A Phoney Recovery

Even though I just let my subscription to The Economist lapse (I'm trying to reduce living beyond my means :-), I've always thought and continue to think that, more than any other weekly magazine, they at least try to present both sides of the argument. And indeed, I think they made a good effort in A Phoney Recovery (which Jim linked to). It's always entertaining and sometimes enlightening reading articles that argue against themselves.

If I had to summarize the article's conclusion in a nutshell it would be this: people are irrationally increasing their debt load and investing in property (and the stock market to a lesser extent) and Greenspan is irrationally keeping interest rates too low which encourages that sort of irrational behavior. If they deleted the "irrational" and "too" (low) part of their description, I'd agree completely. I'd also agree that worldwide economic numbers are not combining in the familiar old patterns of 20 years ago, and this new, unfamiliar territory is discomforting (even to me).

I don't think investors are acting irrationally at all. If Asian countries (notably China) want to buy bonds at absurdly low interest rates (high prices), why is it possibly irrational to sell those bonds, whether to buy a more expensive home or invest in the stock market? It's a classic opportunity to "sell high, buy low." In arguing against the rationality of the approach, the author puts forth a statement I find bizarre:

More serious is that the price of homes or shares can fall, while debts are fixed in value.

If debts are fixed in value, then why, pray tell, are there bond markets? If you sell a bond at an interest rate of 5% and interest rates go up to 10%, the value of that bond drops. If you used that money to buy a home, your monthly payment remains the same. As long as you continue to live in that house, it remains at least as affordable as long as you make at least as much money as when you bought. If you make more money over time, the mortgage payments get more affordable, not less.

Am I saying this is a good thing? No, not necessarily. I don't know. But to call it irrational like drug addiction is way off base in my opinion.

Here is another statement I found incoherent:

In the long run, the only way to create genuine wealth is to consume less than income, and to invest in real income creating assets.

Ummm, well, yes and no. First of all, in the long run we are all dead. Or, more to the point, in the long run everything we invest in real income creating assets today is dead (i.e., it will completely depreciate). It is true that some amount of time before we get to the long run, we will need to invest in income creating assets to create more "genuine" wealth in the long run (by the way, how does "genuine" wealth differ from other kinds of wealth, can you buy more with it?). Anyway, the point is that it doesn't necessarily follow that we should increase our investment in such assets today.

Also, in the long run, the most important thing is knowledge and information, not capital equipment. I'll have a post on this line of reasoning in the next few days.

Finally, we get to the core of the problem:

The current dilemma for the Fed is that inflation is presently too low for comfort, which argues for holding interest rates down.

Well, yeah! No kidding! Sounds like a good argument to me. I think Greenspan is worried that we were actually in a bit of a deflation and that scares him (possibly for good reason). A rational economist could reasonably disagree with Greenspan's position (seems he's taking some heat from economists at the moment for being partisan), but I don't think Greenspan's analysis can be dismissed out of hand as being irrational.

What it comes down to is that there doesn't seem to be a comparable example of low inflation/deflation, rapidly falling dollar, low savings rates, low interest rates, low employment growth, robust GDP growth, rapidly rising property prices, and an increasingly robust stock market. Greenspan certainly does have a dilemma on his hands. His chosen to err on the side of growth and hope for the best. That would be my choice as well. I hope he's right. Only time will tell (and even then, only the barest glimpse of the truth will be told).