It seems Alan Greenspan is to wannabe economists as
Harry Potter is to elementary school students: Each introduce their
reading audience to new, exciting and yet mysteriously nebulous terms.
Not that I don't know what a "conundrum" is, but like "irrational
exuberance," Greenspanage linguists can add "conundrum" to the list of
newly coined economic technical terminology.
Sometimes I like to stay up to the wee hours of the
morning watching joint congressional economic committee testimony on
C-Span. Most recently, I enjoyed no less than three hours of Mr.
Greenspan's testimony regarding the state of our economy.
Congress and Greenspan seem to be concerned, and
obviously confused, as to the "conundrum" regarding the interest rate
spread-that is, the difference between short-term interest rates and
long-term interest rates. The problem is that even as short-term
interest rates continue to rise, long-term rates seem to-believe it or
not-even drop at times. Not normal, says the Fed-true; but is it really
a conundrum?
Not if you ask Adam Smith. Remember him, the Father
of Modern Economics? Professor Smith would say the answer is obvious:
Long-term rates are driven by the market, and short-term rates are not.
The Fed sets the short-term rates, and it's their perception of the
market, not the market itself, that sets the Fed's policy.
Think about it in your own terms. You know-because
Greenspan has repeatedly said so-that short-term rates will continue to
rise. Do you want to "lock in" to an interest rate for ten years when
you know that if you wait just a little longer, you can "lock in" to a
higher rate? How many people are buying five-year CDs right now? Most
are buying one- to two- year CD's, which makes perfect sense.
Sometimes I think Greenspan and his band of Ivy
League economists live in a world one or two levels removed from the
majority of America. Don't take my criticisms of the Fed too
seriously-even Babe Ruth struck out now and again. For the most part,
they have governed brilliantly, and Mr. Greenspan made some very
insightful remarks during his Congressional testimony that I was
relieved to hear.
Most importantly, the Fed seems to indicate that it
finally realizes the financial universe is forever changed. Simply put,
it no longer makes sense to think of America as a closed economic
system, since financial globalization and multinational corporations
have forever changed the global economic landscape. A good analogy
might be the United States in the early 1800s, where Georgia had very
little economic interest in what went on in Detroit.
In the early 1900s, the U.S. had very little
economic interest in China, for example. As you well know, that has
certainly changed. What has not changed, however, is the kind of
intranational, zero-sum valuations and closed-system-mindedness that
have persisted since World War II. What has already begun, and must be
recognized and indeed, even embraced, is the extrapolation of an
economic system from nationalism to globalism as once it extrapolated
from intrastate to interstate. This is already happening.
Mr. Greenspan could not be more correct in his
insistence that Congress and the President get the federal fiscal
budget under control, as well as deal with the impending liabilities
required to service our Social Security system and other social systems
that are sure to require more funding-especially given the projected
demographics of our society in the decades to come.
We are witnessing an incredible event in the annals
of human history, as the entire world-save one or two outlaw
states-participate in a world global market ... the predecessor of a
one-world market, and even a single global currency.
In and of itself, this event would be theoretically
financially advantageous to all participants. Ultimately only time will
tell. Nevertheless, what is certain is that the adjustments will be
rough, and the transition slow and confusing to many. The Internet, in
addition to making the world a smaller place, has made it much easier
for the average person to make adjustments in his accounts. This
anomaly is not restricted to America, but is a phenomenon occurring en
masse all over the world.
With the Internet, everybody can be a trader, and
you can do it right from the comfort of your own home, in the middle of
the night in your pajamas, no less. In 1980, less that 900 million DJIA
shares were traded; by 2002, that number had skyrocketed to well over
85 billion-an increase of over 9,000%. And how are these millions of
new global investors making their investment decisions? Sadly, they are
nothing more than media consumers.
For example, every February, Money magazine
publishes its famous "Best Funds to Buy Now." In 1992, they came out
with "20 Great Mutual Fund to Buy Now." The following year, the 1993
issue listed the "12 Funds to Buy Now," but only one was a repeat of
the 1992 list. The 1994 issue had "The Nine Best Funds to Buy Now," but
again, no repeats. The 1995 issue listed the "Eight Most Dependable
Funds." Would you like to guess how many were repeats? You got it:
zero. The 1996 issue: nine funds, no repeats; 1997 issueƦ11 funds, no
repeats; 1998 issueƦfive funds, once again, no repeats.
What does this tell us? Well, after seven years, and
recommending 74 funds where only one was a repeat, all they are doing
is reporting what funds were the best performers last year-which for
next year is useless.
By understanding how and why these new, chaotic
forces drive the global markets, we can take advantage of these trends
by acting conversely. Most important, however, is the resistance to "go
along with the herd." Lessons of the last decade should be proof enough.
Today's professional advisor needs to be, among
other things, the "noise diffuser," and constantly remind clients that
"by the time you hear about it, it's usually too late." Clients will
appreciate your caution and rational thinking during an era when
sensational headlines outsell boring rational advice 1,000 to 1.
As it turns out, Greenspan's "conundrum" makes
perfect sense. Free-market forces are driven by supply and demand, and
the Fed funds rate is anything but "free." As soon as the market thinks
the Fed is done manipulating the rate (let's just call it what it is),
you'll see the demand for longer terms strengthen, and "poof"-just like
that, there goes the conundrum.
Kevin Meaders, J.D., CFP, ChFC, CLU, is founder of Magellan Planning Group Inc in Atlanta.
Riding Out The Interest Rate Conundrum
September 2005
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