Jorge Nascimento Rodrigues, editor of Gurusonline.tv, January 2008

A conversation with Martin Hutchinson, editor of Greatconservatives.com and columnist of 'Bear's Lair'

Selected article:
Article at The Globalist: 'The Fed's decade of deception'

Martin Hutchinson writes a weekly column, 'The Bear's Lair' at PrudentBear.com, providing economic and market commentary. He was also Business and Economics Editor at United Press International, in Washington, D.C. from 2000 to 2004. Previously, he was an international merchant banker for 25 years working in London, New York and Zagreb. He is the author of Great Conservatives (Academica Press, 2004), which examines the British governments of 1783-1830. Hutchinson has a first class Honors degree from Trinity College in Cambridge and a Master of Business Administration from Harvard Business School.

In the same week (January 2008) Anna Schwartz, the High Priestess of US monetarism blames the FED for sub-prime crisis, in The Telegraph, London, columnist Martin Hutchinson talked with Gurusonline.tv about the Heritage (a poisoned one) of Alan Greenspan, the previous FED Chairman that governed the monetary policy of the US since 1987 until 2006, working with four Presidents (Reagan, Bush father, Clinton and Bush son), and feeding two bubbles since 1997. Greenspan, along the worldwide marketing of his recent book, try to pass the idea that he has nothing to do with his "babies", the bubbles of the dot-com era (1997-2000) and the following one from 2001 until 2007 around the "creative" financial tools like the sub-prime and the rest that will burst soon.

INTERVIEW

Now it seems that FED's policy since end of the 1990s was focused in 'feeding' two successive bubbles. First it was the dot-com; afterwards the "creative" credit tools (subprime, derivatives, etc). Instead of the so-called knowledge economy and increase of productivity, we saw the emergence of a rent-seeking business model in the United States in the last decade?

MARTIN: That's basically right. The standard economic model assumes a constant value of money; nothing in it claims to work well in a period in which money supply is being inflated at 9-10% per annum. Normally, such increases would cause rampant consumer price inflation fairly rapidly, but in the late 1990s the forces of globalization were powerful enough to overcome that inflationary tendency. In fact, globalization should have brought us price deflation, like when the railroads came to the Plains states in the 1880s and caused world agriculture prices to drop - the decline in prices for e.g. clothes from China or software from India should have overwhelmed the price rises domestically. However, with rapid money supply growth we didn't get deflation, we got asset bubbles instead. And, as appears to be usual, bubble periods allowed crooks and charlatans to flourish and suppressed long term growth projects.

Alan Greenspan, along his present marketing campaign selling his book, speaks everyday day and night about a growing recession risk in the US, and he talks as he has nothing to do with this mess. It seems he wants to kill his baby. For a foreign reader all this is very confusing. Can you explain what's going on?

MARTIN: It was Greenspan's error in 1996, in spotting "irrational exuberance" in a speech December 4, and then the following year discovering a productivity "miracle" which allowed stock prices to be exuberant, that set off the bubble in the first place. The Fed in the mid 1990s was working off a theory that rising asset prices had no effect on the real economy; they now accept that every $1 rise in asset prices produces 3-4 cents in real output. After 2001, Greenspan and Bush didn't want the recession that appeared inevitable after the bubble, so they inflated the money supply further and cut taxes, producing the housing bubble (while business investment had a very weak recovery, showing that 1999 did indeed produce over-investment.) Now the double downturn in housing and eventually stocks will produce a very unpleasant recession. Bernanke [Greenspan' successor at FED) is attempting to postpone the recession still further by cutting interest rates again, and Greenspan is trying to distance himself from Bernanke's efforts. Bernanke's new cuts will just cause inflation to accelerate; the deflationary effect of globalization and the Internet seems to have pretty well worked its way through the system, so monetary expansion will now produce real inflation, as was the case in the 1970s. You can see the effects of Bernanke's new rate cuts and the ECB injections of liquidity in oil and gold prices, both up close to 40% in 5 months.

We heard recently in the news that the US is at risk of losing its triple A credit rating for the first time since was first assessed in 1917. What's your comment?

MARTIN: There's no God-given reason why the US should be AAA; it depends on its fiscal policy and debt level. At the moment, the fiscal policy has been over-expansionary since 2001 (the Bush tax cuts were sensible, but they didn't restrain spending as they should have) but the debt level is reasonable. However the baby boomers, born in 1946-64, began to retire this January 2008 - that will cause a rapid increase in social security and Medicare costs, which will produce much larger deficits by 2017-2018. At that point, the US credit rating will drop. It may indeed drop sooner; if as I expect we get a deep recession, the federal budget could quickly be running a deficit in the $750 billion - 1 trillion range, 6-8% of GDP, and that would cause the debt rating to be lowered.

In the 1980's we saw the Japanese buying everything it moves in America. Now it's time for Middle East prince billionaires' holdings and sovereign wealth funds or Chinese Banks to rescue American financial baby dolls. Wall Street is approaching a sold out season?

MARTIN: Wall Street needs more sovereign wealth funds to buy, because the current write-offs they have had, of about $100 billion after Citigroup and Merrill Lynch report this week (January 2008), are nowhere near the end of the story. Essentially, buyers of US financial service companies are speculating on a recovery before the downturn has finished, always a way to lose money. So in that case, like the Japanese in the late 1980s, they are almost certainly making poor investments. However, in some cases the recession will drop oil prices and lower the Chinese surplus (China in any case has a $1 trillion bad debt problem) so the sovereign wealth funds won't have huge amounts of money to invest. As for Wall Street, I'd expect the industry itself to suffer a drastic downsizing, and many of the current top houses to disappear.

Printing money and inflating the M3 money supply seems the official medicine of Ben Bernanke (and also the guys of European Central Bank). What can we expect from this entire pumping money machine?

MARTIN: Reported inflation in the US will be close to 10% by December 2008, I think. The ECB is essentially exporting European inflation to the US, by means of the US payments deficit. New money will cause more inflation than it prevents recession. The only plus is that rapid US inflation will cause US house prices to stop dropping, as incomes, increased through inflationary pay rises, rise to meet them. That will improve the US credit picture somewhat but not much.

2008 Scenarios in the US are very pessimistic: Stagflation, the risk of a new stock market crash and oil barrel at 100-150 USD. Do you see a way out of this mess?

MARTIN: The only way out is through. As I said above, the inflation will lessen the credit problem from housing. Oil prices will drop back once recession has hit, particularly as the Fed (probably following Bernanke's resignation) will have to switch to fighting inflation, probably late this year or in early 2009. Once the bad debts and bad investments have been liquidated, not just in the US but worldwide (think of Spanish housing, for example) we'll go back to growth, but I'd be surprised if that happened before 2011-2012.

What can be the geopolitical consequences of all this Decade of Deception?

MARTIN: Almost certainly a weaker US, not just weaker than in 1991 but weaker than we would have had if money had been kept under control. One of the principal advantages of rich countries over poor ones is a cheaper cost of capital, so that new investments can be made more cheaply, competing with poor countries' cheap labor. With excessively cheap money and the US payments deficit, much of the world's capital has flowed to the savings economies of Asia and the Middle East. Once capital becomes more again scarce, the West will have relatively less of it, so they will have burned off much of this comparative advantage. In general, Western wage rates and those in India, China and other competently run countries will tend to converge. Tata Motors and its Indian and Chinese competitors will take over most of the world's auto industry, for example.

© Gurusonline.tv, Jorge Nascimento Rodrigues