Greenspan's Catch 22 (page 1 of 3)

In the late 1990s, numerous economists and strategists distinguished between the 'old economy' and the 'new economy'.

'Old economy' companies were companies that made some money, had reasonable stock market valuations, and a relatively high earnings visibility. 'New economy' companies, on the other hand, were engaged in new and unproven industries, in which were the pace of technological innovation was extremely rapid and, therefore, also obsolescence.

Moreover, all the profits and some more had to be reinvested in research and development. New economy companies were also characterized by very high valuations (in March 2000, NASDAQ at 5000), and almost no earnings visibility.

Well, we now know what happened to the then popular buzzword 'new economy', but to be fair, there is indeed a new economy in the world. It is just different than what the visionaries had anticipated.

The new economy is characterized by the rise of China, India and to some extend also Russia as global economic and geopolitical players. Out of the blue and certainly totally unexpected to the American visionaries that spent their days counting irrelevant eyeballs in order to value Internet stocks, China has overtaken the US in many markets such as for steel, iron ore, copper, not to mention in the production of appliances and consumer electronics.

But more importantly the 'newest economy' is characterized by seemingly endless bubbles, courtesy of the man who has done more to destroy the value of paper money than any one else in the 200 year history of capitalism: Mr. Alan Greenspan.

The destruction of paper money as a store of value - the most important quality paper money should have - occurs only in one way and that is through increasing the quantity of paper money at a higher rate than real GDP growth.

At times this excessive money supply growth will lead to real wages rising strongly, such as in the 1960s, or to commodity and consumer prices soaring, such as in the 1970s. But, excessive money supply growth can also lead to the most dangerous form of inflation and this is asset inflation, which at times will boost equity prices to lofty levels (Kuwait in 1980, Japan in 1989, Taiwan in 1990, NASDAQ in 2000, etc) and on other occasions boost the value of real estate into cuckoo-land (Tokyo in 1990, Hong Kong in 1997, and now in the Anglo Saxon countries).

The reason asset inflation is so dangerous is that central bankers - usually unemployable in any other capacity - not even as waiters - only pay attention to consumer price inflation. Therefore, when consumer prices do not rise much, for example because of international competition (as is now the case), they print money like water.

So, with the entry of China and India into the global economy we had low consumer price increases around the world - although higher than the statisticians in the US are under political pressure computing, calculating and doctoring - and this led Mr. Greenspan to create, after he fueled the NASDAQ investment mania with easy money, another gigantic bubble: the housing bubble!

How to spot bubbles

There are many ways to recognize a bubble. One of the most reliable indicators that an investment mania is underway is always very high volume. In the case of US housing it is the number of home sales as a percentage of households that show how speculative the market has become.

Annual home sales as percentage of households is now at all time high. I am not suggesting that US housing cannot get even more over-heated but very clearly we are in housing not near a low such as was the case in 1971, 1982, and 1992.