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The Fog of Economic Folly

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  • The Fog of Economic Folly

    The Fog of Economic Folly
    Beware Today's Economic McNamaras

    On TV a few nights ago, I watched the movie Fog of War, Eleven Lessons from the Life of Robert S. McNamara. That was the 3rd time I'd watched it.

    I'm trying to come to terms with McNamara's self-aggrandizing mea culpa, in which in his old age he puts himself at the center of many major historical events. The reason I bring this movie up is not to bash McNamara, whom I met once by accident at an airport in DC. He was in a wheelchair and not looking well. I want to point to one scene in the movie that offers a lesson for our economic leadership today.

    At one point in the movie, McNamara tells interviewer Errol Morris that he "... now realizes the Vietnam conflict was considered by the North Vietnamese to be a civil war and that they were fighting for the independence of their country from colonialism."

    I bet 90% of those who watched that scene reacted as I did. "How could he not have known that at the time? Nearly everyone else did."

    In August 2002, I was attending an event in Boston put on by an investment bank. I sat next to a man who was a Federal Reserve bank president during the 1990s bubble era. At one point I asked him, "Why did the Fed finally decide to raise rates in 1999?" He replied, "We took a look at the telecommunications industry and said 'Holy cow! Look at what they've done with our money!'"

    Who could have known?

    For years before that, among other sites had been sounding the alarm on the technology stock market bubble. specifically warned that when the tech stock market bubble popped, the collapse was going to take my industry -- high tech -- down with it. Here we are six years later and the industry is still broken. As evidence, when was the last time a Boston based high tech company went public?

    Many of you knew at the time that this was going to happen. The data were readily available but the Fed did nothing. The bubble grew larger and larger and finally collapsed. The technology industry around which the bubble formed hasn't recovered.

    Makes you wonder what you know now that the Fed doesn't know.

    You know that the Fed has since 2002 allowed a housing bubble to grow in many regions of the U.S. to outrageous proportions. You know you have friends and neighbors who live in huge houses filled with expensive goods and drive expensive cars and will tell you, as the smiling man on the rider lawnmower in the famous television ad says, "How do I do it? I'm in debt up to my eyeballs. Somebody help me."

    We all know how it's going to turn out. The same as the Vietnam War and the tech stock market bubble. It's going to be a disaster.

    The bearish sites passed the point of accepting that outcome as fact years ago and have focused their energy on trying to figure out whether the disaster will be characterized by deflation or inflation. Ka-Poom Theory says inflation is the most likely outcome as the dollar will lose much of its value in the process. But it's just a theory, and like any responsible inventors of a theoretical model, we're constantly hammering it into finer detail in the face of fresh evidence.

    If so many can foresee disastrous outcomes of follies like the Vietnam War and the Technology Bubble coming, why can't the folks in charge see the same thing?

    The Vietnam War and tech stock bubble lessons are parallel. Insulated by power and reinforced by bureaucracy and self-fulfilling careerist orthodoxy, men and women at the top of the system can make horrific policy misjudgments that seem incomprehensible to the man or woman on the street. Once in place, these policies take on a life of their own, become institutionalized, mostly by the career limiting consequences of either pointing out someone else's error or admitting one's own. On and on they go. When the inevitable happens, the McNamaras of the economy finally see what everyone else saw all along. What was for years mundane daily experience for most enters the consciousness of leaders as a sudden revelation of fact.

    You can often see a disaster like the tech stock bubble coming at you from miles away, like a slow motion economic tsunami rolling inexorably toward you.

    Reports of excessive debt levels by households and the U.S. government itself have been in the press for years, just as the anti-war movement and later the press detailed the folly of U.S. involvement in Vietnam's civil war. The fact these policy mistakes can go on for years or even decades is what makes them so insidious. As each year passes, most of us succumb to the natural human tendency to adapt to the increasingly perverse circumstances around us. We become immune to the constant torrent of warnings.

    At some point, usually toward the end of the cycle at the peak of cognitive dissonance between what we feel is wrong and what we can intellectualize, we may even be tempted to join the risk takers, thinking that if the ice has been holding up for this long, why not a bit longer? Or maybe it isn't so thin. Or maybe it isn't ice at all, it's concrete. If you question the ability of otherwise perfectly sane humans to internalize data that contradicts common sense and adapt to bad government policy, political or economic, I point to Nazi Germany as an extreme example of how a population can go along with their leaders even where their leaders are completely insane.

    Stock market bubble collapses in the U.S. 1930s and in Japan in the early 1990s got all of the press. But it was the secondary collapse of credit bubbles -- the underlying foundation of stock market bubbles -- that caused the real economic carnage. In the U.S. in the 1930s, the credit bubble collapse was nearly simultaneous with the collapse of the stock market bubble, while sixty years later in Japan their credit bubble did not collapse until a few years after their stock bubble collapsed. More than fifteen years later, they are still struggling with the result.

    I'm in a restaurant in London in 2002 meeting with a investment bank analyst. We're talking about the credit bubble. "Oh, my god." He said, rolling his eyes. "I'm not looking forward to what happens when that ends." I have to remind myself of these conversations, and many others, because otherwise I'm just as susceptible as anyone to become complacent.

    Lessons of the Vietnam War and the 1990s tech stock bubble, prelude to the collapse of the global credit bubble:

    Lesson #1: Do not listen to vague assurances from the current cast of economic McNamaras. You know more than they do. Listen to your good common sense.
    Lesson #2: There is nothing new under the sun. Don't believe that anyone has built a better mouse trap. They have not.
    Lesson #3: You are not helpless. There are things you can do. We talk about them here and offer links to many other sites that can help give you guidance.


    Eric Janszen

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    Last edited by FRED; 07-03-06, 08:39 AM.

  • #2
    what the fed knows

    A really good piece, Eric, as are so many.

    The problem you point to, of those in power who don’t know what is common knowledge, is perhaps in fact a case of not wanting to know. I think of Greenspan’s “irrational exuberance” speech, which he made after meeting with Robert Shiller, about 1996 with the Dow at 6000 if I recall. When the markets hiccoughed Greenspan did a fast backpedal and shifted to cheering on the N*E*W E*R*A. So did he know or didn’t he? The minutes from the Fed meetings in the late 1990’s make clear that they knew there was a bubble. But again Greenspan flinched. He could have raised margin rates but I think he was more concerned about being re-appointed and being loved. The Maestro, indeed. So he convinced himself that the risks were too great, and that market sophisticates had ways of going around margin restrictions anyway, and then later he said he couldn’t tell there was a bubble until it popped in his face. I’d bet he believes the lies he tells himself, and he sleeps well at night as he collects his speaking fees and writes his $8million memoirs.

    When Greenspan recommended that Joe Sixpack take out an ARM, did he know that was the worst possible advice at the worst possible time? Or did he just not even think about that, since his main interest was peddling more happy talk to Congress and the nation. Later he said that anyone who hadn’t re-arranged his affairs to anticipate higher rates must want to lose money. Did he think Joe Sixpack was still listening, and understood? So that $1.8 TRILLION in ARM’s will reset over the next two years, going off like M-80’s in the faces of poor suckers who believed all the happy talk.

    What does the Fed not know now? I think they might really know what we know. But the system is so fragile that they’ve got to play the game. Bernanke learned that really fast after he decided to whisper sweet nothings into Maria Bartiromo’s ear – why do they take every word so seriously? he asked. But of course the markets then took those words so seriously.

    It’s a game of chicken being played between the Fed and the markets. We know that Greenspan chickened out and wrote the market the famous Greenspan put. Now Bernanke et al have to play the game, talk tough but be very, very careful.

    So even if they know there’s a housing bubble, they can’t say so. Think about it. Suppose you woke up tomorrow and heard on the radio that Bernanke had made a speech saying that indeed there was a housing bubble, that housing prices were bound to decrease sharply and that many mortgages would be defaulted on and houses foreclosed. It would make 1987 look like a picnic.

    There’s that line that Jack Nicholson delivered in some movie: “You want the truth?! You want the truth?! You can’t handle the truth!”

    The world can handle the truth from you or me, but it can’t handle the truth from Bernanke. He has to play Oz. “Don’t look at that man behind the curtain, I am the all powerful Oz.
    Last edited by jk; 06-29-06, 04:11 PM.


    • #3
      Pure Self interest of Bureaucrats and people

      I think the Fed's employees are acting like people and they are solely self interested. What is the incentive for any one at the Federal Reserve to put an end to the credit/money supply party. People are interested in improving there own lot , advancing in their organization, moving up the career ldder and they aren't really concerned with the societal consequences. To seek advancement in the Federal Reserve system or any organization you must drink the Kool aid. Governement bureaucrats drink alot of Kool Aid and their prime concern is where is their career , and they never lose sleep worrying about the impact on the US Citizens: there is no incentive to look out for the US Citizens.

      How popular would Greenspan be today if he had prevented the wealth creation ofthe late 1990s or the Real Estate boom? Greenspan's tenure would have been a lot shorter had he been a conservative Federal Reserve Chairman?


      • #4
        The Fed is not your friend

        One of the more pervasive and wrong-headed beliefs in the country today is that the Fed is somehow the consumer's friend. It's not. It's not really meant to be.

        The Fed is designed to regulate the pitch and roll of the economy at the highest, most impersonal levels (well, impersonal for most of us). Eric, you could do your readers a real service by getting into this and explaining it in plain English.

        I watch what the Fed says and does, but I don't assume it's going to act in my interest or serve as an effective early-warning system for me. I assume it will act in what it believes is the most effective outcome for the economy at a very macro level. (I strain to assume that in many cases.)

        The more we depend on foreign governments and markets for our health and welfare (perhaps an unpleasant term in this context), the fewer options the Fed has for adjustments.

        Remember: The Fed watched risk be shifted to the consumer in the past five years. I don't recall warnings to average consumers about that, yet it has affected virtually every citizen of this country. Well, most citizens - the unsuspecting ones, which would be a majority, I fear.


        • #5
          the privatization of debt/risk

          Originally posted by S
          Remember: The Fed watched risk be shifted to the consumer in the past five years. I don't recall warnings to average consumers about that, yet it has affected virtually every citizen of this country. Well, most citizens - the unsuspecting ones, which would be a majority, I fear.
          as corporations have repaired their balance sheets the individuals' and governments' balance sheets have deteriorated. [remember when greenspan supported the bush tax cuts because he was afraid that with all the surpluses we'd retire the whole national debt and the government would be forced to purchase private debt and equity?] the only way to repair the balance sheets of individuals [short of default] will be for government to run even bigger deficits.


          • #6
            Bravo EJ! ...a masterpiece. You captured the twisted psychology of it all so well.


            • #7
              I blame most the news media ...

              First, my title aside, EJ's "... we may even be tempted to join the risk takers, thinking that if the ice has been holding up for this long, why not a bit longer? Or maybe it isn't so thin. Or maybe it isn't ice at all, it's concrete." recalls for me the saga of Issac Newton in the South Sea Bubble -- and if that could happen to him ...

              On title:
              Incoming financial information is mostly all from the financial services industry and the financial news media, and the people take what they wish. Bubbles-history in the public's face ongoingly would be new-bubble-deterring, but it's very largely omitted! In our system, as I see it, it's nobody's JOB to dissuade the exercise of our freedom in a free market to be ignorant/stupid herdies -- and so it doesn't get done, given that the two above entities make more money from bubbles.

              I blame most the news media, because their conperson-behavior falls short the most from their projected image.

              With little thought, but just recalling the 3 warnings in 90+ years recounted here:
              "the 3 Fed Chair warnings, Real DJIA" at
              I might blame the Fed least.


              • #8
                who's to blame?

                Originally posted by Ed
                I might blame the Fed least.
                i won't repeat what i've written in other threads about the specifics of greenspan's performance, but i think sir prints-a-lot, writer of the "greenspan put," defender of the n*e*w e*r*a, believer in the magickal ability of derivatives to make risk disappear into the luminiferous aether, deserves plenty of blame.


                • #9
                  Greenspan: Businessman, economist, politician, philosopher

                  Originally posted by jk
                  i won't repeat what i've written in other threads about the specifics of greenspan's performance, but i think sir prints-a-lot, writer of the "greenspan put," defender of the n*e*w e*r*a, believer in the magickal ability of derivatives to make risk disappear into the luminiferous aether, deserves plenty of blame.
                  Agree that Big Al's greatest weakness is his desire to be liked. On the site FAQ in Jan. 1999: "My favorite target is Greenspan. While I respect his profound intelligence, his history suggests a man who has a personality trait that is a serious hazard for a central bank chairman: he wants to be liked. Volker, for example, didn't have that problem. Right now he's enjoying a reputation as the smartest central banker in history. But he's making nearly the same mistakes as his predecessors in the 1920s, providing too much liquidity at the wrong time, fueling a speculative mania during a time of rapid technological innovation. What will be learned from this -- again -- is that the Fed's rate and money supply moves can distort the market's utilization of capital, leading to credit and asset value excesses and potentially a bust. Greenspan may not go down in history as a hero."

                  Yesterday's heresy is tomorrow's obvious truth.

                  The "interview" with Alan Greenspan has held up well after seven years. May be time for a "follow-up" to see if "he" has any misgivings, now that the wheels are coming off his crazy contraption.