convince anybody here of anything. As Wab put it in another thread –“you choose your valuation model and you takes your choice!” Couldn’t say it better myself. I am just trying to pass along my concerns honestly to the good people on this Board who I have come to view as friends for well over a year now – lurking and posting. So, read, think what you will, and act accordingly. Evaluate your own personal circumstances carefully. We are all different. One size does not fit all. What is good for the goose is not necessarily good for the gander. Try to avoid the “I’m right and you’re wrong!” yadda, yadda, yadda. Don’t let anybody here or at Fidelity or Vanguard or elsewhere lay their market ideology, philosophy, wishes, fears, hopes and fantasies on your particular situation. Not even me. Go in peace whether you agree with me or disagree violently.
But please don’t say you were never warned by Volker, Greenspan, and Donner, too!
Donner
I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change
So I think we are skating on increasingly thin ice. On the present trajectory, the deficits and imbalances will increase. At some point, the sense of confidence in capital markets that today so benignly supports the flow of funds to the United States and the growing world economy could fade. Then some event, or combination of events, could come along to disturb markets, with damaging volatility in both exchange markets and interest rates. We had a taste of that in the stagflation of the 1970s -- a volatile and depressed dollar, inflationary pressures, a sudden increase in interest rates and a couple of big recessions.”
Paul Volker, Washington Post -- April 10, 2005
http://www.washingtonpost.com/wp-dyn/articles/A38725-2005Apr8.html
“The structure of our economy will doubtless change in the years ahead. In particular, our analysis of economic developments almost surely will need to deal in greater detail with balance sheet considerations than was the case in the earlier decades of the postwar period. The determination of global economic activity in recent years has been influenced importantly by capital gains on various types of assets, and the liabilities that finance them. Our forecasts and hence policy are becoming increasingly driven by asset price changes.
The steep rise in the ratio of household net worth to disposable income in the mid-1990s, after a half-century of stability, is a case in point. Although the ratio fell with the collapse of equity prices in 2000, it has rebounded noticeably over the past couple of years, reflecting the rise in the prices of equities and houses.
Whether the currently elevated level of the wealth-to-income ratio will be sustained in the longer run remains to be seen. But arguably, the growing stability of the world economy over the past decade may have encouraged investors to accept increasingly lower levels of compensation for risk. They are exhibiting a seeming willingness to project stability and commit over an ever more extended time horizon.
The lowered risk premiums--the apparent consequence of a long period of economic stability--coupled with greater productivity growth have propelled asset prices higher. The rising prices of stocks, bonds and, more recently, of homes, have engendered a large increase in the market value of claims which, when converted to cash, are a source of purchasing power. Financial intermediaries, of course, routinely convert capital gains in stocks, bonds, and homes into cash for businesses and households to facilitate purchase transactions. The conversions have been markedly facilitated by the financial innovation that has greatly reduced the cost of such transactions.
Thus, this vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent. To some extent, those higher values may be reflecting the increased flexibility and resilience of our economy. But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low risk premiums.”
Alan Greenspan, Jackson Hole, Wyoming Aug 26, 2005
http://www.federalreserve.gov/boarddocs/speeches/2005/20050826/default.htm
These guys are talking about the same thing and the thing that I have been pounding my head against the wall about here on this Board-- really to no avail and at the cost of being viewed as a doom ‘n gloomer--since I first began posting last Christmas.
There are tremendous imbalances in the world economy at present which on the one hand have had the effect of firing up asset values all across the board but which on the other hand are unsustainable over the long run. Both Volker and Greenspan see the situation clearly enough. What is really, really of concern is that both of them see no likelihood of policy action to forestall a coming crisis. The crisis will be a crisis of “confidence”. Volker posits “an event or combination of events” as the trigger. Greenspan, in his much more nuanced and oblique way references “ any onset of increased investor caution” arising from …..what? Probably “an event or combination of events”.
Both men, and Donner, too, see market values today, including equities, bonds and real estate, as incorporating a greatly elevated degree of “confidence” or “animal spirits”.
I think Greenspan’s comments in particular are pretty chilling. You really should read his entire comments. Weeding through the Greenspan-speak, what he says, basically, is that: a) we really don’t know what the hell is going on; b) we have no effective simple monetary tools to deal with what we don’t know is going on; c) our most recent experience has shown that we can survive the financial collapse of markets (1987, Tech Stock Meltdown etc.) without experiencing undue adverse effects in the real economy; d) our job is not to pamper investors or the international financial community but to assure some balance between monetary stability (inflation) and unemployment in the “real economy”; e) we are mildly amused at investors willingness to swallow an amazing amount of risk without demanding risk premiums, BUT WE ARE NOT WORRIED ABOUT IT AND WE DO NOT PLAN TO DO A DAMN THING ABOUT IT; f) if we stay “flexible” enough we will be able to ride out the next surely coming crash in real estate, bond, equity, and exchange markets without too much damage to the real economy – too bad for those wacky investors who are going to get killed when “events or a combination of events” ultimately transpires; g) our job is to have enough bullets ready in the gun to deal with the aftermath of the surely coming financial and real estate market meltdown – i.e., don’t expect any halt in our “measured” pace of rate hikes any time soon; h) rest assured that we will rush to support the real economy with needed liquidity when the time comes after the next market collapse – that is our MO and it worked real well after the last couple of collapses.
Investors should take heed. I believe one of the reasons that risk premiums are so low right now is that many players, including the Chinese and Japanese central bankers, are convinced that the Fed will play the role of buyer of last resort when “an event or combination of events” occurs. That is, they believe that the Fed will enter the bond markets in a big way to prevent a collapse of prices as interest rates rise unchecked because of that durned “event or combination of events” that zaps “confidence” and “animal spirit” leading to escalating risk premiums and associated plummeting valuations in the markets. Reading Greenspan’s remarks I think you have to conclude THAT IS NOT THE PLAN AT THE FED. The plan is to pick up the pieces after the blood is spilt. Whose blood? Why that would include the Chinese, the Japanese, all those other foreign investors and, oh yes, all the ERs, ER Wannabes, Rs and R wannabes, like you and me, that’s who. And Mr. Greenspan, and his successor whoever that is going to be, won’t shed a single tear over what is going to happen to us. And the real economy is going to go merrily along its way. The problem of too much liquidity in the system will evaporate in a very rapid meltdown. One day it will be there, the next day it will be gone. Balance will be restored to the financial system – the hard way as far as investors are concerned but the easy way as far as the Fed is concerned. Consumers will continue to consume – the Fed will see to that. No recession. No depression. Inflation will be “well contained” and unemployment won’t budge an inch. GDP growth will be at a sustainable pace. Productivity – that golden nostrum for all that ails – will continue to improve. Corporate profits will continue to hit their “consensus” targets this quarter. All will be well in the real economy. All that will be missing is investors over-priced capital investments – gone to rising risk premiums. The best part of it is the Chinese and Japanese will be stuck with the bill, along with all those unfortunate domestic investors who have their retirement portfolios parked in over-priced long-term financial assets and real estate. I guess the Fed will just consider that as “collateral damage”, an unfortunate side effect of sticking it to the foreign investors and re-establishing balance here at home. Oh well, there’s always safety net programs like Social Security to take care of the casualties.
Now, I know, I know. The laptops are just heating up all over the place as many of you are leaping to be the first to condemn this post as the ranting of a crazed gloom ‘n doomer who has finally gone over the edge into total mental derangement. Save your breath. I am prepared for that and I am quite immune to it. I am posting this simply because I think there are some really good, honest, hard-working people reading these posts who may be in a quite vulnerable situation. Also, it’s raining here in DC on this Saturday morning and I can’t do any yardwork!
I know there are a lot of people here who are very put off by my lengthy posts. I apologize for that but it’s because these are very complex issues and I am not a good communicator. I wish I could articulate in the short, brilliant bursts which is so characteristic of this Board. But after some practice I must conclude that I am not very good at that. Sorry. Don’t take my word for this admittedly downbeat view of the future. Read Volker and Greenspan and come to your own conclusions. Folks, the handwriting is on the wall. Volker, Greenspan, Donner and others can read it quite clearly. I have advised my family and others to take measures to protect their hard earned savings. I, like Volker or Greenspan, cannot tell you when the “event or combination of events” is going to take place. It might be tomorrow, or next week, or next month, next year, or three years from now. But it is surely on the way. I agree wholeheartedly with Greenspan’s observation that “history has not dealt kindly with the aftermath of protracted periods of low risk premiums”. This is Greenspan’s own quirky and inimitable way of warning you to take cover.
There are those here that will advise riding the storm out. 4% SWR and FIRECALC and all that. A decline of 20% to 30% in the market value of their portfolio is no biggie to them. Think long term. Asset allocation will protect and immunize you. Modern Portfolio Theory-- diversify and hold through thick and thin. The market has never failed to reward those that have the faith to persevere through adversity. CONVENTIONAL WISDOM. That’s ok for some folks – young ERs and ER wannabe’s with a sizable portfolio cushion, a working spouse and the option of going back to **** with a long way to go in retirement and old farts praying for one more good year can afford to ride the wave of price volatility over a considerable period and come out whole at the end or dead, as the case may be. They have the legs to carry them through. God bless ‘em. But a 20% to 30% hit to the portfolio for someone like me at the brink of retirement with only a small cushion in the portfolio and lingering health issues precluding the likelihood or opportunity of returning to **** constitutes a very big biggie. It would put off my retirement, possibly for a long time. And I’m not sure I am going to be able to put off retirement for very much longer. As I have described in previous posts, I have a high and dry portfolio that is concentrated in cash and short to intermediate term Gov’t bonds that I believe will survive the coming acceleration of risk premiums in the market. So my retirement is going to remain on track “event or combination of events” , or, no “event or combination of events”, either way.
I realize I have used very strong language, perhaps shocking to some, to describe the problem as I see it. But I am not ranting. I realize my apocalyptic view is hard to swallow for many people given the benign nature of the economy and the markets right now. All is calm and the sunsets are beautiful. If you want the warm, fuzzy and optimistic take on growth and stability stretching out to the unbounded horizon check out any Lawrence Kudlow article or tune in to CNBC any afternoon. It’s there and it is well articulated based on the economic facts on the ground. Just keep this in mind – a good many people in the “finance industry” cannot and will not tell you what they really think. They would be fired and/or lose their client base, probably both. Wall Street and its professional flack class is compromised. They proved that in the 1990’s. You will never, never get the straight stuff from them. They are trying to make a buck and you can’t get rich in that business by urging caution. Don’t worry, be happy! is their permanent mantra.
Personally, I feel as prepared as I can possibly be, short of selling my residence and renting for a while, to weather the storm I see coming down the road. I feel no urgent need to convince anybody here of anything. As Wab put it in another thread –“you choose your valuation model and you takes your choice!” Couldn’t say it better myself. I am just trying to pass along my concerns honestly to the good people on this Board who I have come to view as friends for well over a year now – lurking and posting. So, read, think what you will, and act accordingly. Evaluate your own personal circumstances carefully. We are all different. One size does not fit all. What is good for the goose is not necessarily good for the gander. Try to avoid the “I’m right and you’re wrong!” yadda, yadda, yadda. Don’t let anybody here or at Fidelity or Vanguard or elsewhere lay their market ideology, philosophy, wishes, fears, hopes and fantasies on your particular situation. Not even me. Go in peace whether you agree with me or disagree violently.
But please don’t say you were never warned by Volker, Greenspan, and Donner, too!
Donner
