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Does Greenspan Deserve Another Term? / Artikel mises.org

verfasst von - Elli -, 21.11.2003, 16:52

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Does Greenspan Deserve Another Term?

 
By Joseph T. Salerno

[Posted November 21,
2003]

<img alt src="http://www.mises.org/images/absolut-small.gif" align="right" border="0" width="178" height="248">On
April 22, 2003, President Bush declared
in response to a reporter's question,"I
think Alan Greenspan should get another term."  Bush's expression of
support for Greenspan's reappointment to another four-year term as Fed
Chairman came more than a year in advance of the expiration of the Chairman's
current term in June 2004. Even if he ultimately decides to decline
reappointment, the question"Does Greenspan Deserve Another Term?"
deserves to be considered for the light it sheds on the performance of the
U.S. economy in the twenty-first century.

To begin with, my
answer to the question posed is a resounding"No!" There are two
reasons for this negative response. First, the Fed's performance has been
astoundingly bad throughout Greenspan's tenure as Chairman. And second, and
perhaps worse, Greenspan has been a relentless purveyor of economic fallacies
designed to obscure and justify this egregious performance.

Unfortunately,
Greenspan's exalted position combined with his unrivalled facility for
circumlocution and obfuscation has resulted in his blizzard of fallacious
dicta being seized upon by the media, the markets and even many professional
economists as profound insights into the economic process.

Incredibly, the
media-fueled cult of Chairman Greenspan continued on throughout the 1990's
despite the fact that some of the most celebrated pseudo-profundities that he
uttered represented blatant reversals of views he had expressed just months
earlier. For example, Greenspan's famous"discovery" that the
productivity growth of the New Economy was causing the stock-market boom of
the late 1990's came hard on the heels of his contradictory and equally famous
declaration that the stock market run up was being driven by"irrational
exuberance."<a id="_ftnref1" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn1" name="_ftnref1">[1]</a>

In an
address a few years ago, I gave a
detailed analysis and critique of Greenspan's public utterances on money and
the economy. I concluded that they added up to little more than empty rhetoric
that served as a cover for the Fed's cheap money policy of the Clinton years,
which had caused massive and unsustainable malinvestments in the real economy
and an inflationary bubble in financial markets.

There is no need to
repeat this analysis here. However, I would like to quote the concluding
paragraphs of this paper because they bear on Greenspan's more recent words
and deeds that will be dealt with below. In February 2001, I wrote:

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">
This
monetary tightening [of 2000] devastated the New Economy and the NASDAQ
tanked, falling by over 50 percent from its high in March 2000. But, even
more importantly, it also brought the investment boom in the real sector of
the economy to a screeching halt. This momentous news was duly noted in the Wall
Street Journal...:  'And new numbers out yesterday [January
31, 2001] show that investment did drop in last year's fourth quarter...
business investment on equipment and software actually fell at a 5% rate—a
dramatic reversal from 21% growth in the first quarter of 2000. A big drop
reported last week in orders for capital goods, excluding aircraft and
defense, suggest that capital retrenchment isn't over.'

This news
should give Greenspan a great pain in the pit of his stomach.<a id="_ftnref2" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn2" name="_ftnref2">[2]</a>  Unfortunately,
it is unlikely to do the economy any good, because Greenspan and the legion
of economists, journalists and business leaders that he has misled with his
empty talk believe that the slowdown is a simple matter of sagging spirits
and lost faith and that this malaise can be cured by the psychological hocus
pocus of reducing short-term interest rates—i.e., turning on the monetary
spigot full blast again. This does not appear to be working however.
Although Greenspan's first interest-rate cut on January 3 appeared to give
the NASDAQ a boost, despite a second cut in interest rates on January 31,
the index has fallen back into the doldrums where it began the year. So I
hold out great hope that before the end of this year, with the arrival of a
full-blown recession, all will finally see that the Maestro has no clothes—and
absolutely no real knowledge of how the economy works. I wonder what the
probability would be of his resigning in that case?

[/i]
Permit me to boast of
my prowess as a contrarian economic forecaster for a moment:  one month
after I wrote those words, the U.S. economy plunged into recession according
to the official definition of the NBER.

Actually, my forecast
that the economy was on the precipice of recession, when almost everyone else
was misled by Greenspan's talk of a"soft landing," was based
squarely on the Austrian Theory of the Business Cycle. This theory informs us
that a fall in real investment resulting from a reversal of inflationary
monetary policy, which occurred in 2000, presages the inevitable onset of
economic recession.  

Moreover, the theory
focuses our attention on the pattern of real investments in the economy, which
is distorted by the Fed's persistent manipulation of interest rates. Once such
distortions have built up over time and have been embodied in the economy's
structure of physical capital goods, it requires a long period of readjustment,
which non-Austrians call a"recession," to correct them.

Unfortunately most
economists and market pundits ignored this insight and focused exclusively on
financial markets rather than the underlying entrepreneurial combinations of
concrete capital goods to which stocks and bonds are mere property titles.
Thus they were taken in by Greenspan's assertion that the Fed could safely
pilot the economy in for a"soft landing" by slowly letting the air
out of the stock market bubble.

What the prevailing
consensus overlooked was that a cessation or even a slow down in the growth of
the money supply precipitates a rise in interest rates back toward levels
reflecting voluntary saving and risk preferences in the economy and, in the
process, reveals to entrepreneurs the unsustainability of many capital
investments. This revelation induces a time consuming process of liquidation
and destruction of various capital-labor combinations and the reallocation of
the more versatile of these resources, especially labor, to more valuable uses.

Thus, for example, when
interest rates suddenly rise, investment in the continued construction and
utilization of new plants manufacturing oil-drilling equipment may be
abandoned as unprofitable. Construction and factory workers are laid off from
these projects and must then search for employment opportunities in plants
producing consumer goods or in the retail sector, while the idled raw material
stocks, power generating capacity and transportation equipment are also
diverted back toward consumer goods' production and distribution.

Now let us return to
Greenspan. As 2003 dawned, the economy had been mired in two years of
recession and"jobless recovery," and Greenspan's tattered
reputation was threatening to disintegrate like the New Economy he had
trumpeted for so long. His convoluted and banal pronouncements were
increasingly met with skepticism, if not outright incredulity, by the media
and the markets. His cherished serioso image as the profound Maestro of
Money was giving way to the perception of a cunning but clueless Master of
Illusion who has suddenly run out of tricks. But Greenspan did have one more
trick up his sleeve. And so earlier this year he played the deflation card—and
he played it with all the guile at his command.

Deflation-phobia had
been ignited earlier in the U.S. by a few isolated monthly declines in
consumer and producer prices that occurred in the latter half of 2001. Almost
immediately a deluge of articles gushed forth warning of the looming prospect
of a catastrophic, Japanese-style deflationary depression in the U.S., if the
Fed did not promptly and drastically cut interest rates. The authors of the
first wave of these articles were mainly financial columnists and think tank
economists associated with the supply-side school, although a few Keynesian
academic economists also weighed in with dire warnings. The deflation
hysteria abated somewhat after the CPI and PPI finished 2001 2.8 percent and
2.0 percent higher than the year before, respectively. The Fed, to its credit,
ignored this initial wave of deflation-phobia.

As the recession/jobless
recovery lingered on, relentlessly dragging down the number of jobs along with
Greenspan's prestige, the Fed's tune began to change, however. Thus in
November 2002, Fed Governor Ben Bernanke, a former Princeton University
professor and prominent macroeconomic theorist, delivered remarks to the
prestigious National Economists Club in Washington, D.C. entitled"Deflation: 
Making Sure 'It' Doesn't Happen Here."
Now, as a Fed Governor, the topic, content and venue of Bernanke's remarks
would had to have been at least cleared by Greenspan, if not actively
suggested by him.

Bernanke began his
speech by affirming his belief"that the chance of significant deflation
in the United States in the foreseeable future is extremely small...." 
He further expressed confidence"that the Fed would take whatever means
necessary to prevent significant deflation in the United States and, moreover,
that the U.S. central bank in cooperation with other parts of the government
as needed, has sufficient policy instruments to ensure that any deflation that
might occur would be both mild and brief."

In a Greenspan-like
equivocation, Bernanke added: "So having said that deflation in the
United States is highly unlikely, I would be imprudent to rule out the
possibility altogether."  He then went on to identify the cause of
deflation in standard Keynesian terms as"in almost all cases a side
effect of a collapse of aggregate demand—a drop in spending so severe that
producers must cut their prices on an ongoing basis in order to find buyers."

Bernanke devoted the
rest of his remarks to detailing the measures available to the Fed to prevent
deflation from occurring and to cure it if such preventative measures somehow
failed. Not surprisingly all of these preventive and remedial measures
amounted to little more than conventional and unconventional guidelines and
techniques for creating money.

For example, Bernanke
suggested that to prevent an unanticipated fall in aggregate demand from
initiating a deflation, the Fed needed to establish"a buffer zone for
the inflation rate." This means that the Fed should deliberately aim at
inflating prices in the U.S. from one to three percent per year. But this is
not enough—the Fed should also remain continually on the alert for any sign
of weakness in financial institutions and markets and stand ready to flood the
financial system with inflationary credit in case of, for example, a stock
market crash or even a shock to confidence caused by a terrorist attack.
Finally, even with the inflation rate safely with in the buffer zone,
if the Fed observes a sudden deterioration of the fundamentals of the
macro-economy, such as a fall in investment or consumption spending, it must
act"more preemptively and more aggressively than usual" to
forestall deflation.     

In the
unlikely event that these tried and true precautionary measures fail to stave
off the dreaded fall in prices and the Fed has already reduced the fed funds
rate to zero, Bernanke assures us that the Fed has an arsenal full of
additional weapons at its disposal capable of generating the desired positive
inflation. These unconventional techniques for money creation include:

<ul>
<li class="MsoBodyText">Reducing
and capping yields on medium- and long-term Treasury debt by committing
itself to making unlimited purchases of these securities at a fixed price
consistent with the targeted yields.
<li class="MsoBodyText">Following
the same strategy in the market for foreign government debt, which the Fed
has been legally empowered to purchase since 1980 and the outstanding
stock of which is several times the size of U.S. government debt.
<li class="MsoBodyText">To
circumvent the restrictions on Fed purchases of private securities,
extending zero-interest rate loans to banks accepting commercial paper,
corporate bonds, and even mortgages as collateral, thus effectively
driving down the yields on these debt instruments.
<li class="MsoBodyText">Financing a
massive Treasury tax cut, dollar for dollar, by monetizing the resulting
deficit to the full extent of the lost tax revenues; or monetizing direct
Treasury purchases of current goods and services or private financial and
physical assets.</li>
</ul>
As Bernanke points out,
this last alternative is tantamount to showering the country with money via
Milton Friedman's famous helicopter. And make no mistake about it, Bernanke is
proposing inflation pure and simple—and plenty of it—as the panacea for an
economy beset by a falling price level. This is explicit in the following
passage: 

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">
The
conclusion that deflation is always reversible under a fiat money system
follows from basic economic reasoning. A little parable may prove useful: 
Today an ounce of gold sells for $300, more or less. Now suppose that a
modern alchemist solves his subject's oldest problem by finding a way to
produce unlimited amounts of new gold at essentially no cost. Moreover his
invention is widely publicized and scientifically verified, and he announces
his intention to begin massive production of gold within days. What would
happen to the price of gold?  Presumably, the potentially unlimited
supply of cheap gold would cause the market price of gold to plummet. Indeed,
if the market for gold is to any degree efficient, the price of gold would
collapse immediately after the announcement of the invention, before the
alchemist had produced and marketed a single ounce of yellow metal.

What has this got to
do with monetary policy?  Like gold, U.S. dollars have value only to
the extent that they are strictly limited in supply. But the U.S. government
has a technology, called a printing press (or, today, its electronic
equivalent), that allows it to produce as many U.S. dollars as it wishes at
essentially no cost. By increasing the number of U.S. dollars in circulation,
or even credibly threatening to do so, the U.S. government can also reduce
the value of a dollar in terms of goods and services, which is equivalent to
raising the prices in dollars of those goods and services. We conclude then
that, under a paper-money system, a determined government can always
generate higher spending and hence positive inflation.

[/i]
This passage
is both true and chilling. Bernanke's analogy is based on correct economic
analysis:  the Fed indeed does have the power to bring about a collapse
in the value of the dollar. What is so frightening is that the Fed Governor,
an allegedly moderate free-market macroeconomist who was appointed by a
Republican administration and has been rumored to be Greenspan's heir apparent,
dares to propose the use of such power as the remedy for a minor rise in the
value of money. After all, the deflation of consumer prices in Japan, which
Bernanke is so determined to avoid here in the U.S., has averaged less than a
paltry 1 percent per year since it began in mid-1999.<a id="_ftnref3" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn3" name="_ftnref3">[3]</a> 

Now one might
plausibly object that I misinterpreted Bernanke's remarks, that they were
meant to apply only in the realm of theoretical conjecture and that no one in
full possession of his senses—besides Paul Krugman and some overly excitable
supply-siders perhaps—really expects a Japanese-style deflationary recession
to take hold in the U.S. But this would be to ignore the context of his
remarks, for Bernanke was only setting the stage for the latest performance by
the Master of Illusion himself. The very fact that a prominent member of the
Fed would address his remarks to deflation before a business group on such a
highly visible occasion signaled the unfolding of a new strategic tack by the
beleaguered Fed Chairman.

And so it was
that a few months later when Greenspan testified before Congress in April
2003, he shocked the markets by proclaiming that a further drop in inflation
was"an unwelcome development," slyly stoking the still smoldering
fears of deflation. A few weeks later, the Fed Open Market Committee followed
up Greenspan's bombshell by releasing a typically ambiguous, Greenspan-era
statement indicating a"minor" probability that"an unwelcome
substantial fall in inflation" outweighed the risk of higher inflation.<a id="_ftnref4" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn4" name="_ftnref4">[4]</a> 
The FOMC's oblique warning appeared to be confirmed a week later when data
were released showing small declines in April's CPI and retail sales, although
these developments were mainly due to falling oil prices as the U.S. invasion
of Iraq wound down. Nonetheless inflation fears were once again running high.
These fears were at fever pitch when Greenspan valiantly leaped into the
breach a few days later, solemnly declaring
before a Congressional panel,"we
see no credible possibility that we will at any point... run out of
monetary ammunition to address problems of deflation...."

Although May's
data did not bear out the threat of the imminent onset of deflation widely
perceived in April's numbers, the FOMC subsequently cut the fed funds in late
June to its lowest level since 1958.

Despite the
rate cut and the Maestro's soothing words, payrolls continued to shrink, the
unemployment rate was stuck at its highest level in nine years, and industrial
production continued to grow at a snail's pace—fully 20 months after the
official end of the recession declared by the NBER. Moreover, doubts began to
spread among economists about the wisdom of the Fed's inexplicably sudden
concern with deflation. Stated
Chicago economist David Hale: "They
let themselves get swept up in the deflation delirium and it's locked them
into a rate cut that they may not want or need to make right now."

Nonetheless,
Greenspan would not be deterred from reinventing the Fed as an
anti-deflationary crusader that could be depended upon to pump progressively
cheaper money into the economy for as long as it took to slay the fictitious
deflation monster.

Indeed, the
rationale for Greenspan's strategy had been laid out in a
little noted speech the
month before the June rate cut by the Fed's director of monetary affairs,
Vincent Reinhart. Reinhart suggested that the central bank conduct monetary
policy to bolster markets and revive the economy by"shaping expectations"
without necessarily cutting rates. According to Reinhart,"A central bank
can provide impetus to the economy at an unchanged short-term interest rate by
encouraging investors to expect short term interest rates to be lower in the
future than they currently anticipate."

In other words,
Greenspan's strategy was to deliberately mislead the markets regarding the
future course of interest rates. Thus Greenspan again transparently played the
deflation card in his semi-annual monetary
policy report to Congress
in mid-July, alluding to the"especially pernicious, albeit remote,
scenario in which inflation turns negative against a backdrop of weak
aggregate demand" and avowing that the Fed"stands ready to maintain
a highly accommodative stance of policy for as long as it takes to achieve a
satisfactory economic performance."

The desperate
Maestro also let slip—and the media breathlessly reported—that at its June
meeting the FOMC had discussed at some length the possibility of utilizing
"alternative" methods of reducing interest rates, including the
purchase of longer-term securities, but the committee had concluded that it
was"unlikely" that these unconventional measures would be necessary.
So it was a short jump from Governor Bernanke's theoretical ruminations about
cures for potential deflation to Chairman Greenspan's reference to them as
"alternative" practical policies in a prospective, but supposedly
"remote," war against deflation.

If we look a
little more closely at Greenspan's testimony, we find that in his cynical
attempt to manipulate markets he has profoundly contradicted himself. While he
was pointing to the"remote" probability of deflation with one hand,
with the other he was encouraging the housing bubble with the other. Thus
he noted "a solid
advance in the value of the owner-occupied housing stock," noting"changes
in technology and mortgage markets that have dramatically transformed
accumulated home equity from a very illiquid asset into one that is now an
integral part of households' ongoing balance-sheet management and spending
decisions."

In plain
English this means that the ready availability of cheap mortgages via Internet
shopping has fuelled consumption spending as people cash out some of the gains
realized in the ever-expanding housing bubble.

Unfortunately
for Greenspan, the media and the markets have finally begun to catch on to his
verbal legerdemain and are no longer diverted by his invocation of the specter
of deflation. By solemnly talking up the threat of prospective deflation and
the Fed's determination to fight it, Greenspan hoped to stimulate investment
spending and economic recovery by duping the markets into expectations of
aggressive rate cutting.

The Fed then
proceeded to disappoint market expectations by reducing the fed funds rate by
a measly one-quarter of a point in June. Hence the strategy backfired and, as
one
journalist noted in late
August,"Greenspan now finds himself the subject of derision and doubt in
the bond market. Investors, stung by the wide swings in bond prices over the
past few months, blame Greenspan and the Fed for misleading the markets about
the threat of deflation and the central bank's likely response to it."
Even some regional Federal Reserve Banks, such as the relatively"hard
money" St. Louis and Cleveland Feds, sought to subtly disassociate
themselves from Greenspan's deflation hysteria by attempting to distinguish
between benign and malignant deflation.<a id="_ftnref5" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn5" name="_ftnref5">[5]</a>

By the end of
September, the yield on 10-year Treasury bonds and the rate on conventional
mortgages had both risen by nearly one percentage point, indicating spreading
anticipations of future inflation as the Fed continued to rapidly expand the
money supply to get the economy back on track.<a id="_ftnref6" title href="http://www.mises.org/fullstory.asp?control=1377#_ftn6" name="_ftnref6">[6]</a> 
Indeed one
perceptive journalist, Ian
Campbell, has pinpointed the real and present danger to the economy: 
unrestrained money creation to maintain low interest rates in the face of an
exploding Federal budget deficit. Wrote Campbell:

<blockquote dir="ltr" style="MARGIN-RIGHT: 0px">
The danger, to our
mind, is that Greenspan's 'solid advance' is not solid at all. It is all
based on flooding the markets with liquidity, forcing down mortgage rates to
indecently low levels, cutting rates on savings deposits, encouraging the
creation of more and more debt—while friend George racks up the government
debt—and encouraging spending based on extracting equity from an asset,
housing, whose price is inflating recklessly and which subsequently, like
the equity market is likely to fall.

[/i]
It remains to be seen
whether this was the last performance by the Master of Illusion but, in any
case, it has flopped badly. At seventy-seven years old, Greenspan may yet
decide to forego the reappointment to another term promised by President Bush.
However, his departure from the stage might not be cause for unalloyed joy
among proponents of sound money—Ben Bernanke could be lurking in the wings.

-------

Joseph T. Salerno
teaches economics at Pace University. See his archive and send him mail.
This paper was delivered at the 2003 Mises Institute Supporters Summit. Hear
the audio
version of this talk.

<div class="MsoBodyText">
 
<hr align="left" width="33%" SIZE="1">
<div class="MsoBodyText" id="ftn1">
<a id="_ftn1" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref1" name="_ftn1">[1]</a>
Bob Woodward, Maestro:
Greenspan’s Fed and the American Boom (New York: Simon &
Schuster, 2000), pp. 172-74, 179-82, 195-96, 223.

</div>
<div class="MsoBodyText" id="ftn2">
<a id="_ftn2" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref2" name="_ftn2">[2]</a>
This refers to Greenspan’s
belief that the visceral discomfort he experienced when poring over
economic data was a good predictor of the economy going sour (Woodward, Maestro,
p. 120).

</div>
<div class="MsoBodyText" id="ftn3">
<a id="_ftn3" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref3" name="_ftn3">[3]</a>
According to the Fed’s own
publications, the annual declines in the Japanese CPI from 1999 through
2002 have been 0.3%, 0.7%, 0.8%, and 0.9%, respectively
("Deflation," The Federal Reserve Bank of Cleveland 2002 Annual
Report, p. 10, available at   www.clevelandfed.org/Annual02/Essay.pdf
). Also see James Bullard and
John Seiffert,"Japanese Deflation Loses Something in the Translation,"
The Federal Reserve Bank of St. Louis National Economic Trends
(September 2003), p. 1, available at www.research.stlouisfed.org.

</div>
<div class="MsoBodyText" id="ftn4">
<a id="_ftn4" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref4" name="_ftn4">[4]</a>
Quoted in John M. Berry,"Fed
Fears a Spiral of Falling Prices: Deflation Risk May Prompt Rate
Cuts," The Washington Post (May 7, 2003), p. A01. Available at
www.washingtonpost.com.

</div>
<div class="MsoBodyText" id="ftn5">
<a id="_ftn5" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref5" name="_ftn5">[5]</a>
See, for example
"Deflation," The Federal Reserve Bank of Cleveland 2002 Annual
Report cited in fn. P above (which was released on May 9, 2003); and
also James B. Bullard and Charles M. Hokayem,"Deflation, Corrosive
and Otherwise," National Economic Trends (July 2003), p. 1
available at .research.stlouisfed.org.

</div>
<div class="MsoBodyText" id="ftn6">
<a id="_ftn6" title href="http://www.mises.org/fullstory.asp?control=1377#_ftnref6" name="_ftn6">[6]</a>
For current monetary and interest
rate data, see The Federal Reserve Bank of St. Louis Monetary Trends
available at .research.stlouisfed.org.

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Does Greenspan Deserve Another Term? / Artikel mises.org - - Elli -, 21.11.2003, 16:52