Greenspan Worries About Asset Prices

Speaking at the annual Federal Reserve Jackson Hole Symposium sponsored by the Kansas City Fed, Chairman Alan Greenspan said he was concerned about the increase in asset prices. “Our forecasts and hence policy are becoming increasingly driven by asset price changes,” he said. When the value of stocks and bonds to say nothing of real estate rises relative to income, it isn’t economic growth. It is asset price inflation. The only reason no one worries about it is that it favors the rich. The Fed should have been worrying about this all along.

To illustrate what is meant by asset-price inflation, one needs look no farther than the stock market. Consider a company that has its stock trading at $10 a share with a price to earnings ratio of 10:1. Presume also that it has 10 million shares outstanding and that its earning per share last year were $10 million. There are only two legitimate ways for its stock to trade at $20 a share this year. Either there is a reverse stock split reducing the number of shares to 5 million, or earnings have to rise to $20 million. Any other reason (such as the usual speculation made on Wall Street according to models or pure guess work) for the stock to rise is bogus. It is speculative, and it doesn’t represent an increase in the underlying value of the company. Instead, an increase in the stock’s price absent one of those two reasons reflects investor’s perceptions about the future value of the stock. In other words, it’s not reality.

Why should anyone care? Because the stock market operates on the “Bigger Fool” premise. John Doe is speculating that the stock price will rise and that John Q. Public will be willing to buy it from him when it does. In other words, “there’s a bigger fool out there.” And when there isn’t, the market crashes as Mr. Doe sells at a loss.

That is bad enough, but the talk of the housing bubble (about which a great deal of skepticism is in order) suggests the very same thing is going on in real estate. And bond prices are acting funny as well, as if yields will stay low forever, allowing prices to rise. And yet, nothing extra is being produced. No added value is created. In short, the increase in asset values reflects . . . nothing.

Mr. Greenspan is done as Chairman of the Fed in January, and it is too late for him to mend his ways – although his statement about asset prices puts him in the right direction at last. His successor needs to focus on the excessive speculation brought on by the pro-capital policies that have existed since Ronald Reagan’s first term. Wage inflation scares the bejesus out of Washington and Wall Street. The time has come for asset inflation to be treated the same way. As Mr. Greenspan said, if that change is made, the problem “can be rectified by adjustments in process, interest rates, and exchange rates rather than through more wrenching changes in [falling] output, [lower] incomes and [un]employment.”



© Copyright 2005 by The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without written consent.
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