Readers of the last post concerning former Chairman Greenspan have been in touch. Concerned that m* has somehow lost an earlier grasp of things, or is finally going soft in the head, several have pointed out that the temperature of the water in the pot that the USD based financial system finds itself in is starting to climb decisively. The advances in gold, the Hang Seng, and the hard currencies over the last three days are loud testament to the radical and relentless pressure on the value of the world's major reserve currency now given fresh impetus by the Fed's recent rate cut decision.
Where to begin? First, consider the excellent essay and book review of Greenspan's "The Age of Turbulence" in the WSJ by James Grant, of the eponymous Grant's Interest Rate Observer - a first class newsletter in style, information, and intelligence. Mr. Grant concisely deflates much of the irrational exuberance in the Chairman's commonly accepted legacy and offers a far weirder and more concerning picture of a man and a set of policies perhaps less sophisticated than we may have presumed. He writes:
"Sooner or later, the dollar will lose its luster and finally its value, as paper currencies always do. Striving to understand why people trusted it in the first place, historians will naturally reach for the memoirs of the foremost central banker of his day. But Mr. Greenspan's "The Age of Turbulence" will leave them just as confused as they ever were...."
"The fantastic irony of Mr. Greenspan's career path -- from gold-standard libertarian to federal interest-rate fixer -- seems hardly to have registered on Mr. Greenspan himself..."
"Having watched his mentor, Arthur Burns, struggle with the chairmanship, Mr. Greenspan notes, "it did not seem like a job I felt equipped to do; setting interest rates for an entire economy seemed to involve so much more than I knew."
Mr. Grant adds, "A deeper kind of libertarian might have added: 'Maybe nobody can know enough to set interest rates for an entire economy.' "
Mr. Grant's piece is a highly disturbing visit to a rare distortion free zone (think bubble vision) and m* highly recommends reading the entire essay.
One of the most confusing aspects of the Greenspan legacy, no less confusing even to "the Maestro" himself has been the so-called interest rate conundrum. If money has been too cheap and credit has been too plentiful, where are the wage and price inflation pressures and concomitant higher long term interest rates elementary economics would expect?
Mr. Greenspan initially ascribed the lack of price pressures to increased productivity, (a presumed permanent increase actually) brought on by, yes, that new fangled thing known as the internet.
Later, he and others caught on to the impact of globalization, a catch all for the productivity improvements (in a statistical sense) gained by beaming capital and knowhow (and environmentally and fiscally unencumbered means of production) to one billion new job aspirants in recently opened and underdeveloped countries for the manufacture of goods for export back to developed nations' markets.
With few domestic liquid assets available to them, the exporters' central banks have recycled their unprecedented trade surpluses back into the developed nations' financial markets, especially the government securities that set the domestic market price for borrowing (particularly mortgage borrowing) thereby sustaining a virtuous circle of low interest rates and import consumption and leading to a chicken and egg debate between "savings glut," a now official term, and "credit bubble."
The "savings glut" has become the socially acceptable explanation (as it avoids any taint of an extended disequilibrium and the messy unraveling such situations inevitably entail) and its proponents frequently thrive as successful sell-side economists, macroeconomic research directors, and even future Federal Reserve Chairmen.
An especially abstract and sadly for m* fascinating bunch of monetary economists (mostly) attribute the reduced risk premiums and stable inflation expectations to the stellar central banking of the last several years.
"The change in the behaviour of inflation over the last few decades cannot be explained at least in any great degree by changes in globalisation... By far the main thing is how central banks have behaved in terms of providing money growth and setting interest rates," says John Taylor, an influential monetary economist at Stanford, as quoted by Krishna Guha in the FT recently.
Ali G, John Taylor is in the Green room.
The "credit bubble" has become the touchstone for "the moralists," of which m* confesses to knowing a few, and rests its credulity on the mountain of counterfactual evidence for the rosy explanation offered by the other two, as so succinctly cataloged by Mr. Grant above.
Kenneth Rogoff, Harvard economics professor, explains this conundrum with a subtlety that has been lost on most observers (and been a struggle to articulate for m* quite frankly) with his observation that China, far from being a blanket source of deflationary pressure, has in fact been changing relative prices. "Fed treads a fine line between perils" byKrishna Guha, FT What this means is that one can accept certain facts of the "savings glut" argument without succumbing to the entire (somewhat common-sense defying to m*) explanation of why it should continue.
Unfortunately, Rogoff's insight comes too late to prevent the Greenspan Fed's ultra-stimulative policy error of 2003-4 and the undeniable bubbly aftermath in credit and housing markets today.
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