I loaded up the Financial Times website just now and realized that I had suddenly struck blogger gold: it contained a link to a new op-ed penned by the father of the housing bubble, Alan Greenspan. No matter your view of Greenspan, many argue that he was the most powerful figure in the U.S. during his reign as Fed chairman, so his opinion is worth noting. I was tempted to dissect his piece, paragraph-by-paragraph. But instead, I'll just focus on one controversial part.
Again, I highly advise reading his whole piece, because I think it's interesting. He begins by giving his assessment of whether we're in recovery and how to make sure we get there. He then warns, at length, about inflation. He concludes by extolling the virtues of capitalism, reminding his readers that government controlled economies don't work.
He's not the first to worry about inflation, and I'll leave his pro-free market conclusion for someone else to complain about. But I find something he says about our economic recovery worth a bit of analysis. His advice for recovery: buy stocks.
Global stock markets have rallied so far and so fast this year that it is difficult to imagine they can proceed further at anywhere near their recent pace. But what if, after a correction, they proceeded inexorably higher? That would bolster global balance sheets with large amounts of new equity value and supply banks with the new capital that would allow them to step up lending. Higher share prices would also lead to increased household wealth and spending, and the rising market value of existing corporate assets (proxied by stock prices) relative to their replacement cost would spur new capital investment. Leverage would be materially reduced. A prolonged recovery in global equity prices would thus assist in the lifting of the deflationary forces that still hover over the global economy.
I recognise that I accord a much larger economic role to equity prices than is the conventional wisdom. From my perspective, they are not merely an important leading indicator of global business activity, but a major contributor to that activity, operating primarily through balance sheets. My hypothesis will be tested in the year ahead. If shares fall back to their early spring lows or worse, I would expect the "green shoots" spotted in recent weeks to wither.
The first paragraph above seems pretty logical. Higher stock prices help companies. No argument from me there.
But the second paragraph fascinates me. He seems to turn the usual wisdom regarding the correlation of stock prices and a healthy economy on its head: it's higher stock prices that can get us out of the recession -- not coming out of the recession that gets us higher stock prices.
In a sense, he must be saying irrationally positive expectations about the economy are self-fulfilling. Investors just need a mind-over-matter attitude about the economy and they can will it into recovery. Three cheers for consumer confidence: Hip, Hip, Hooray!
I see what he's saying here, and I even think his logic, strangely, makes some sense. But I can't get past his seeming denial that firms must have some underlying value that their stock price should be based on. Greenspan appears to indicate that the value is simply whatever we will it to be. The reason that could make sense is probably because future growth is part of a stock's underlying value. Still, it seems a tad presumptuous to say that growth will be higher simply because we say so.
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