Greenspan Warns of Bond Bubble

Former Fed Chief Alan Greenspan is sounding the alarm.  Interest rates that are too low for too long come with consequences and eventually, history shows, rates with go up.  As for what that means for the markets?  "Not good," he tells me in an exclusive interview.  Watch here https://www.facebook.com/RealTrishRegan and read transcript below:  

Greenspan On the Economy - "EXTRAORDINARILY SLUGGISH"

REGAN: So let's start first with your sense of the economy.  How would you assess it right now?  

 GREENSPAN: I would say it's extraordinarily sluggish, it's fundamentally being suppressed by a very low rate of increase in productivity, in fact, close to zero, and you can't get more than a 2 percent growth rate out of those numbers. 

REGAN: So why is it that, you know, we're in an environment where money's so cheap, I mean, people can borrow for basically next to nothing, and yet we're not growing more?  

GREENSPAN: Well, the basic problem is that we're not getting any capital investment that significantly adds to the growth in output per hour.  In fact, the best way of looking at this whole process is the fact that the sum of gross domestic savings in the United States and entitlements has been a constant relative to GDP for 50 years.  And if that is the case, then it means that for every increase, dollar increase in entitlements, you lose a dollar of savings. 

Greenspan on How Entitlements Prohibit Investment 

REGAN: In other words, we've got an entitlement problem on our hands?  

GREENSPAN: We've had an entitlement problem for years because entitlements have been growing under the administrations of Republicans and Democrats close to 10 percent a year for a half century.  We're finally at a point where it is, essentially, crowding out -- 

REGAN: But is this the reason, Chairman Greenspan, why companies aren't spending?  You say we've got this lack of capital investment.  Why is there such a lack of capital investment, given that money's so cheap?  

GREENSPAN: Well, basically because a goodly part of what is invested is the savings of people, and we're getting less and less of that as the consumption involved in entitlements year by year eats up, eats up the savings.  You cannot have investment without savings either borrowed from abroad or, hopefully, domestically. 

REGAN: You know, there are a lot of people that are very concerned about this low interest rate environment.  They say, to your point, you're not seeing enough investment by companies in things like infrastructure and people.  But you are seeing a lot of investment in the way of, say, mergers, with one company gobbling up its competition, as we well know, it may improve efficiency and productivity, but it doesn't really create jobs in the here and now.  And there are people, Chairman Greenspan, that are very concerned we're actually potentially looking at an asset bubble thanks to these low rates. 

 I want to share with you something that Carl Icahn said to me just recently on the program.  

 (BEGIN AUDIO CLIP)

 CARL ICAHN, BILLIONAIRE INVESTOR: The financial markets, I believe that there really is a bubble brewing, and interest rates now are at a low that, in the history of the Federal Reserve, they've never been held down this long, and I don't think anyone will deny that it's uncharted territory.  And it could be very, very destructive.

 (END AUDIO CLIP)

 REGAN: Chairman Greenspan, does Carl Icahn have a point?  

 Greenspan on Whether Fed Policy will be Destructive

GREENSPAN: He does.  Remember this: Normal interest rates, for a reasonably good debt, have always been in the 4 to 5 percent annual rate going back millennia.  We have data going all the way back to ancient Greece.  And interest rates were not all that significantly different then than now.  And we have daily data going back to 1694 with the Bank of England. 

 The reason that this is a critical issue is it's telling us that the interest rates we're looking at in history is probably almost certainly built into human time preference.  It's inbred. And that means we have pressed the interest rates well below normal for a protracted period of time and -- 

Greenspan Warns of Bond Bubble

 REGAN: And a what's the danger in that?  

 GREENSPAN: The danger is that they will begin to come up where they've always been for millennia.  

 REGAN: And what does that do to the markets when they do?  

 GREENSPAN: Not good.  Remember what a bubble is in a bond market.  We tend to think of stock market bubbles as very substantial price earnings ratios.  Well, if you turn the bond market around and you look at the price of bonds relative to the interest received by those bonds, that looks very much like the usual spread which would concern us if it were equities, and we should be concerned.  

 REGAN: So does this mean you're worried about a bond bubble right now in fixed income?  In bonds?  

 GREENSPAN: I think that it's -- there are two possibilities. Either we move slowly back to normal, or we do it in a fairly aggressive manner.  History tells us it's the latter which tends to be more prevalent than the former.  

 REGAN: So, as an investor, if you were an investor in this environment right now, would you be exercising caution?  

 GREENSPAN:  I wouldn't be answering your question. 

 (LAUGHTER)

REGAN: Meaning?  why not?  

 GREENSPAN: Because I don't talk about my individual investments and I don't talk about the Federal Reserve policies directly.  

 REGAN: That's fair.  But overall as you look at the market right now that has sustained itself on -- you know, some people have criticized it's sort of a sugar high -- has sustained itself on these zero interest rates, I think the big question in everyone's mind is whether or not this market is -- is able to continue moving higher if the Fed decides to raise.  

GREENSPAN: Well, I think the best way of looking at this is to recognize that the price earnings ratio is really statistically made up of two forces.  One is the equity premium which, actually, is a little out of line now, but not been materially so.  Plus, the level of riskless interest rates.  It's there that the basic problem arises, because, for whatever reason, whether it's the Fed moving or the market moving itself, bond prices fall, you begin to get very significant downward pressure on stock prices.  And there's where the real problem lies as far as equities are concerned, is that it cannot be dissociated from the fact that interest rates are historically too low and will have to move higher eventually.