Greenspan's astonishing view of 'financial equilibrium' and perhaps some famous last words about 'not really' a crisis brewing. A Doug Noland retort follows.
Hooked on “The Hand”:
Alan Greenspan spoke (via satellite) yesterday to the Federal Reserve Bank of Chicago’s Conference on Bank Structure. His speech was titled “Risk Transfer and Financial Stability” and is available at the Federal Reserve’s website.
From the Q&A session:
Question: “Can more (hedge fund) transparency be required – should it be required?”
Chairman Greenspan: “You have to remember, that the one extraordinary important issue relating to the hedge funds is they act to increase liquidity in markets. And you have to be very careful to make sure that, on the one hand, that the hedge funds are completely transparent to their investors and that the investors are acutely aware of the nature of the risks and the level of the risk they are taking. But you also have to be careful about imposing regulation on these funds to the extent that you inhibit their actions. Remember, collecting data on hedge funds may appear to give you a degree of transparency, but most of the data you get – at best – will tell you about their strategy of last night. This morning they have a new one. Consequently, the type of data which is supposedly to be collected to create a degree of transparency and knowledge about how these funds are behaving is actually history. And it’s usually quiet unusable, because it’s their very nature to be innovative, changing and never actually to anticipate necessarily what they are going to find next in the marketplace which will suggest to them some imbalance – some potential exceptionally large profit arbitrage which they haven’t even anticipated would exist 48 hours earlier. So I think the question here is to be very careful to be sure that the people we want to protect are the counterparties to the hedge funds – meaning they have to get all the information that they need. And that will protect the marketplace and all their investors.”
Question: “Are there any financial crises brewing at the moment?”
Chairman Greenspan: “Well, not really. I mean, the problem that I have is that crises that you can see are probably already behind us. You have to remember, that the vast majority of imbalances that occur in markets are addressed very quickly by prices and we never hear of them. So, it strikes me that what we have to recall is the terrific insight of Adam Smith that there is something equivalent to an ‘invisible hand’ which continuously is readdressing market imbalances towards equilibrium is indeed what we are seeing virtually everyday – in fact, every hour and every minute – in the markets in which we deal. And I would suspect that the international context – looking at the increasing degree of globalization that we see almost on a day-by-day basis – that there is something attuned an international invisible hand that seems to be at work. Markets are always by their nature driving towards equilibrium. It looks as though it’s chaos- indeed it’s that chaos which was disposed of by Adam Smith in the great insights of more than 200 years ago – which in some respects hold up with very little revision to this day. In a certain sense that so called ‘creative destruction’ in markets which is what Schumpeter defined the process as many, many years later obviously, is a continuous train which is always creating a sense of nervousness about something going wrong. In fact, it’s normal. And it strikes me that crises are very difficult to forecast. Or, let me put it another way: the numbers of forecasts of crises that one gets day-by-day, week-by-week, is far in excess of the number of crises that actually occur. This is the reason why I’ve argued previously that since we really cannot know that we are about to get a crisis until we are right up against it, economic policy-making should be heavily focused on the issue of creating and sustaining the flexibility of markets so that when we get pressures of one form or another, the markets respond in a balanced manner and essentially remove the disruptions that are causing the difficulties.”
It is inadvisable to have one man singularly reign over monetary policy-making for 18 years. It is potentially disastrous when this individual is an ardent ideologue. And one of the painful lessons that will be ascertained from this experience is that the greatest risk with regard to discretionary monetary policy is the propensity for policy errors to engender only greater errors – along with a lot of rationalizations.
As chairman Greenspan’s views harden and become increasingly fanatical, identifying serious analytical errors is a less demanding endeavor. He has grown comfortable making grand economic declarations, ignoring the reality that many are valid only in an environment of sound and stable “money”/finance. Adam Smith’s wonderful “invisible hand” insight was made in the context of forces governing the mutually beneficial exchange of tradable goods. It is an Economic Sphere concept that certainly cannot be haphazardly projected to contemporary electronic markets for securities, derivatives and other financial instruments. As we have witnessed, an environment of Credit and liquidity excess will foster asset price distortions, speculation, and boom and bust cycles in the Financial and Economic Spheres. Unbounded finance nurtures self-reinforcing excess and distortions, the antitheses of the “invisible hand.”
Moreover, Mr. Greenspan’s assertion that “markets are always by their nature driving towards equilibrium” is categorically false. This is instead a holdover notion from Milton Friedman’s flawed belief that there is no such thing as “destabilizing speculation.” I have no qualms with the analysis that a well-anchored Financial Sphere and system pricing mechanisms will (generally) entice enterprising speculators to act when prices stray from normal bounds. In such an environment, capitalizing on speculative opportunities will tend to stabilize the system, pressuring markets back to the so-called “equilibrium” level.
Importantly, however, the financial backdrop plays a decisive role with regard to the character of - and ramifications for - speculative market dynamics. As much as a culture of sound finance tends to cultivate stabilizing speculation, profligate and unhinged finance promotes the opposite. Speculative profits become more easily captured betting that prices will continue to inflate away from normal bounds. Moreover, as Credit and speculative excesses fuel rising prices, myriad inflationary manifestations promote additional Credit and liquidity excesses. Financial Sphere excesses tend to stimulate the Economic Sphere, seductively validating the financial claims and asset inflation. Over time, as a system falls deeper into Credit Bubble dynamics, there will be an overwhelming propensity for destabilizing speculative dynamics and consequent asset price Bubbles. Left to its own devices, the Credit system will eventually succumb to dangerous speculative blow-offs. And if this Macro Credit Analysis is less than persuasive, there are hundreds of years of market history and scores of spectacular Bubbles (several over the past two decades) that are inconsistent with Mr. Greenspan’s |
