Postponing the Day of Reckoning Only Makes It Worse - TheStreet

Postponing the Day of Reckoning Only Makes It Worse

Watch out for weakness in the dollar. Also, Easy Al speaks.
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Editor's note: This column, which reflects market activity from the day before, originally appeared May 8 on To sign up for RealMoney, where you can read Bill Fleckenstein's commentary every day, please click here for a free trial.

The foreign markets were a nonevent, but foreigners delivered big news when the European Central Bank and the Bank of England announced their decision not to lower interest rates. That set off an explosion in the euro, and it tanked our stock index futures. When the casino opened for business, the major averages were down about 1%. By that time, the euro was up nearly 1.5%. Then the euro started to retreat, and with that, the stock market began creeping up, almost in a tick-for-tick fashion.

Dollar-Denominated Relief

: I point this out because it strikes me as so reminiscent of people's response to dollar weakness in early 1987. Today, the market gapped lower as the euro gapped higher. Then, as the euro started to decline, stocks ticked up as bulls decided all would be well. (I think bulls were also emboldened when


(WMT) - Get Report

shares were barely dented and, in fact, turned green after the company once again reported lowered growth in same-store sales.) It's a classic pattern of seeing only the trees and not the forest, and there will probably be more of this (trying to put a bullish spin on the dollar's decline) before the dollar's decline has run its course. I fervently believe that we are headed for real trouble in currency land. Folks who think otherwise had better have a darn good reason, and not just revert to arm-waving.







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In any case, after the initial setback in the euro/rally in stocks, we went into a mini-flop-and-chop, and then the market started sinking. After basically grinding lower in fits and starts, we closed pretty near the lows of the day, though as the box scores show, those prices were not terribly extreme. It was interesting to note that the bank stock index was appreciably weaker than everything else. And, the euro managed to finish, in essence, on its high tick of $1.115, a closing price seen only on a handful of days since it began trading in early 1999.

Simon Says, Be Sanguine

: I talked to a couple of thoughtful stock bulls today and asked them why they weren't concerned about the dollar. They pointed out that the fixed-income market showed no signs of being worried about the dollar. They added that if the dollar were a problem, it should show up in the fixed-income market first. I agree that it probably should show up there first. But when I talked to one of my most knowledgeable friends who watches the fixed-income market, he said that the fixed-income market wasn't paying any attention to the dollar because it believed it had a Greenspan put, and that the


would make the entire curve trade higher in price. So, one can quickly see that if those are really people's views, we could easily witness a massive dislocation at some point.

Away from stocks, I have already reprised much of the action in the currencies. Fixed income closed slightly firmer. The metals, however, were quite firm, with silver and gold up 1.5%.

Blowing Off a Time Bomb

: Turning to the news, there are a couple of items worth discussing. Easy Al was speaking to the Conference on Bank Structure and Competition about derivatives. To his mind, they've probably been one of the greatest innovations in the history of finance, if not the world. He said, "Although the benefits and costs of derivatives remain the subject of spirited debate, the performance of the economy and the financial system in recent years suggests that those benefits have materially exceeded the costs." I would just add, SO FAR.

Near as I can tell, the one thing you can say about derivatives is that they've behaved darn well so far. Despite lots of dislocations in lots of markets, we haven't had any financial system implosions,


that doesn't mean they won't happen. Certainly, that is the belief of clear thinkers like Warren Buffett and Charlie Munger, who since owning General Re have had a pretty close look at derivatives.

Sir Al Raises His Excuse Excalibur

: Greenspan did acknowledge some of the dangers, citing the fact that there are just a handful of dealers. He allowed as how he is worried about "potential implications for market liquidity and for concentration of counterparty credit risks." Well guess what? This has been the story all along. Even though some dealers have dropped out of the market, there's been a huge concentration for some time. And by definition, these are nonstandard derivatives contracts that are illiquid in the first place. So, now he's trying to throw up a straw horse, whereby if there's a problem, it won't be his fault because the markets


illiquid and concentrated. By his reckoning, there was nothing wrong with this wonderful idea called (nonexchange-listed) derivatives per se.

This is pure, utter nonsense -- the kind he has been spewing for years. He starts a financial experiment, he gets us into a corner, things start to blow up, he does something else, winds us into another corner, and we keep going and going until sooner or later, the whole thing caves in, which is the path we're on right now. I won't go into great detail, but just think about what he's done in his "illustrious" tenure as Fed chairman: the bailouts of Mexico and Orange County in 1994, the Asian crisis in 1997, Long Term Capital and Russia in 1998, and the Year 2000 in 2000. Most recently, he has precipitated a housing bubble.

So, now we find ourselves trapped in a corner. We're dependent on levered-up houses to carry the economy; we're dependent on derivatives not to go haywire, and, we're dependent on foreigners not to precipitate a serious out-of-control move in the dollar. That is a recipe for enormous trouble. How happy can anyone be with a Fed chair who has unleashed such damage, and yet who remains blind to the consequences of his reckless behavior?

Bull's-Eye, at First Blush

: Turning from the clueless to the almost clueless, I was struck by an editorial in today's

Wall Street Journal

titled "Greenspan's Post-


." (Do you think they read my

speech, "Spinning Financial Illusions: The Story of Bubblenomics"?) Initially, the


seems to demonstrate an understanding of the problem -- at last. Referring to the easy-money policies of the Fed, it says, "All of that easy money has helped cushion the economy in the wake of the bursting telecom, dot-com and stock-market bubble, notably by financing a real estate price boom. This in turn has buttressed consumer confidence and spending, which has provided most of the growth we've had while business struggles to get its groove back." Yep, that's absolutely correct.

The editorial then goes on to note: "The bad news is that real estate prices can't rise by 15% and 20% a year forever, any more than stock prices could," although when stock prices were rising like that, the


never seemed to think there was any direction but up, as it shared Greenspan's belief in the "new economy" -- and continues to capitalize the


and the


in that extinct notion.

Anyway, the editorial proceeds to opine that "regarding this fear of deflation, it's important to point out that

not all falling

prices are dangerous

the emphasis is mine." It deems falling prices of "goods and services" to be OK, because that's a result of productivity. Continuing on, it adds, "The deflation that Mr. Greenspan wants to avoid is in



the paper's emphasis, not mine, such as real estate. That's the kind of deflation that can create a cycle of stagnation, or


the emphasis is mine."

All Apogee, All the Time

: And this, ladies and gentlemen, is the problem. It is completely and totally naive, stupid, dangerous, mad, whatever adjective you want to use, to think that we can have permanent prosperity. But that is held up as a goal by the newspaper's editorial board. Whatever happened to the inherent boom-and-bust cycle of capitalism, where the bust sets the stage for the boom, the boom causes the bust, etc.? What Greenspan has tried to do is to attempt to subvert capitalism by replacing the bust with permanent prosperity, which will ruin the system for everybody for quite some time. The


almost seems to understand this, but then appears to advocate the "wisdom" of fighting off the downside. This is pure lunacy.



goes on to compound this with the following: "We trust that the Greenspan Fed isn't signaling this week that it's willing to reinflate to keep real estate and thus the broader economy afloat." Huh? What else does the paper think he's doing, and how can it possibly say that? The answer lies near the end of the editorial, I believe, when we see that it's using our problems as a stalking horse to push for tax cuts. This is wrongheaded, though not because tax cuts are a bad idea. I'm all for them, as I think the government can always make do with less (though reasonable people can argue about that).

Greenspan Auditions for Mother Nature

: Tax cuts are not a solution to our problems for the same reason that the 12 rate cuts haven't worked. Before the government can be of help (usually an oxymoron), we have got to let the markets start to clear, let capacity get rationalized, and let the bust that follows a boom start to do its work. Then, we can talk about help from the government. What the government and the Fed have been doing is, they've tried to stop the tide from coming in, or the tide from going out, depending on how you want to look at it, through interceding in the creative destructive side of capitalism, thereby postponing the day of reckoning and making things worse, such that by the time nature has run its course, there won't be anything they can do to try to make it better.

This is why the bust that follows a bubble lasts for a decade or so. In the 1930s, the government meddled. In Japan, the government has meddled. And here we are meddling. That is why bubbles are so dangerous. They create massive dislocations, and then the "powers that be" try to fight them off, and we end up in the soup. Of course, as we wind down this path toward trouble, there are intermittent periods where things don't look so bad, and Greenspan can get away with some of these idiotic statements he's making, and folks can proclaim a new bull market. But all that is pure folly.

William Fleckenstein is the president of Fleckenstein Capital, which manages a hedge fund based in Seattle. Outside contributing columnists for and RealMoney, including Mr. Fleckenstein, may, from time to time, write about securities in which they have a position. In such cases, appropriate disclosure is made. At time of publication, Fleckenstein Capital did not hold any positions in stocks mentioned, although positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Mr. Fleckenstein's columns are his own and not necessarily those of While Mr. Fleckenstein cannot provide personalized investment advice or recommendations, he invites you to send comments on his column to