Did Greenspan Deserve Another Term?

0:00Okay, my answer to the question posed by the title of the paper is no, no, a million times no. I am tempted to end the paper and do magic tricks for the rest of the half hour. But entertaining you with cheap tricks of illusion would then qualify me as an ex-fed chair. So I'll give the entire paper. Since I'm a libertarian, I don't want to audition for the chair. There are two reasons for the negative response to this. First, Greenspan's performance has been astoundingly bad both before and after his reappointment to his fourth full term as Fed Chairman in June 2000. And second, and perhaps worse, he has been a relentless purveyor of economic fallacies designed to obscure and justify his egregious performance.

0:50Unfortunately, Greenspan's exalted position as Fed Chairman, combined with his unrivaled facility for circumlocution and obfuscation has resulted in these fallacies being seized upon by the media, the markets, and even many professional economists as profound new insights into the economic process. Incredibly, the media-fueled cult of Chairman Greenspan continued on throughout the 1990s, even though some of the most celebrated pseudo-profundities that he uttered represented a blatant reversal of a view he had expressed earlier. For example, Greenspan's famous discovery that the productivity growth of the new economy was causing the stock market boom of the late 1990s came hard on the heels of his contradictory and equally famous declaration that the stock market run-up was being driven by irrational exuberance.

1:46In a presentation to a similar audience in February 2001, 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's no need to repeat this analysis here if you wish you can read my article on Mises.org. However, I would like to quote the concluding paragraphs of the article because they bear on Greenspan's more recent words and deeds that will be dealt with below. I wrote then, the monetary tightening of 1999 devastated the new economy and the Nasdaq tanked, falling by over 50% from its high in March 2000.

2:38But even more importantly, it also brought the investment boom in the real sector of the economy to a screeching halt. This fomentous news was duly noted in the Wall Street Journal, and then I quote some statistics here. This news should give Alan Greenspan a great pain in the pit of his stomach. Okay, now as an aside, Greenspan had claimed that any visceral discomfort he experienced when pouring over economic data was a good predictor of the economy going sour. And you can see that in my first article. Yeah, he actually says that, okay, that if his stomach's upset, well then he thinks something's wrong with the economy. All right, now continuing with my analysis in that first article, I continue, 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.

3:38That is, 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 3rd, and we're talking about 2001 now, appeared to give the NASDAQ a boost, despite a second cut in interest rates on January 31st, 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. Okay, permit me to boast of my prowess here 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.

4:27Seriously though, my forecast that the economy was on the point 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 monetary policy, which occurred in 1999, 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 period of adjustment, which non-Austrians call a recession, to correct them.

5:15Unfortunately, most economists and market pundits ignored this insight and focused exclusively on financial markets, to which stocks or 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 they overlooked was that a cessation or even a slowing down in the growth of the money supply precipitates a rise in interest rates back towards levels reflecting voluntary saving and risk preferences in the economy. and in the process reveals to entrepreneurs the unsustainability of many capital investments.

6:05This revelation induces a time-consuming process of liquidation and destruction of various capital-labor combinations, that is, firms going out of business, and the reallocation of the more versatile of these resources, such as labor, to more valuable uses. Thus, for example, when interest rates suddenly rise, investment in the continued construction and use of new plants manufacturing oil drilling equipment may be abandoned as unprofitable. Construction 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 idle fuels, power generating capacity and transportation equipment are also diverted back toward consumer goods production and distribution.

6:52Now let me 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 image as a 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.

7:43Now, deflation phobia, this unreasoned fear of falling prices, which are really good for consumers, had been ignited 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 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 the PPI finished 2001 2.8% and 2.0% higher than the year before respectively.

8:37So we continue to have inflation in 2001. 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. Thus, in November 2002, Fed Vice Chairman Ben Bernanke, a prominent and well-respected former Princeton economist, Delivered Remarks to the Establishment National Economist Club in Washington, D.C. Entitled, Deflation. Making sure it doesn't happen here. Now, as a Fed second-in-command, the topic, content and occasion of Bernanke's remarks would had to have been at least cleared by Greenspan, if not actively suggested by him.

9:27Bernanke began his speech by affirming his belief, quote, He continued that the chance of significant deflation in the United States in the foreseeable future is extremely small, unquote. He further expressed confidence, quote, 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, unquote. In a Greenspan-like equivocation, Bernanke added, quote, So having said that deflation in the United States is highly unlikely, I would be imprudent to rule out the possibility altogether. Okay.

10:13I would... 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. That is, 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 fail. Not surprisingly, all of these preventive and remedial measures amounted to a little more than conventional and unconventional 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.

11:06This means that the Fed should plainly aim at inflating prices in the U.S. from one to three percent per year. But this is not enough, according to Bernanke. 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 a stock market crash, or even a shock to confidence caused by a terrorist attack. Finally, even with the inflation rate safely within the buffer zone, that is, even with prices going up by 1-3%, If the Fed observes or senses a sudden deterioration of the fundamentals of the macroeconomy, such as a fall in investment or consumption spending, it must act, and I'm quoting Bernanke here, more preemptively and more aggressively than usual to forestall inflation.

11:59In the unlikely event that these tried and true measures fail to stave off the dreaded fall in prices, and the Fed has already reduced the Fed funds rate to zero as Professor Garrison talked about. 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, now Roger mentioned buying medium and long term treasury debt, but there's many more that they've come up with. Another measure is following the same strategy in the market for foreign government debt, that is, buying up, by creating dollars, foreign government securities, which the Fed has been legally empowered to purchase since 1980, and the outstanding stock of which is several times the size of the U.S. government debt, so it will never run out of things to purchase.

12:55Number three, to circumvent the restrictions on Fed purchases of private securities, they're not currently permitted, except in extreme emergencies, to buy up private stocks and bonds, but they have a way of circumventing it, by 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. And finally, Bernanke mentions, 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. In other words, merely printing up the money and giving it to the treasury to begin buying up the country.

13:43So you have all this new money flowing in. In fact, as Bernanke points out, this last alternative of simply cutting taxes and then creating money to finance these tax cuts is no different than Milton Friedman's famous helicopter in which money is simply sprinkled throughout the country. And make no mistake about it, Bernanke is proposing inflation, pure and simple, and plenty of it, as a cure for an economy, be set by a falling price level. Okay, now this is explicit in the following passage, I mean this is really an incredible passage from the Fed Vice Chairman. I'm quoting Bernanke here. 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.

14:33Now 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.

15:21But the U.S. government has a technology called a printing press. And I'm still quoting him here, or today it's electronic equivalent that allows it to produce as many 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. So, hallelujah, we don't have to worry about deflation. Now, this passage is both true and chilling. Bernanke's analogy is based on correct economic analysis.

16:07The 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 Vice Chairman, an allegedly moderate free-market macroeconomist who was appointed by a Republican administration and may be Greenspan's heir apparent, dares to propose the use of such power as a 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 US, has averaged less than a paltry 1% per year since it began in mid-1999. So he wants to bring about a collapse of the value of the dollar to prevent consumers from enjoying prices falling at 1% per year. 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, really expects a Japanese-style deflationary recession to take hold in the U.S.

17:12But 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 tact by the beleaguered Fed Chairman. And so it was that a few months later, early 2003, when Greenspan testified before Congress in April, he shocked the markets by proclaiming that a further drop in inflation was, quote, quote, an unwelcome development, unquote, slyly stoking the still smoldering fears of deflation. A few months later, the Fed Open Market Committee followed up Greenspan's bombshell by releasing a typically ambiguous Greenspan era statement indicating, quote, a minor probability that an unwelcome substantial fall in inflation outweighed the risk of higher inflation.

18:15Okay, now what does all this obfuscation lead to? Well, the FOMC's oblique warning appeared to be confirmed a week later when data were released showing small declines in April CPI and retail sales. Although these developments were mainly due to falling oil prices as the US invasion of Iraq wound down. Nonetheless, inflation fears once again running high. These fears were at a fever pitch when Greenspan valiantly leaped into the breach a few days later, solemnly declaring before a congressional panel, quote, We see no credible possibility that we will at any point run out of monetary ammunition to address problems of deflation, unquote. Although May's data the next month did not bear out the threat of the onset of deflation, widely feared or widely seen in April's numbers, The Fed Open Market Committee subsequently cut the Fed funds rate in late June to its lowest level since 1958.

19:15Despite 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. But Greenspan would not be deterred from pursuing a strategy of bolstering markets and speeding up the recovery by reinventing the Fed as an anti-deflationary crusader that would pump cheap money into the economy for as long as it takes to slay the fictitious deflation monster. Thus, Greenspan again shamelessly played the deflation card. In his semi-annual monetary report to Congress in mid-July, Greenspan alluded to the, quote, especially pernicious, albeit remote, scenario in which inflation turns negative against the backdrop of weak aggregate demand.

20:13And he vowed that the Fed stands ready, quote, stands ready to maintain highly accommodative stance of policy for as long as it takes to achieve satisfactory economic performance, unquote. The desperate maestro also let slip and the media breathlessly reported that at its June meeting, the Fed Open Market Committee had discussed at some length the possibility of utilizing alternative methods of reducing interest rates, including the purchase of long-term securities. But the committee had concluded that it was unlikely that these unconventional measures would be necessary. So it was indeed a short jump from Vice Chairman Bernanke's theoretical ruminations about cures for potential deflation to Chairman Greenspan's reference to them as alternative practical policies in a supposedly remote war against deflation.

21:03But if we look a little more closely at Greenspan's testimony, we find that in his cynical attempt to manipulate markets, he profoundly contradicted himself. While he was pointing to the remote probability of deflation with one hand, with the other hand, he was encouraging the housing bubble with the other. Thus, he noted a quote, 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 Asset into one that is now an integral part of household's ongoing balance sheet management and spending decisions." Now, what does that mean in plain English?

21:49In plain English, this means that the ready availability of cheap mortgages via internet shopping has fueled consumption spending as people cash out some of the gains realized in the ever-expanding housing bubble. So here he is praising the fact that we have inflation and an inflationary bubble in real estate and yet warning people at the very same time against deflation. Unfortunately for Greenspan, the media and the markets appear to have finally caught on to his verbal sleight of hand and are no longer diverted by his invocation of the specter of deflation. As long-term interest rates are again on the upward track indicating future inflation as the Fed continues to rapidly expand the money supply to get the economy back on track.

22:39Indeed, one perceptive journalist, Ian Campbell of UPI, has pinpointed the real and present danger, wild money creation to maintain low interest rates in the face of an exploding federal budget deficit. And Campbell wrote this past July, and let me just quote a little from Campbell's article. 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 almost to zero, 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.

23:31So it looks like, well actually before I conclude, even elements of the Federal Reserve system have backed away from Greenspan's deflation phobia. In fact, if you look at the September 2003 National Economic Trends report from the Federal Reserve Bank of St. Louis, They point out that Japan has experienced extremely low money supply growth in the last four or five years, whereas the U.S. money supply growth has been at very, very high levels. Okay, so obviously we're not following Japan into any deflation. And then in the 2002 annual report of the Cleveland Federal Reserve Bank, which was released in early 2003, it was pointed out that price deflation is compatible with rapid growth and a prosperous economy.

24:18In fact, they took the example of China. From 1998 to 2001, China's real GDP grew by 7% per year in more than twice the level of the US. And at the same time, consumer prices in China fell by 2% per year. So it looks like the master of illusion has given his last performance and has flopped badly. Greenspan's term is up in 2004 and it is probable that he will not be reappointed given his age and his performance. However, this might not be cause for unalloyed joy. Ben Bernanke may be lurking in the wings. Thank you.