Alan Greenspan Conversation

 at Council on Foreign Relations 

 on Oct. 29, 2014

Alan Greenspan, former chairman of the US Federal Reserve, recently participated in a conversation at the Council on Foreign Relations with Gillian Tett of the Financial Times. Gillian Tett is an award-winning journalist at the Financial Times, where she is a markets and finance columnist and US managing editor. She holds a PhD in social anthropology from Cambridge.

The conversation took place shortly after the publication of Greenspan's latest book, The Map and the Territory 2.0: Risk, Human Nature, and the Future of Forecasting. 

The conversation almost coincided with the end of Federal Reserve's Quantitative Easing, an expansionary monetary policy that had been ongoing for 6 years.

In this article, I will cover the following topics:

• Alan Greenspan's comments

• Gillian Tett's thoughts

• My own excerpts from Greenspan's comments, which lead to presenting the following:
• QE's timeline
• Corporate profits as a baseline for judging the amount of QE 
• Greenspan's views quantified

Greenspan's comments

• Video
• Transcript

I recommend watching the video over reading the transcript because Greenspan speaks in ambiguous terms, so one loses less by listening to him than by reading. He himself admits in his comments that economists are good at "equivocating". 

Gillian Tett concluded the conversation with the following remarks.

"I take away three keys points, firstly, that the current state of the world is very unhealthy and unbalanced; secondly, that we're not going to be able to exit this without some form of turmoil or crisis, let's call it turmoil; and, thirdly, that Chairman Greenspan is trying to engage with these fundamental problems in a very refreshingly frank manner." 

Gillian Tett's thoughts

Gillian Tett then wrote an article in the Financial Times on Nov. 21, 2014 in which she provided the following synopsis ((alternative link):

"For what he [Greenspan] revealed on the CFR platform was that he harbours considerable doubts about whether recent western monetary policy experiments have actually helped economic growth. He also fears that such experiments have been so wild that it will be very hard to exit from these policies in the future – in the US or anywhere else – without sparking huge market volatility. Indeed, Greenspan is so worried about future turbulence that he apparently sympathises with investors (and central banks) who are currently stocking up on gold."

Note that "market volatility" seems to be a euphemism for "turmoil" which itself is a euphemism for "high risk of market correction."

My own excerpts

1) On gold. Greenspan is bullish on gold. Eventually, people are going to grasp the fact that paper money is being devalued by all the quantitative easing that has occurred. Gold is the only kind of money whereby the seller of goods and services isn't concerned about the buyer's creditworthiness. Gold's price movement is driven by two factors: to the extent that gold is a commodity, it's price will move along with other commodities, which is why it has fallen since peaking in Sept. 2011. On the other hand, to the extent that gold is a currency, it will move independently of other commodities.

2) On the Euro. For the Euro to work, Europe has no choice but to unify politically. In the absence of this, the Euro will eventually collapse. It's only a matter of time.

3) On the (US) economy. The economy is not healthy because there is not enough aggregate demand.

4) On (US) interest rates. Long-term interest rates are much lower today than their historical levels that span many centuries.

By the way, Greenspan refused to provide his opinion as to what the Fed ought to be doing now (regarding raising or not raising interest rates).

But he did seem to be saying that asset prices and financial market levels were high.

5) On the success of QE. QE (quantitative easing) has succeeded in lowering long-term interest rates. QE has not succeeded in spurring aggregate demand.

Side note: QE involved buying mortgage-backed securities and long-term Treasury bonds. The act of buying exerts upward pressure on price. When the price of a bond rises, its yield falls, and we say that long-term interest rates have fallen. 

Lowering interest rates was a goal of QE because (a) it made it easier for borrowers to refinance outstanding loans and avoid / postpone bankruptcy and (b) it took pressure off from the interest rate payable on variable interest rate mortgages.

6) On the economic health of US vs Europe. Europe is in much worse shape than the US.

Side note: The reason for this may be because the debt-to-GDP ratio in Europe is higher than in the US. For more on this, please see Hoisington's report below at the very end.

7) On the level of investments. Greenspan lamented that gross domestic investment relative to GDP is depressed, and this is a pattern seen in many countries. One reason that he gave was the abnormally high level of perceived uncertainty. For example, in the US, there is concern for rising taxes, so investors don't invest. The reason for this is that entitlements (e.g. Social security and other benefits promised by the government) haven't been fully funded, so investors seem to conclude that they'll eventually get funded through tax hikes.

Side note: Here's the data on investment-to-GDP ratios by country and year and the data on GDP by country and year. (Afterthought: GDP forecasts by country) I didn't have the resources to analyze all countries, so I limited myself to the US, Germany, Japan, and China. The first three may be thought of as a proxy for the developed world and the last a proxy for the developing world. The data supports the fact that in US, Germany, and Japan, gross domestic investment has been growing at a slower rate than GDP for the last 30 years. This is not true for China however, where gross domestic investment has been growing at a faster rate than GDP.

Here is an interesting question which I won't be answering in this article: Why has the ratio of investment-to-GDP been falling while the debt-to-GDP ratio has been rising?

8) On what's in store for financial markets. When the Fed had its first tapering discussion, the markets reacted strongly, so the Fed backed off. That's all Greenspan said, so I will elaborate.

Side note 1: My research shows that the time frame that Greenspan was referring to when he spoke of  "tapering discussion" was the first half of 2013.

Tapering doesn't mean increasing interest rates. It means slowing down the rate of bond buying, which is still expansionary. So, the act of increasing interest rates, which is synonymous with tightening, is bound to have a bigger effect. I believe this is what Greenspan was getting at.

Side note 2: As of this writing, expectations are for the Fed to increase (short term) interest rates sometime between the second half of 2015 and early 2016.

Side note 3: I thought it would be interesting to provide the timeline of QE. It appears next.

QE's Timeline

I have highlighted in yellow the duration of each leg so as to provide a heightened sense of time. I have also highlighted the rate of the liquidity injection, but this time in blue.

1. 2008 Financial Crisis
1. Time frame: Sept./Oct. 2008 -- 2 months
2. Intended purchase amount = $985Bn -- see note below regarding the word "intended"
3. Intended purchase rate = $492Bn / month
2. No pause
3. QE1
1. Time frame: Nov. 25, 2008 - March 31, 2010 -- 16 months
2. Intended purchase amount = $1.75Tn
3. Intended purchase rate = $109Bn / month
4. Open-ended when first announced
4. 7-month pause
5. QE2
1. Time frame: Nov. 3, 2010 - June 30, 2011 -- 8 months (half of QE1)
2. Intended purchase amount = $600Bn
3. Intended purchase rate = $75Bn / month
4. End-date was announced at the outset
6. 14-month pause (twice as long as the pause before QE2)
7. QE3
1. Time frame: Sept. 13, 2012 - Dec. 18, 2013 -- 16 months (same as QE1)
2. Intended purchase amount = $1.36Tn
3. Intended purchase rate = $85Bn / month (greater than QE2 but less than QE1)
4. Open-ended when first announced
8. No pause, but taper's start was postponed from Sept. 2013, i.e. by 3 months
9. Taper
1. Time frame: Dec. 18, 2013 - Oct. 21, 2014 -- 11 months
2. Intended purchase amount = $480Bn estimated
3. Intended purchase rate = $44Bn / month (started with $75Bn/mo and ended with $15Bn/mo)
4. Apparently open-ended when first announced, originally scheduled to end by mid-2014

Sources for QE Timeline: Bankrate, About, BloombergView, Forbes, Bloomberg.

Overall statistics of QE

• Aggregate duration of QE = 6 years, 1 month
• Aggregate duration of pauses during QE = 21 months, i.e. 29% of the time
• Aggregate intended purchase amount = $5.175Tn
• Average intended purchase rate = $70Bn / month including the pauses, $100Bn / month excluding them

(Side note: The reason that I have used the word "intended" before "purchase amount" is that apparently, the Fed's balance sheet hasn't expanded by a full $5.175Tn since Sept. 2008. According to the following article, "the Fed’s balance sheet expanded from about $850 billion to more than $4.4 trillion", as of Aug. 14, 2014, which equates to an actual "purchase amount" of $3.55Tn up to Aug. 14, 2014. If one assumes additional purchases of approximately $40Bn before the taper came to an end in October 2014, then the estimated actual "purchase amount" would amount to $3.95Tn.

There is still an unexplained gap of $1.225Tn between my $5.175Tn and others' $3.95Tn figure ... )

Side note: Federal Reserve System's balance sheet reports are consistent with the aforementioned article.

Story of QE

The above numbers tell the following story for QE. For the first two months, the Fed injected liquidity at the massive rate of almost a half trillion dollars per month. Then for 16 months, it injected at a rate of almost $110Bn per month; this was QE1, and at its outset, was an open-ended operation with no upfront end-date. The Fed then paused for 7 months. Then it began QE2 with an injection of $75Bn per month for a relatively brief 8 months, with the end-date having been announced upfront, after which it took a rather long 14-month pause.  This pause was twice as long as the pause following QE1. It then began QE3 for a relatively long period of 16 months, which was the same duration as QE1, during which it injected at a rate of $85Bn per month, which was 15% higher  than the rate of QE2's monthly injections. QE3's end-date wasn't announced up-front, but after QE3, the Fed began the "taper" with a delay of 3 months, which it then conducted for 11 months as an open-ended operation with no upfront end-date.

Baseline for QE

It is rather difficult to come to grips with the meaning of numbers in the billions and trillions of dollars. It is also difficult to imagine what it means for the Fed's balance sheet to expand by 5 times over 6 years. We need some kind of baseline against which we can compare a liquidity injection at the rate of $70Bn per month which persists for 6 years.

The baseline that comes to my mind is corporate profits. 

It would be interesting to look at cumulative corporate profits during these 6 years and to compare them to the amount of QE. Profits represent the reward for economic activity and are what the private corporate sector aims at maximizing.

According to this source, corporate profits, after-tax, for the 12 months ending in Sept. 2009 were $1.273Tn in the US.

For the 12 months ending in Sept. 2010, they were $1.499Tn.

Similarly,

Sept. 2011:   $1.430Tn

Sept. 2012:   $1.715Tn

Sept. 2013:   $1.803Tn -- I used this other source to double-check my figures.

Sept. 2014:   $1.873Tn

The sum of the above figures is $9.593Tn.

Therefore, for the 6 years spanning the same time frame as QE (albeit to within one month), cumulative after-tax corporate profits amounted to $9.6Tn rounded. The cumulative amount of QE was $4Tn rounded according to others and $5Tn rounded according to my own estimates. By comparing figures, we can say that the cumulative amount of QE was about half of the cumulative after-tax corporate profits during the period of QE.

Stated the other way around, for every dollar of after-tax profits that the US economy generated, the Fed injected about 50 cents. Note that in making this statement, I am not implying anything about a cause-and-effect relationship. I am merely comparing magnitudes.

In this light, QE appears to have been substantial.

I will now take a detour and present Hoisington's quarterly report for 2014q3.

Greenspan's Views Quantified

In the conversation covered above, Greenspan basically said that he didn't find the state of the world economy as being healthy. But he didn't elaborate, perhaps as encouragement for us to read his book. Or perhaps he didn't want to burden us with numbers and figures.

Dr. Lacy H. Hunt, executive vice president of Hoisington Investment Management Company, a firm with $5Bn assets under management for institutional investors, produces a quarterly report along with Van R. Hoisington, president and chief investment officer of the same company.

Here's Hoisington's quarterly report for 2014q3. This report does go into the numbers, which I will spare the reader, and covers the following:

• low household income
• high debt
• low economic growth
• low inflation
• asset bubbles
• rising US dollar
• falling Treasury bond yields

A sentence from the report that caught my attention was the following: "[We] would define an asset bubble as a rise in prices that is caused by excess central bank liquidity rather than economic fundamentals ....  Eventually, ... the crowd understands the imbalance, and markets correct."

I wonder if this could have been what Alan Greenspan was implying during the conversation.

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However, the bubble may continue to inflate because now that quantitative easing has ended, something else seems to have taken its place. It's called called "quantitative greasing"! I'm referring to the collapse in the price of crude oil (Brent) to $70 per barrel, down from $110-$120 per barrel in June (i.e. only 5 months ago). This is a 4-year low. See historical oil price chart and current price quote.

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An article published in the Financial Times on Jan. 30, 2015 caught my attention. The article comes shortly after the ECB announced that it would engage in QE in Europe from March 2015 through September 2016 (total of 18 months) and inject at the monthly rate of 60Bn Euros. 

The article in question mentions that if QE is intended to create inflation in Europe, the fact of the matter is that US inflation is currently the same as in Europe. However, the US has had QE for a good 6 years. 

Link to article.

Author is also on Twitter.

China's Warren Buffet, Guo Guangchang

Guo Guangchang elaborated his investment strategy during an interview with the Financial Times, which was published in the November 8/9, 2014 edition of the daily newspaper.

"The aim of tai chi is not to strike first to gain dominance over an opponent but to wait and hit at the right moment. That is, to be the first one to take action after feeling the change in momentum. Investing is similar to doing tai chi. No one holds a permanent speed advantage in the market due to the limits of human intelligence and vision. Your advantage comes from your ability to feel the change faster and take decisive action faster."

Buddhism teaches you that "everything starts from your heart, and feeling the heart of others is the most important doctrine in Buddhism. In doing business that means seeing things through other people's eyes. I feel that doing business is just like practicing Buddhism. Money is not your only purpose. Your purpose is to make things better for other people, and in the end, money will come as a result."

"Business is also the best form of charity. By making a company successful, you can provide more employment, and, if you treat your staff well, then your business itself becomes a charity."

Guo Guangchang, age 47, is the co-founder of Fosun, an $8bn conglomerate in China, which he co-founded with three university friends in 1992, using Rmb38,000 as the company's founding capital. (Today, Rmb6 = 1 US dollar.) Fosun is the largest private conglomerate in China. It has investments ranging from steel to mining, tourism to pharmaceuticals.

The name Fosun means "star of Fudan University", Guo's alma matter and Shanghai's most prestigious academic institution. At Fudan, Guo got a degree in philosophy.  He also honed his business skills by selling bread to hungry classmates when they finished studying at 11 each night. He earned Rmb5 a night, which seems a paltry sum until he points out that his monthly expenses were only Rmb30 at that time.

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Quiz. Calculate Guo's monthly profits from selling bread while in college. Next, express the founding capital for Fosun in terms of number of months of profits. Next, compare the result to the number of years required to complete a college degree. Did the founding capital for Fosun come entirely from Guo's selling bread?

If we assume that Guo sold bread for all 12 months of the year and that his college term lasted 4 years, then his profits from selling bread amount to only 15% of Fosun's founding capital! Derivation: [(Rmb5 earnings/day x 365 days/year x 4 years) - (Rmb 30 expenses/month  x  12 months/year x 4 years)] / (Rmb 38,000 Fosun founding capital) = 15%.

So, Guo must have had other sources of capital.

Author is also on Twitter.