At Arm's Length - Financial Commentary about Money, Investing, and How It Affects the Average Investor

At Arm's Length: 02.18.05

An Unanimous Call for Length

Pension problems have created new problems for the fixed income market. Many investors are not aware of the shortfall in pensions and how they will affect the bond trade but the underestimated numbers recently announced by the Labor Department speaks volumes. Elaine Choa spoke to the issue suggesting that many defined benefit pensions have missed their projections by nearly $450 billion.

Changes in the current actuarial rules would send this vast sum shopping for securities and this has brought the call for the 30 year long bond to be reissued. The Treasury stopped issuing this bond in 2001 citing the expense of long term borrowing. Traders however are beginning to suggest that times have changed and with the yield curve experiencing volatility, the disappearance of the surplus - the other reason the bond was pulled, and the possibility that these deficits will be a long term problem, the 30 year long bond is more important than ever.

The price on the 30 year long bond has climbed recently as a result of this rule change. In fact, the Pension Benefit Guaranty Corporation has also started to change their investment strategy to target some of their own underestimations. PBGC is basically an insurance company sponsored by the federal government, collecting premiums from member companies and insuring the retirement plans from default. The agency has come under pressure recently because of the large amount of plans it is now responsible for, which has caused much concern in the fixed income markets.

The reluctance of the Treasury to reissue this bond has become endemic of the leadership at the department. The argument is simple. Worldwide, the yields on long issues have remained incredibly low. It stands to reason that the US offering would also be kept low. Offering the long bond would be beneficial for tax payers and that should be reason enough.

Inflation worries have piqued with the release of the Wholesale Producer Price Index. The oddly important core number that rose 0.8% against an expectation of 0.2%. The effects of this number will be spread across many markets.

In fixed income securities, the yield curve that had be worrisome because of flattening will steepen as investors look to protect themselves from inflation. The worry that Mr. Greenspan will push the short term rates higher as a result of this problematic number also should push the yield higher.

In stocks, this would have the greatest effect on inflation sensitive issues that would include dividend producing equities.

At Arm's Length: 02.14.05

If not Alan, then Who?

This week marks one of the final meetings that Alan Greenspan will have with the elected on Capitol Hill as the Federal Reserve Board Chairman. Traveling to first the Senate Banking Committee on Wednesday and then to the House to appear before the Finance Committee, the nation's top banker will be delivering his semi-annual Humphrey-Hawkins report. The chairman is scheduled to retire in 2006.

While speculation among pundits is running wild about who his successor will be, the change in leadership at the Fed should come with a brief understanding of what that job now entails.

Mr. Greenspan began his career as Director of Domestic Policy for the Richard Nixon campaign in 1967. His career in economics took him farther away from his consulting firm when he accepted the job of Chairman of the Council of Economic Advisors under President Ford in 1971. He left that position when Carter defeated Ford choosing instead to re-enter the Washington limelight as the Chairman of the National Commission on Social Security Reform from 1981 to 1983. In 1987, he began his leadership role as the head of the Federal Reserve. He has held that position for five consecutive terms.

How history will judge his accomplishments as chairman will be based largely on how he leaves the nation's banking system.

Many, including myself, have faulted the nation's top economist for his seemingly methodical handling of economic crises that have occurred during his tenure. The run up to the stock market bubble in the late nineties and the eventual crash may have been facilitated by his policies. Calls for tighter margin controls, which it is only fair to note do not fall under the Fed's jurisdiction, may have been unwarranted.

Greenspan has always been a fan of the gold standard and an important essay about the subject written by him was included in the Ayn Rand book, Capitalism, the Unknown Ideal, a non-fiction effort full of her well known objectivist views. Greenspan was part of her inner intellectual circle.

In his essay, Gold and Economic Freedom, he wrote:

The existence of such a commodity is a precondition of a division of labor economy. If men did not have some commodity of objective value which was generally acceptable as money, they would have to resort to primitive barter or be forced to live on self-sufficient farms and forgo the inestimable advantages of specialization. If men had no means to store value, i.e., to save, neither long-range planning nor exchange would be possible.

Offering gold as "sufficiently durable to serve as a medium", "easily portable" as well as "homogeneous and divisible", he argued that the gold standard would free banking, enabling it to "create bank notes (currency) and deposits, according to the production requirements of the economy".

Once a standard is established, the currency of a nation did not matter as long as the money was backed by something tangible such as gold or silver.

The Federal Reserve, created in 1913, was not always successful in their economic policies. One of these policies, which seemed to mirror the freewheeling availability of money supply which lead to an incredible run-up in the stock market of recent years became the speculative bubble burst that led to the Great Depression. Unfortunately for the banking system, the mixed gold standard that Federal Reserve used at the time was blamed almost solely on the gold portion of the equation.

Politicians realized that gold, the tangible asset, could not be used to create deficit spending. Politicians believed that borrowing money without the backing of gold was the only way to finance welfare expenditures on a scale large enough to lift the country out of the Depression. That thinking is prevalant today.

While the one main function of the Federal Reserve is to regulate the money supply so as to keep production, prices, and employment stable. This is a feat that Greenspan has achieved with mixed success. He has had memorable moments of overwhelming success followed by periods of uncertain accomplishment.

Under his tenure, the stock market has rallied and fallen, often hinged on his cryptic messages about direction, the pace of interest rate increases or contractions, his belief in the underlying principles of deficits and tax deductions, and his comments about productivity and employment.

The bond market has reacted much the same way, often mirroring the equities markets as they scratch their collective heads trying discern the meaning of "measurable" and "sustainable". Recently, his gradual and steady interest rate increases have not have the desired market correction needed to rein in overspeculation, the twin deficits, and the proposed permanence of the President's tax cuts.

The housing market took off after the stock market bubble burst aided by his ability to flood the market with readily available and inexpensive money. This boosted consumer confidence even as the savings rate dwindled to near zero and unemployment picture improved little. In fact, even as the unemployment rate has fallen, the ranks of disparaged workers has grown.

Productivity, once thought to be the bastion of stability was increased largely due to the ability of companies to decrease the size of their workforce rather than increase the amount of products produced.

As he prepares to leave his position, productivity is slowing, the deficit, both federal and trade, continue to climb unabated supported by false promises of restraint and fiscal discipline, and the distance between income classes widens.

The big question now becomes, how will the Fed handle itself after Greenspan? They essentially have two choices. They could establish a set of guidelines to govern the economy with and in doing so, would avoid seeming politically motivated by any future decision.

Should they decide that the Fed remain flexible, using what is referred to as a discretionary approach, it would allow them to stand up to the politicians and make unpopular statements. This is the current way the Board conducts business allowing speculation to run rampant while they hold their cards close to the vest.

Expect Mr. Greenspan to assume the position of the Secretary Treasurer soon after he leaves the top banking spot. This would give him the ability to challenge economic policy in a way that might get him fired. But it would be a very high profile dismissal indeed.

The previous week's articles.

COLUMN REQUEST | AT ARM'S LENGTH ARCHIVE | WHO WE ARE | CONTACT US | LEARNING CENTER