Vox: Greenspan
As always, pundits and investors were busy dissecting Alan Greenspan's words Thursday, parsing sentences, weighing adjectives, listening for the right inflection. The recovery, they learned, isn't "close," it's "well under way," but for some reason, stocks and bonds were suddenly worth less in the eyes of investors.
If there really are words worth emphasizing, they might be these: "an array of influences unique to this business cycle seems likely to moderate its speed."
What makes this business cycle unique is that it created the most extraordinary asset bubble in history.
Perhaps not unique but nonetheless worth noting is that the Federal Reserve did little to stop it.
True, Mr. Greenspan famously warned of irrational exuberance (that, hard as it is to believe, was five years ago). Yet interest rates were left unchanged for three months and even then he took only a feeble shot, tightening credit supply by a thin 25 basis points.
That wasn't enough to pop the bubble, but it was enough to raise the ire of politicians and bovine investors. Daunted, the Fed dropped its financial weapon and raised its hands.
Worse, Mr. Greenspan fell victim himself to the insidious false promise of the New Economy. A little more than four years after his market-jolting warning, the Fed chairman gave a speech to Boston College in which he again enthused over the New Economy and the productive benefits it brought. "The essential contribution of information technology is the expansion of knowledge, and its obverse, the reduction of uncertainty." As it turns out, his speech, as Grant's Interest Rate Observer pointed out last August, coincided nicely with the peak of the Bloomberg B2B stock index, which went on to lose 95 per cent of its value — and most of its members.
All of this was akin to "setting out the conditions under which the exuberance might actually be rational, when the bubble might not be a bubble," as Morgan Stanley economist Stephen Roach put it in a recent essay.
By signalling that it would not ratchet up rates again after that initial foray drew a chorus of outrage, Mr. Roach goes on, the Fed "set up the delicious moral hazard that speculators quickly pounced on. With the Fed out of the game, there was no stopping the equity market."
Mr. Roach alleges that the Federal Reserve lacked the courage and wisdom to defuse the bomb before it went off. By way of evidence, he offers quotes from newly released transcripts taken during a meeting of the Federal Open Market Committee.
These are released after five years, so the quotes tell us what the central banker was thinking prior to his "exuberance" warning, Sept. 24, 1996, to be exact, when the Dow Jones industrial average was quoted at 5,874.
"I recognize that there is a stock market bubble problem at this point . . . We do have the possibility of raising major concerns by increasing margin requirements. I guarantee that if you want to get rid of the bubble, that will do it."
Margin requirements, of course, were not raised, despite concerns voiced by at least one other Fed governor, who warned of the dangers of bubbles. "They include a reduction in the long-term saving rate, a seemingly random distribution of wealth, and the diversion of scarce financial human capital into the acquisition of wealth. As in the United States in the late 1920s and Japan in the late 1980s, the case for a central bank ultimately to burst that bubble becomes overwhelming. I think it is far better that we do so while the bubble still resembles surface froth and before the bubble carries the economy to stratospheric heights."
What's unique about this business cycle might be that we dodged a big fat bullet, or that we made the mistake of thinking we did.
vox@globeandmail.ca
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