Alan’s Bubble — The Rinse Cycle

Greenspan The following is “Greenspan Speak” for “Oh shit, I’ve created the mother of all asset bubbles and when the rinse cycle comes it ain’t gonna be pretty… and I’m gonna be remembered as the man who made it all possible… They might even call it ‘Alan’s Bubble!’”

In Alan’s own words:

 

“History has not dealt kindly with the aftermath of protracted periods of low risk premiums.”

 

“What they perceive as newly abundant liquidity can readily disappear,” Greenspan said.

 

“Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher prices.”

 

“If we can maintain an adequate degree of flexibility, some of America’s economic imbalances, most notably the large current-account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more-wrenching changes in output, incomes, and employment.”

That last bit means this:

Asset prices ==> down

U.S. interest rates ==> up

U.S. dollar ==> down.

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Housing boom is an imbalance: Greenspan

By Greg Robb, MarketWatch

Last Update: 10:01 AM ET Aug. 26, 2005

 

JACKSON HOLE, Wyo. (MarketWatch) — In his sharpest words to date about rising home prices, Fed chief Alan Greenspan described the housing boom as an economic imbalance that could end badly for the economy.

 

In prepared remarks to the Jackson Hole Fed policy conference, Greenspan said high home prices were due in part to low risk premiums demanded by investors. Such increases in asset values “are too often viewed by market participants as structural and permanent.”

 

“History has not dealt kindly with the aftermath of protracted periods of low risk premiums.” Read his remarks.

 

Greenspan warned asset values could fall if investors grow cautious and demand higher interest rates. “What they perceive as newly abundant liquidity can readily disappear,” Greenspan said.

 

“Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher prices,” Greenspan said.

 

Greenspan said the flexibility of the economy is the most important policy asset in handling any shocks from a fall in asset values.

 

He expressed optimism that the adjustments could be made gradually and a recession could be avoided.

 

“If we can maintain an adequate degree of flexibility, some of America’s economic imbalances, most notably the large current account deficit and the housing boom, can be rectified by adjustments in prices, interest rates, and exchange rates rather than through more-wrenching changes in output, incomes, and employment,” Greenspan said.

 

Protectionism and the large U.S. fiscal deficit threaten flexibility, he said.

 

The Fed chairman, who is scheduled to leave his position by the end of January, said central bank forecasts and monetary policy are becoming increasingly driven by changes in asset prices, such as equities, bonds and real estate.

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