John Browne: Yellen follows in Greenspan's footsteps
In what many felt was a generally dry speech, then-Federal Reserve Chairman Alan Greenspan spoke to the American Enterprise Institute in 1996 about the inverse relationship exhibited by price/earnings ratios and the rate of inflation in the past.
“But how do we know when irrational exuberance has unduly escalated asset values,” Greenspan asked, “which then become subject to unexpected and prolonged contradictions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”
Equity markets plunged by 10 percent after the “irrational exuberance” speech.
Buoyed by continued Fed-infused liquidity, the Dow Jones Industrial Average recovered from that correction and rose by some 80 percent and the Nasdaq index by 200 percent. It took about four years before a market collapse occurred in 2000.
Greenspan's additional frank justification of low interest rates in his speech was largely ignored.
Fast-forward to last week. Fed Chairwoman Janet Yellen assured markets that despite “tapering” its bond buying infusions, the Fed would maintain the large liquidity levels and its zero interest rate policy — which is a negative “real” cost of money. Naturally, this was welcomed by bond and equity markets and served to continue to pump up investment there.
However, Yellen then took the unusual step of commenting on specific market sectors. She singled out social media and biotech stocks as having “stretched” valuations.
Bam! These sectors took a hit, with “Yelp” falling some 4 percent that day.
In the same semiannual report to Congress, Yellen hinted at continued negative “real” interest rates.
Similarities in the comments by Greenspan and Yellen on security valuations were immediately drawn by many commentators. Like Greenspan before her, however, the far more interesting remark about interest rates drew little reaction or comment.
In her written report to Congress, Yellen asserted that asset values were in line with “historic norms” and that, supported by the Fed's current zero interest rate policy, the economy would continue to grow.
But she switched quietly the goalpost for raising interest rates, from a declining unemployment rate to an increase in hiring and wage rates and to when the effects of the financial crisis are “completely gone.”
In Greenspan's 1996 speech, he noted: “During World War II, and through 1951, however, monetary policy was effectively subservient to the interests of the Treasury, which sought access to low-cost credit.”
Facing direct Treasury debt of more than $17 trillion and estimated total debt obligations of more than $100 trillion, the Treasury still needs continued low-cost money, desperately.
With most banks, insurance companies and pension funds invested heavily in “secure” bonds, a return to “neutral” interest rates would devastate bond prices, precipitating chaos. Therefore, while most observers wait patiently for the Fed to hike rates, others believe the Fed is in a corner and simply cannot raise rates for years to come.
Therefore, Yellen likely will continue to follow Greenspan's lead in distorting markets by funding “irrational exuberance” or perceived over-confidence.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Contact him at email@example.com.
Show commenting policy
TribLive commenting policy
You are solely responsible for your comments and by using TribLive.com you agree to our Terms of Service.
We moderate comments. Our goal is to provide substantive commentary for a general readership. By screening submissions, we provide a space where readers can share intelligent and informed commentary that enhances the quality of our news and information.
While most comments will be posted if they are on-topic and not abusive, moderating decisions are subjective. We will make them as carefully and consistently as we can. Because of the volume of reader comments, we cannot review individual moderation decisions with readers.
We value thoughtful comments representing a range of views that make their point quickly and politely. We make an effort to protect discussions from repeated comments either by the same reader or different readers.
We follow the same standards for taste as the daily newspaper. A few things we won't tolerate: personal attacks, obscenity, vulgarity, profanity (including expletives and letters followed by dashes), commercial promotion, impersonations, incoherence, proselytizing and SHOUTING. Don't include URLs to Web sites.
We do not edit comments. They are either approved or deleted. We reserve the right to edit a comment that is quoted or excerpted in an article. In this case, we may fix spelling and punctuation.
We welcome strong opinions and criticism of our work, but we don't want comments to become bogged down with discussions of our policies and we will moderate accordingly.
We appreciate it when readers and people quoted in articles or blog posts point out errors of fact or emphasis and will investigate all assertions. But these suggestions should be sent via e-mail. To avoid distracting other readers, we won't publish comments that suggest a correction. Instead, corrections will be made in a blog post or in an article.
- Penguins GM Rutherford ‘wouldn’t make’ Despres trade today
- Starkey: Kang story of the year for Pirates
- Healthy defensive back Mitchell eager for 2nd season with Steelers
- Taliani’s 3 homers propel Deer Lakes to 2nd WPIAL softball title in 4 seasons
- Dormont man missing since Wednesday found dead at Station Square
- Man uninjured after leap from Hulton Bridge
- Pyrotechnics to be used in TV filming in New Kensington
- Sabres hire Bylsma as coach; Penguins receive 3rd-round pick
- Man’s body found hours after disappearance on Youghiogheny River
- Police seek help finding missing Squirrel Hill man
- Chevron settles fatal shale gas well fire lawsuit for $5M