Comments on the Fed testimony - Dave Lewis
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Dave Lewis
CHAOS-ONOMICS
chaos-onomics.com
Jul 20
But of the tree of the knowledge of good and evil, thou shalt not eat of it: for in the day that thou eatest thereof thou shalt surely die. Genesis 2:17
I extend my apologies to readers for a long, unannounced absence from the screen. A succession of golf tournaments flowed into the annual family pilgrimage to the Adirondacks and finally a decision to purchase a new PC have kept me otherwise occupied. While I still have a few summer projects to complete, I plan to devote more time to the site from mid August on.
I decided to jump back onto the screen a bit earlier than originally planned (I have yet to migrate all the necessary files to my new PC) after reading the latest Fed testimony to Congress. Oddly enough, I forgot to pack a few books for my trip north and was resigned to re-reading James Billington's Fire in the Minds of Men, an examination of the ideological themes of the revolutions of the late 18th, 19th and early 20th centuries . Upon my return, I came across two revolutionary shots across the bow; articles by Morgan Stanley's Stephen Roach, The World's Biggest Hedge Fund, and the UPI's Martin Hutchinson, Life after Greenspan. It seems to this observer that the natives, in economic circles, are getting a bit restless.
Let's start with Roach's perspective; Unfortunately, the role of the US central bank goes beyond benign neglect. Over the past several years, the Fed actually has been quite aggressive in arguing why excesses are not bad. That was the case when it repeatedly justified the equity bubble on the basis of the so-called productivity renaissance of the New Economy. It has also been the case when the Fed has argued that America is not suffering from a debt problem, nor a twin deficit financing constraint. By serving as a cheerleader when financial markets are going to excess, the Fed is losing its credibility as an objective observer. It is no longer the tough guy that relishes the role of "taking away the punchbowl just when the party gets going" -- to paraphrase the legendary mantra of former Fed Chairman William McChesney Martin. By condoning excesses, the Fed, in effect, has become a stakeholder in the carry trades it spawns. Investors, speculators, income-short consumers, and financial intermediaries couldn't ask for more. It's the ultimate moral hazard play that that has turned the world into one gigantic hedge fund.
Gee, Stephen, tell us what you really think
Mr. Hutchinson is somewhat more subdued; It is therefore likely that in January 2006, a new Fed chairman will be struggling with a renewed bout of price inflation, being forced to push short-term interest rates higher than the state of the economy would suggest, which in turn will produce a sluggish economy or even a recession, and an unpopular Fed. At that point, whoever is appointed may wonder whether Alan Greenspan's 18 1/2-year Fed chairmanship, with the Fed chairman acquiring unprecedented market credibility, has really been worth it. Indeed, the heretical thought may arise: is huge market credibility for an inevitably fallible Fed chairman a good thing?
Contrast the views of these gentlemen who both foresaw the inevitable crash of the tech bubble and current swoon of the US$, two forecasts which eluded Mr. Greenspan's crystal ball, with the views of the Fed Chair; Economic developments in the United States have generally been quite favorable in 2004, lending increasing support to the view that the expansion is self-sustaining. Not only has economic activity quickened, but the expansion has become more broad-based and has produced notable gains in employment. The evident strengthening in demand that underlies this improved performance doubtless has been a factor contributing to the rise in inflation this year. But inflation also seems to have been boosted by transitory factors such as the surge in energy prices. Those higher prices, by eroding households' disposable income, have accounted for at least some of the observed softness in consumer spending of late, a softness which should prove short-lived.
Before considering these opposing views, let me explain my opening quote. I opened with the passage from Genesis because of an interpretation of the scripture I found enlightening. To wit, to think that you know good and evil just by looking (or sometimes more lethal, to think that other people know good and evil just by looking) is to invite mental death or, in other words, once you think a thing good or bad, the mental process ends. One of the aspects of current popular economic dogma I find unhelpful is this fixation on the goodness of badness of a report, development or even economy as a whole. Mr. Greenspan's assertion that economic developments have been quite favorable begs the question, for whom? for how long? and most importantly how do you define favorable? This doesn't seem like science to me, but rather, as Mr. Roach opines, cheerleading.
Economics, at least if it aims to be a study of the patterns of change in methods of resource allocation in societies, and their effects, should be no more inclined to denote a change "good" than a physicist should denote the transition of water from liquid to solid, "good." Rather, if one would prefer to see things in some causal chain, one focuses instead on, in the latter case, to name a few, the amount of heat required to inspire the change, or the amount of time, relative to the ambient temperature, that the water remained in vapor form. In the economic frame of mind, instead of thinking the economy is good, one might wonder what caused it to exhibit the current traits, and what historically has occurred when similar causes have engendered similar effects. In my view, and Mr. Hutchinson's the effect of the policies which have brought the US economy to this pass, given the elastic currency of the Fed, is either inflation, if the Fed stays behind the curve, or a wrenching depression if they get the nerve to invert the curve.
Delving a bit further into the notion of good or bad, in my view, economies per se are never one or the other. The subject of study is the transfer of resource control, and subsequent use, over time. There will always be winners and losers. Even in the go-go days of the late 90s, not everyone thought the US economy good. Indeed, I know a few stock brokers who now bemoan the late 90s they used to applaud because it deluded them into expanding their balance sheets beyond their eventual ability to repay. What was thought to be all good, became something else-a cautionary tale to those in the real estate and mortgage broker industry. All of which brings me back to the hanging question from Mr. Greenspan, for whom has the economic developments in the first half of 2004 been favorable? Certainly not for everyone. More importantly, will the beneficiaries of the "favorable developments" come to rue them as certain beneficiaries of the previous windfalls have come to rue theirs?
So where does Fire in the Minds of Men fit into the mix, you might be wondering, if that is, you have managed to wend your way this far down the page? One of the elements of the book was the cyclical falling away of the intellectual backing of policy leaving only apologists in their wake. More and more in the mainstream of economic thought, I see fewer and fewer defenses of the Greenspan strategy. More interesting still, the critiques, which used to more subtle, are becoming quite direct. For many years now, Greenspan has been telling all who would hear that things are good, but the crowd of listeners shrinks as his forecasts fall short. One wonders how much longer it will be before a child, whose parents have fueled up their car with $4.00 gas shouts, hey, the funny looking dude with glasses has no clothes! I want to see a real economist!
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