Analysis: D Minus for Greenspan
Wednesday, 27 June 2001 15:44 (ET)
By MARTIN HUTCHINSON, UPI Business & Economics Editor
WASHINGTON, June 27 (UPI) -- The Federal Reserve Board lowered interest
rates again Wednesday, but this time by only one-fourth percent, to a 3.75
percent federal funds rate.
Good. Alan Greenspan is still inflating the economic bubble, but now only
half as hard. The next meeting's not till Aug. 21; hopefully Greenspan will
take a vacation till then and not do anything in the interim to make things
worse.
As it is now halfway through 2001, it seems reasonable to assess the
Federal Reserve's performance so far, and issue a report card to Greenspan
for his work. In my view, the grade will be poor. Not an F (you only get
that for immediate precipitation of the Great Depression, which Greenspan
hasn't done --- yet ) but not much above it, say a D minus.
Both my colleague Ian Campbell and I called at the beginning of the year
for higher, not lower interest rates; indeed, facetiously I called for the
return of Paul Volcker and a federal funds rate of 12 percent.
The rationale for this was that the economy since 1996 has been in the
grip of a classic asset price bubble, in which stock prices and more
recently house prices have risen beyond any possible estimation of their
long-term value. Greenspan called in December 1996 for a reduction in the
market's "irrational exuberance"; at that time the Dow Jones industrial
average was at 6,400 compared with 10,400 today. Everybody now agrees that
new economy stocks became hugely overvalued when the Nasdaq index hit 5,000;
what most people don't realize, or don't want to accept is that the
overvaluation in the old economy is still as present as it was a year ago.
The productivity miracle, which Greenspan and Wall Street used to justify
the sky-high stock valuations, was a myth.
Given this fact, it is clear that there is still a great deal further for
the stock market to drop, and that the drop will cause a negative "wealth
effect" in the U.S. economy that will cause a very substantial recession.
Greenspan's interest rate cuts cannot eliminate the stock market drop, or
the negative effect, or the recession. They can only delay it.
OK, so what? you may ask. Pain tomorrow is presumably better than pain
today, so why not delay pain as long as possible? Indeed, if you're a
Democrat, you may be cheering -- pain tomorrow means pain just before the
2002 midterm elections or even, with luck, pain still lingering at the time
of 2004's presidential election. GOP conspiracy theorists, remembering
Greenspan's 1997 marriage to liberal TV journalist Andrea Mitchell, may
suggest that delaying pain for political reasons to elect Democrats was in
fact Greenspan's objective all along.
There are two reasons why delaying the pain of this recession is
unattractive. It messes up resource allocation while we're waiting, and it
makes the eventual recession very much more difficult to get out of. Rather
than delay the pain, Greenspan should have pursued a tight monetary policy,
possibly even a "shock therapy" tight monetary policy, to get the Dow down
to 5,000 or so as soon as possible, so we could begin the process of
rebuilding.
Resource allocation, first, is very difficult in the period going into a
recession. Everything -- stocks, real estate, tangible assets -- is
overpriced and poor value. Yet flows of funds for investment are still very
substantial, because investors remember the pleasure of the gains they
enjoyed in 1995-2000, and believe that it is only a matter of a modest delay
before these pleasures resume. Hence investible funds continue to be poured
into venture capital, stocks, and high priced houses. Meanwhile, consumption
continues unabated -- with today's infamous savings rate of minus 0.8
percent -- because consumers think, if the recession's to be mild and short,
why cut back?
Of course, the misallocated investment funds, when the recession does
come, result only in losses, while the continued high consumption results in
a higher level of bankruptcies during the recession than would otherwise be
the case. Thus, the result of both effects is a deeper, longer recession
than would otherwise have been necessary.
The other problem with Greenspan's loose monetary policy is that it has
disarmed policy-makers of weapons that could have been used to get out of
the recession once properly in it. At the beginning of the year, as well as
calling for a 12 percent federal funds rate, I welcomed President Bush's tax
cut proposal because I thought that, as in 1981-2, it would take at least a
year to become effective, and would thus assist in bailing out the economy
in early summer of 2002, near the bottom of the downturn.
Of course, I was wrong. Greenspan cut interest rates aggressively, thus
delaying the downturn, while Congress moved with unprecedented speed on the
tax cut, as well as backdating it, thus ensuring that its principal economic
effect would be felt when a blizzard of $300 checks are mailed out, in the
third quarter of 2001. At that time, we will presumably be close to where we
are now, still far, far above the bottom of the valley. The stimulative
effect of the tax cut will delay the downturn further, but do nothing to
alleviate it.
By late 2002, or even early 2003, when the bottom has finally been
reached, we will have no tools left to pull us out of recession. Interest
rates will be below 4 percent, negative in real terms -- for M3 money supply
has been expanding for more than 6 months now at a rate of 14 percent,
inevitably bringing within 18-24 months a substantial resurgence in
inflation.
Meanwhile, the budget will be in very substantial deficit, and there will
be neither the room nor the political will to use fiscal policy to bring us
out of slump -- other than, no doubt, a "fiscal stimulus" of government
spending, such as was used in Japan in very similar circumstances in the
1990s. This "fiscal stimulus," unlike a tax cut, will have little
significant short-term effect, since it will crowd out private borrowers in
the bond markets, and in the long term will inflate the level of government
debt and make it impossible to pay full pensions to retired baby boomers
after 2010.
At that point, with no easy exit to the recession in view, the years will
roll by in substantial numbers, until technological progress has moved on so
far that new investment, and the creation of new products becomes
irresistibly attractive, and the economy can once more recover. Judging by
the precedents of the 1930s United States or 1990s Japan, that will not be
before 2010, or even 2015.
Gee, thanks, Alan.
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