Original source URL: http://www.informationclearinghouse.info/article17214.htm NEWS YOU WON'T FIND ON CNN Tuesday's Market Meltdown; Greenspan's "Invisible Hand" By Mike Whitney 02/28/07 "ICH" -- -- Yesterday¹s stock market freefall has Greenspan¹s bloody fingerprints all over it. And, no, I¹m not talking about Sir Alan¹s crystal ball predictions about the impending recession; that¹s just more of his same circuitous blather. The real issue is the Fed¹s suicidal policies of low interest rates and currency deregulation which have paved the way for economic Armageddon. Whether the Chinese stock market contagion persists or not is immaterial; the American economy is headed for the dumpster and it¹s all because of the wizened former fed-chief, Alan ³Great Depression² Greenspan. So, what does the stumbling Chinese stock market have to do with Greenspan? Greenspan was the driving force behind deregulation which keeps the greenback floating freely while the Chinese and Japanese manipulate their currencies. This gives their industries a competitive advantage by allowing them to consistently underbid their foreign rivals. Big business loves this idea, because it offers cheaper sources of labor and allows them to maximize their profits. It¹s been a disaster for Americans though, who¹ve seen their good paying jobs increasingly outsourced while US manufacturing plants are dismantled and air-mailed to the Far East. Greenspan has been the biggest champion of deregulation; it¹s another way he pays tribute to the Golden Calf of ³free trade", the god of personal accumulation. Yesterday, the Chinese got whacked with their own stick. By keeping the value of their currency down, they spawned a wave of speculation which inflated their stock market by 140% in one year. When the government threatened to tighten up interest rates the stock market went into a nosedive and the overall index got a 9% haircut in a matter of hours. If they had been playing by the ³free market² rules, rather than pegging their currency to artificially cheap greenbacks they could have avoided inflating their stock market. As it happens, the rumblings in the Chinese market sent tremors through the global system and triggered a 416 point loss on Wall Street; the biggest one day slide since 9-11. Now the world is watching nervously to see if the markets can recuperate or if this is just the beginning of America¹s great economic unwinding. Wednesday¹s revised numbers of GDP are not encouraging. The Commerce Dept revised their original data from a robust 3.5% GDP to a paltry 2.2. The economy is shrinking faster than anyone had anticipated. Also, durable goods plummeted beyond expectations and the real estate market continues to swoon. Troubles in the sub-prime market are spreading to non traditional loans as more and more over-leveraged homeowners are unable to make their monthly mortgage payments. (By the end of December 24 sub-prime mortgage lenders had already gone belly-up) Greenspan¹s empire of debt is bound to come under greater and greater pressure as volatility increases. On Monday, the National Association of Realtors (NAR) reported a 3% jump in the sales of existing homes, but it was all hogwash. The housing industry has joined the media in trying to conceal what¹s really going on by showering the public with cheery talk of a recovery. Don¹t believe it. Go to their website and you¹ll see that ³year over year² January sales were down by a whopping 290,000 homes. Add that tidbit to ³new home sales² (announced today) which ³fell by 16.6%, the most since 1994² (Bloomberg) and you get bird¹s-eye-view of an industry teetering on the brink of collapse. Greenspan pumped the housing bubble so full of helium; we¹ll be feeling the back-draft for a decade or more. Still, the gnomish ex Fed-master had the audacity to stand in front of the cameras and say, ³We have not had any major, significant spillover effects on the American economy from the contraction in housing.² Really? Apparently, Greenspan hasn¹t taken note of the skyrocketing rate of foreclosures or the growing number of people on public assistance. It¹s doubtful that one notices the struggles of the working stiff from their manicured sanctuary in the Aspen foothills. It¹s not just the housing market that¹s buckling from the expansion of debt, but the stock market as well. The Associated Press reported last week that, ³Investors are borrowing at a record pace to sink into the stock market, and the trend is raising concerns on Wall Street about what might happen if a major correction occursŠ.The amount of margin debt, which is how brokers define this kind of borrowing, hit a record $285.6 billion in January on the New York Stock Exchange. Such a robust appetite, amid a backdrop of complacent market conditions, could leave investors badly exposed if major indexes are snagged by a market decline. Some could find themselves forced to sell stock or other assets to meet what¹s known as a margin call, when a broker effectively calls in the loan". That last time margin debt was this high was at the height of the dot.com bubble in March 2000. We all know how that turned out; the bubble burst taking with it $7 trillion in savings and retirement from working class Americans. It all could have been avoided if there were prudent and enforceable regulations on margin debt. Of course, that would have been a violation of the central tenet of free market exploitation: ³There shall be no law inhibiting the unscrupulous ripping-off of the American people². Margin debt is a red flag that the market is over-inflated by speculation. When the market hits a speed-bump like yesterday the fall is steeper than normal, because panicky, over-leveraged investors start scampering for the exits. This probably explains much of what happened on Wall Street after the sudden decline in the Chinese market. The problems facing the stock market will soon play out whether or not we recover from this ³dress rehearsal²for disaster. America¹s huge account imbalances and the massive expansion of personal (mortgage) debt ensure that there¹s more trouble ahead. The real problem is deep, systemic and difficult to understand. It relates to basic monetary policy which has been tragically mishandled by the Federal Reserve. A healthy economy requires that money supply not exceed the growth of real GDP; otherwise inflation will ensue. The Fed has been cranking up the money supply at a rate of over 11% for the last 6 years ensuring that we will eventually face a cycle of agonizing hyper-inflation. More worrisome is the fact that the world is about to face a global liquidity crisis for which there is no easy solution. See, the Fed loans money to the banks by buying government debt. Then, the banks, through the magic of ³fractional banking², are then able to multiply the amount of money they loan out to their customers. In other words, the loans exceed the amount of the reserves by a considerable margin. Grasping the magnitude of this phenomenon is the only way to appreciate the storm that lies ahead. This excerpt may shed some light on the issue: ³In the 1970s the reserve requirements on deposits started to fall with the emergence of money market funds, which require no reserves. Then in the early 1990s, reserve requirements were dropped to zero on savings deposits, CDs, and Eurocurrency deposits. At present, reserve requirements apply only to "transactions deposits" - essentially checking accounts. THE VAST MAJORITY OF FUNDING SOURCES USED BT PRIVATE BANKS TO CREATE LOANS HAVE NOTHING TO DO WITH BANK RESERVES AND IN EFFECT CREATE WHAT IS KNOWN AS ³MORAL HAZARD² AND SPECULATIVE BUBBLE ECONOMIES. Consumer loans are made using savings deposits which are not subject to reserve requirements. These loans can be bunched into securities and sold to somebody else, taking them off of the bank's books. THE POINT IS SIMPLE. COMMERCIAL, INDUSTRIAL AND CONSUMER LOANS NO LONGER HAVE ANY LINK TO BANK RESERVES. SINCE 1995, THE VOLUME OF SUCH LOANS HAS EXPLODED, WHILE BANK RESERVES HAVE DECLINED.² (Wickipedia) That¹s why we should not be surprised when we discover that, although there are currently $3.5 trillion in bank deposits in the USA, the actual reserves are about $40 billion. This system works fairly well unless there¹s a major market meltdown or a run on the banks, in which case people will quickly find that there are, in fact, no reserves. Even this would not be a concern if the Fed had not increased the money supply by leaps and bounds while, at the same time, fueling the housing bubble through obscenely low interest rates. Now, millions of homeowners will be facing default on their loans, the banks will be stretched to the max, and the stock market will begin to falter. Something¹s gotta give. Last week, in Davos, Switzerland, German banker, Max Weber, warned the G-8 Summit, ³If you misprice risk, don't come looking to us for liquidity assistance. The longer this goes on and the more risky positions are built up over time, the more luck you needŠ It is time for financial market to move back to more adequate risk pricing and maybe forego a deal even if it looks temptingŠ Global liquidity will dry up and when that point comes some of this underpricing of risk will normalize. If there is much less liquidity around, people will not go into such high risk.² It is unlikely that Weber¹s advice will be heeded. The United States has grown addicted to ³cheap money² and ever-expanding debt. The Federal Reserve will keep greasing the printing presses and diddling the interest rates until someone takes away the punch bowl and the party comes to an end. There¹ve been plenty of warnings, but they¹ve all been brushed aside with equal disdain. In a recent article on Counterpunch.org, (³Lame Duck²) Alexander Cockburn refers to a report published by the Financial Services Authority (FSA) ³a body set up under the purview of the British Treasury to monitor financial markets and protect the public interest by raising the alarm about shady practices and any dangerous slides towards instability.² The report ³Private Equity: A Discussion of Risk and Regulatory Engagement² states clearly: ³Excessive leverage: The amount of credit that lenders are willing to extend on private equity transactions has risen substantially. This lending may not, in some circumstances, be entirely prudent. Given current levels and recent developments in the economic/credit cycle, the default of a large private equity backed company or a cluster of smaller private equity backed companies seems inevitable. This has negative implications for lenders, purchasers of the debt, orderly markets and conceivably, in extreme circumstances, financial stability and elements of the UK economy.² The problem is even worse in the US where personal and mortgage debt has increased by over $7 trillion in the last 6 years! This is not an issue that can be resolved by a meager 10% correction in the stock market. The reaction on Wall Street to the sudden downturn in China demonstrates the fragility of the market and presages greater volatility and retrenchment. We should expect to see bigger and more destructive market-fluctuations as investors get increasingly skittish over bad economic news and weakness in the dollar. Yesterday¹s 400 point somersault is just the first sign that Greenspan¹s Goldilocks¹ economy is cracking at the seams. Click here to comment on this and other articles In accordance with Title 17 U.S.C. 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