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John Browne: Yellen follows in Greenspan's footsteps

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Saturday, July 19, 2014, 9:00 p.m.

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

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