“Fear and euphoria are dominant forces, and fear is many multiples the size of euphoria. Bubbles go up very slowly as euphoria builds. Then fear hits, and it comes down very sharply. When I started to look at that, I was sort of intellectually shocked. Contagion is the critical phenomenon which causes the thing to fall apart.”
— Alan Greenspan
A push to lower interest rates to 1% in a world of 2.5% inflation would essentially make
it free to borrow in real terms – and a bubble would result.
July 30, 2025 — Easy money is in its own way a mass psychology event.
As more and more money was spent on information technology, and computational power continued to follow Moore’s law — doubling every 18 months — GDP and productivity numbers began to look like someone with too many facelifts — grotesque and unrecognizable.
But it was not until the last quarter of 1999 that this hedonic measure really put the productivity numbers in their most flattering light.
Info tech spending went wild in the last half of 1999 — urged to excess by the Y2K threat.
This activity was amplified by the Bureau of Labor Statistics to such an extent that its message could be heard all over the world: 6% productivity was a triumph — the New Era was paying off! The third and final quarters of 1999 produced some very healthy numbers for labor productivity.
The Bureau of Labor Statistics recorded the rate of increase at 5% in the third quarter and 6.4% in the fourth. It was partly on the basis of these numbers that the historic shift of money from the Old Economy to the New Economy was justified and explained.
The Old Economy was said to be growing sluggishly, while the new one seemed to be propelled forward at ever-faster speeds by the incredible productivity gains made possible by IT. “Incredible” was the operative word. When the productivity numbers were deconstructed, they looked less than credible, if not outright fraudulent.
As Kurt Richebächer put it, “After three years of near-stagnation between 1992 and 1995, productivity growth all of a sudden began to spurt in [the last quarter of 1995]. What caused that?”
What caused it was that the Bureau of Labor Statistics changed the way it calculated productivity. It began to look at what it called a “hedonic” price index that took into account not just the price of computer equipment, but its computational power.
On the surface, this makes some sense. If a dollar buys twice as much computational power one year as the next, it is as if the price of computing power had fallen in half. The third quarter of 1995 was the first time this change took effect. It miraculously transformed $2.4 billion in computer spending into $14 billion of output, instantly boosting GDP by 20%, lowering inflation, and increasing productivity (output per hour).
The number for the fourth quarter, to repeat, was spectacular. Incredible. It was revised later to an even more incredible 6.9%. The only trouble was that it was not real.
It was, like the New Era that supposedly made it possible, a fraud. More computational power is not the same as economic growth. And being able to turn out more computational power for each hour of labor input is not the same as an increase in labor productivity.
Like the millions of lines of code and the millions of miles of fiberoptic cable, computational power is only as valuable as the money that people are willing to spend to get it. And that is measured not by hedonic numbers, but by real dollars and cents.
What was true for the nation’s financial performance was also true for that of individual companies. Companies engineered their financial reports to give investors the information they wanted to hear. What they were often doing was exactly what Alan Greenspan worried about — impairing balance sheets in order to produce growth and earnings numbers that delighted Wall Street.
Curiously, during what was supposed to be the greatest economic boom in history, the financial condition of many major companies actually deteriorated.
Regards,
Addison Wiggin
Grey Swan Investment Fraternity
Continued Below…
P.S., This essay is an excerpt from the third post-pandemic edition of Financial Reckoning: Memes, Manias, Booms & Busts, Investing in the 21st Century.
Today, as investors clamor for all things AI, talk of increased productivity is back. Yes, AI tools can allow workers to do more in the time they have. And we could see a 1990’s-style productivity boom in the years ahead. But we are also running dangerously close to a bust…
President Trump’s push for lower interest rates would give the economy one last gasp higher – amid a speculative bull market driven by free money, not fundamentals.
Remember, President Trump is calling for 1% interest rates. But inflation is 2.5%. In that world, there’s a strong economic incentive to borrow money and put it to work in anything that could generate a positive return – even if it doesn’t end well a year or two down the line.
Those moves – which the most recent of which can be seen with the SPAC bubble of 2021 – are classic Grey Swan events.
You can forecast them, avoid losses when the bubble pops, and even come out ahead if you know where to invest.
Your thoughts? Please send them here: addison@greyswanfraternity.com
