Greenspan Fears Imminent Stagflationary Slump, Warns The Bubble Is In Bonds Not Stocks

Former Fed chair Alan Greenspan blasphemously warned a year ago of an “imminent crisis”:

“This is the worst period, I recall since I’ve been in public service. There’s nothing like it, including the crisis – remember October 19th, 1987, when the Dow went down by a record amount 23 percent? That I thought was the bottom of all potential problems. This has a corrosive effect that will not go away. I’d love to find something positive to say.”

Adding that fundamentally it is not so much an issue of immigration, or even economics, but unsustainable welfare spending, or as Greenspan puts it, “entitlements.”

The issue is essentially that entitlements are legal issues.  They have nothing to do with economics.  You reach a certain age or you are ill or something of that nature and you are entitled to certain expenditures out of the budget without any reference to how it’s going to be funded.  Where the productivity levels are now, we are lucky to get something even close to two percent annual growth rate.  That annual growth rate of two percent is not adequate to finance the existing needs.

I don’t know how it’s going to resolve, but there’s going to be a crisis.

This is one of the great problems of democracy.  It goes back to the founding fathers.  How do you handle a situation like this?  And it’s very troublesome, but eventually you get things like Margaret Thatcher showing up in Britain.  Their situation is far worse than ours.  And what she did is she turned it all around essentially by, as I remember it, the miners were going to strike and she decided – she knew they were going to strike.  Since at that point, the government owned these coal mines, she built up a huge inventory so that when they went on strike, there was enough coal in Britain so that eventually the whole union structure collapsed.  She fundamentally changed Britain to this day.  The fact that we are doing so well in the E.U. is not altogether clear that it is the E.U. or whether it was Margaret Thatcher.

And now, a year later, Greenspan is back, warning of the return of stagflation unseen since the 1970s…

The former Federal Reserve chairman told Bloomberg the era of sluggish expansion without any meaningful increase in inflation is bound to end — not with an acceleration in growth, but with faster price gains. In other words, stagflation is on the horizon and that bodes poorly for the American economy.

“We’ve been in a period of stagnation since 2008 as a consequence of the sharp decline of capital investment and productivity growth,” Greenspan said during a telephone interview.

“But stagflation is about to emerge. We are moving into a different phase of the economy — to a stagflation not seen since the 1970s — that is not good for asset prices.”

And that, according to Grenspan, means trouble for risk assets. As Bloomberg reports, equity bears hunting for excess in the stock market might be better off worrying about bond prices, Alan Greenspan says. That’s where the actual bubble is, and when it pops, it’ll be bad for everyone.

“By any measure, real long-term interest rates are much too low and therefore unsustainable,” the former Federal Reserve chairman, 91, said in an interview.

“When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.”

However, Greenspan argues that stocks will suffer with bonds, as surging real interest rates will challenge one of the few remaining valuation cases that looks more gently upon U.S. equity prices…

“The real problem is that when the bond-market bubble collapses, long-term interest rates will rise,” Greenspan said.

We suspect Mr. Greenspan is correct…

Finally, as a reminder, In retrospect, the 91-year-old, who clearly is looking forward not backward, offered a simple solution to these problems a year ago: the gold standard.

If we went back on the gold standard and we adhered to the actual structure of the gold standard as it exited prior to 1913, we’d be fine. 

Remember that the period 1870 to 1913 was one of the most aggressive periods economically that we’ve had in the United States, and that was a golden period of the gold standard.  I’m known as a gold bug and everyone laughs at me, but why do central banks own gold now?

Why indeed. And of course, that’s rhetorical.