Greenspan Grumblings...

Complacency and the Rain Dance for Money

By: Richard Benson, SFGroup






September 16, 2004

One has to appreciate, in theory and in practice, Alan Greenspan’s genius, at least in the Machiavellian sense, and how it has been used in the financial markets to drive the real economy. Indeed, many notable economists, financial market participants and the press, are now acknowledging how the Fed has used asset bubbles in stocks, bonds, and housing to facilitate the continued household spending of borrowed money. This has created a false sense of wealth and has kept the economy rolling with no savings.

What is becoming crystal clear is that if the United States’ bond and stock markets suddenly “re-priced to fair value”, the world would witness a crash in stocks, bonds, housing prices and the dollar. This inevitable re-pricing, caused by unsustainable Treasury and Trade deficits, will be fiercely and politically delayed, at all costs, until after the November election. Also, the extent to which the Treasury and Fed can use legal but undisclosed Exchange Stabilization Policies is not widely understood by the financial markets.

More importantly, while the magnitude of aid – amounting to $1.3 Trillion – given to America’s financial markets by foreign central banks has been disclosed, it is not appreciated that these holdings will most likely keep US Treasury rates 3% lower than they would be if the Treasury needed to fund its deficits within the US.

Evidence of the government’s “active hands” in the markets continues to grow. First, there is the manipulation of the gold market that has been solidly documented but not widely disseminated in the press. Beginning under the Clinton Administration, the dollar has been made to look strong by holding down the price of gold. This legal and logical market manipulation has been accomplished by central bank gold sales and by lending gold to bullion banks that could, in turn, sell the gold to earn carry trade profits. You might wonder why our government is so actively involved in keeping the price of gold down. Well, a logical reason would be that when the price of gold takes off, even the investment masses will focus attention on the real problems of massive trade and federal deficits and world-wide money creation. For investors with a long-term view, the price of gold is being subsidized and held well below market. If you like government subsidies, you can get one by buying gold.

Second, evidence also appears in the stock market’s strange but predictable behavior. Whenever the markets look like they are about to crash, major buying suddenly appears at the regular scheduled times during the day to keep the stock indexes from breaking down below major psychological barriers. It always looks like a major player has stepped in with an unlimited checkbook. In reality, the checkbook is a printing press owned by the Fed that can flood the market with REPO funds, and allocate a few billion to have market agents buy stock futures to smooth the market out.

We do know that Greenspan understands and uses psychology to try and create a self-fulfilling prophecy when it comes to the markets. He understands that if he is telling the world one day that the economic recovery has “traction” and the next day the stock market goes south, any economic recovery would suddenly be history. So, what must the Fed hope for and encourage? From their perspective, the best thing would be for a massive stock market rally to occur in anticipation of a Bush re-election. However, with rising interest rates and a slowing economy - the peak having already passed in the corporate earnings cycle – a stock market rally is unlikely with stock and bond prices currently at record levels. So, the best outcome is boredom and complacency in the bond, stock, and currency markets. The key to engendering complacency is engineering low volatility - the Fed’s gift to the White House. With low volatility and high complacency, the stock market looks just as safe as an insured FDIC bank CD.

Keeping volatility low is neither difficult nor expensive. Now that there is no clear market trend, it will pay for major funds and banks to “sell volatility”. These institutions sell puts and calls, take in premiums, and hope that the options will expire “out of the money”. For experienced traders, it is no surprise that close to or on key expiration dates for options, market prices of the index the option is based on are temporarily brought into line so that as many options as possible expire worthless. Just like Las Vegas where small speculators take option bets, the markets spin and, surprise, they lose! (When it comes to “efficient market theory”, all that can be said is that the large financial institutions and commercial market players are very efficient at “skinning the small speculators.)

Finally, you might wonder where the really big market manipulation is. Simply look at the Federal Reserve’s Foreign Custodial Account. Since 2001, it has risen by $700 billion to $1.3 Trillion today. This is a record! All this money has been printed up out of thin air by foreign central banks to buy United States’ Treasury debt and support the dollar at a far higher level, and hold US longer term interest rates at a lower level than they would be without this direct and unprecedented market manipulation. (When it comes to central banks, the polite word for manipulation is intervention). This intervention, which holds the value of the dollar up and interest rates down, also makes bond and stock prices artificially high. In turn, artificially high asset prices encourage consumers to spend and not save. Indeed, with over $1,300 Billion of reported central bank intervention currency what does it matter if a few billion dollars spill over into the stock market?

From the perspective of a prudent investor who is interested in the preservation of capital, two choices seem obvious. The first choice is to use the foreign central bank intervention as a window to get out of US stocks, bonds and the dollar. The second choice is to study with Navajo Indians to learn the secrets of their “rain dance for money” and perform it for the foreign central banks. Hopefully, they will then keep printing up money to buy $300 - $400 billion of dollar assets forever. Perhaps complacency, as a long-term investment policy, is becoming over-rated.


-- Posted Thursday, September 16 2004


- Richard Benson, SFGroup, is a widely published author on securitization and specialty finance, and a sought after speaker at financing conferences on raising equity for mid-market companies.

Prior to founding the Specialty Finance Group in 1989, Mr. Benson acted as a trading desk economist for Chase Manhattan Bank in the early 1980's and started in the securitization business in 1983 at Bear Stearns, and helped build the early securitization businesses at Citibank and E.F. Hutton.

Mr. Benson graduated from the University of Wisconsin in 1970 in the Honors Program in Math, and did his doctoral work in Economics at Harvard University. Mr. Benson is a member of the Harvard Club of New York and Palm Beach.

The Specialty Finance Group, LLC is a Florida Limited Liability Company and is registered with the NASD/SIPC as a Broker/Dealer.