Will the Real Alan Greenspan Please Stand Up?
April 11, 2000
Viewing Alan Greenspan from an international perspective is no easier than assessing
the man within an American context. We pour over his every utterance, but like our
counterparts on the other side of the Atlantic, we can make little sense of the man. Is
the current cheerleader of the new economy the same person who once publicly
fretted about the stock market?s ?irrational exuberance?? Is today?s champion of high
tech derivatives the same stern central banker who warned about of their potential to
create systemic dislocations just six years ago? How does one reconcile the Fed
Chairman?s recent proclaimed scepticism of the efficacy of monetary authorities
seeking to influence asset price outcomes to achieve policy goals with his public
affirmation that the interest rate increases implemented in 1994 were specifically
designed to ?prick the bubble in equity markets?? Given the veneration in which Alan
Greenspan appears to be held in the United States, it may appear sacrilegious to
highlight these inconsistencies, yet we note very little public discussion of this in
America. It is primarily overseas commentators who have gone so far as to attribute
to the Fed chairman an active role in encouraging the euphoric expectations currently
embodied in the US stock market mania.
The endorsement of America?s high priced stock market and its burgeoning trade in
derivatives is to be expected from Wall Street and the money management business.
They are in the business of earning fees, which are directly proportional to the value
of the stocks they sell and manage, as well as profiting from the ever-growing
volume of transactions that flow as a by-product of this rise in asset values. It is
questionable whether this is ever a proper role for the US Federal Reserve,
particularly when all traditional measures of stock market valuation point to growing
and dangerous financial imbalances in the US economy.
Yet consider the recent championing of the New Era. Whereas Greenspan mused as
recently as 1996 that the then-prevailing high stock valuations might be due to
irrational exuberance, he has more recently taken to championing the work of Messrs.
Glassman and Hassett, who recently published a book entitled DOW 36,000. In the
book, Glassman and Hassett essentially dispute the need for an equity risk premium,
contending that over time stocks are in fact no riskier than bonds. The current bull
market in their view is simply about investors wising up to this simple fact of
misperceived equity risk.
Mr. Greenspan has now taken up this line of reasoning. He recently argued that
there could ?be little doubt that the dramatic improvements in information technology
in recent years have altered our approach to risk. Some analysts perceive that
information technology has permanently lowered equity risk premiums and, hence,
permanently raised the prices of the collateral that underlies all financial
assets?Some analysts have offered an entirely different interpretation of the drop in
equity risk premiums. They assert that a long history of a rate of return on equity
persistently exceeding the riskless rate of interest is bound to induce a learning-curve
response that will eventually close the gap?It would be a mistake to dismiss such
notions out of hand.?
Imagine the ridicule that Mr Yasushi Mieno, former head of the Bank of Japan,
would have attracted had he embraced some of the more creative concepts designed by
Japanese stock brokers to rationalise the bubble in Japanese real estate in 1989
(during which the grounds of the Imperial Palace in Tokyo were estimated to be
worth more than the entire real estate value of the state of California). Remember the
sceptical manner in which Western market commentators viewed the whole Japanese
bubble of the 1980?s. And yet just 10 years later, we have the head of the world?s
largest and most important central bank essentially dismissing the collective distilled
wisdom of investors built up over centuries; how could we have been so wrong for so
long? It is striking that no other modern central banker has even dared to defend the
current state of the US stock market, let alone champion its apologists in the manner
of Greenspan.
Mr. Greenspan has displayed similarly contradictory behaviour with respect to the
promotion and regulation of derivatives. Just six years ago, the Fed Chairman
recognised that ?even if derivative transactions [were] not themselves a source of
systemic risk, they may help to speed the transmission of a shock from some other
source to other markets and institutions.? Yet the gravity of these concerns has thus
far not translated into any initiative or leadership on the part of Congress or Federal
Reserve. Quite the contrary. The Fed chairman has more recently opposed even
modest proposals set out by the Financial Accounting Standards Board (FASB) to
make derivative positions more transparent for investors by requiring companies to
calculate a fair market value for their positions and to report changes, if any, in the
market value of the positions held. Greenspan poured cold water on the proposal,
arguing, ?it may discourage prudent risk management activities and could in some
case present misleading financial information.? One wonders how truly ?prudent? the
risk positions must be, if they fail to stand the glare of full and fair financial
transparency. Given Greenspan?s oft-stated belief that the economic fallout that
afflicted much of the emerging world in 1997-98 could have been averted through the
implementation and enforcement of a more financially transparent banking system in
those countries, his distinct lack of enthusiasm for such measures in the United
States is puzzling in the extreme.
Just last week, we saw yet another example of this inconsistency. Whilst
acknowledging that the wealth effect engendered by the rise in the stock market was
contributing to the risk of imbalances in the American economy, Greenspan
maintained that this ?did not imply that the most straightforward way to restore
balance in financial and product markets is for monetary policy to target asset price
levels. Leaving aside the deeper question of whether asset price targeting is an
appropriate governmental function, there is little, if any, evidence that monetary
policy aimed at achieving that goal would be successful.?
Now consider the recently released minutes from the March 1994 Federal Open
Market Committee transcript:
?When we moved on February 4th [1994], I think our expectation was that we
would prick the bubble in the equity markets?While the stock market went down
after our actions on February 4th, it has gone down really quite marginally on net
over this period. So what has occurred is that while this capital gains bubble in
all financial assets had to come down, instead of the decline being concentrated in
the stock area, it shifted over into the bond area. But the effects are the same.
These are major capital losses, which have required very dramatic changes in actions
and activities on the part of individuals and institutions. So the question is,
having very consciously and purposely tried to break the bubble and upset the
market in order to sort of break the cocoon of capital gains speculation, we are now
in a position ? having done that and in a sense succeeded perhaps more than we
intended ? to try to restore some degree of confidence in the System.? (Our
emphasis)
In 1994, it was apparently still possible for a central bank to influence asset price
outcomes. Indeed, Greenspan ruefully implies that the Federal Reserve was almost
too successful in this regard; bubbles can indeed be pricked, but controlling the
aftermath is more problematic, he seems to suggest. Has the character of the capital
markets changed so much over the past six years that the Fed no longer can envisage,
nor desire, breaking ?the cocoon of capital gains speculation?? The current, highly
pronounced scepticism is either disingenuous or a shocking implicit admission that
the Fed Reserve has lost control of the credit system. At best, it implies impotence in
the face of the forces of speculation; at worst, a complete abdication of financial and
monetary responsibility. Neither interpretation is likely to breed confidence in the
future actions of the US monetary authorities.
In 1928-29, the Federal Reserve Board discussed repeatedly the mounting
speculation in the stock market of the time. New York Fed chairman, Benjamin
Strong, pushed hard for a more restrictive monetary policy right up until his death in
the autumn of 1928. Within days of assuming the leadership of the Bank of Japan,
Governor Mieno moved quickly to burst the bubble, implementing a rapid series of
rate increases throughout the first half of 1990. It is therefore remarkable that Mr.
Greenspan appears to have become more dovish in direct proportion to the increase in
speculation and corresponding rise in asset values. One can find endless examples to
support this evolution from conventional central banker to (in the words of Professor
Tim Congdon) ?cheerleader for the New Era?. The more interesting question, which
has yet to be fully explored, is the motivation underlying Greenspan?s apparent
conversion to New Age Apostle. The person who can best answer that question
might go a long way toward providing a plausible explanation for some of the recent
extraordinary gyrations the US stock, bond, and commodity markets. |
