BLOWING BUBBLES
Issue of 2004-07-12 and 19
Next March, Alan Greenspan will turn seventy-nine. Sound health persisting—he plays tennis and golf regularly—he will be well into his eighteenth year as chairman of the Federal Reserve Board and, depending on what happens in November, will be serving his fourth or his fifth President. Greenspan’s lugubrious face and nasal monotone are as familiar and as comforting to ordinary Americans as Prozac and “The Simpsons,” both of which débuted in 1987, the same year President Reagan appointed him to office. Greenspan’s absence, like that of Lord Palmerston in Victorian Britain, has come to seem unthinkable.
But, in our system of checks and balances, Greenspan’s position is an anomaly. The Fed is at once an independent institution and part of the government. Its chairman is Presidentially nominated and senatorially confirmed, but he takes orders from no one. The Fed’s decision last week to raise short-term interest rates by a quarter of a point cannot be appealed—not to the White House, not to Capitol Hill, not to the Supreme Court. Although Congress obliges the Fed chairman to report to it twice a year on the conduct of monetary policy, politicians rarely challenge his authority. Last month, when the Senate Banking Committee endorsed Greenspan’s nomination for a fifth four-year term, Senator Jim Bunning, Republican of Kentucky, cast the only vote against him. (Bunning objected to Greenspan’s voicing opinions on subjects such as tax cuts and the budget deficit, which he believes are outside the Fed’s jurisdiction.)
Given Greenspan’s role in promoting and prolonging the stock-market bubble that burst in 2000, the deference that surrounds him seems a little overdone. A few months ago, he argued that the unusually mild recession in 2001, and the subsequent recovery, however uncertain, had vindicated the Fed. “There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful,” Greenspan told a meeting of economists. Perhaps. It’s true that he has quashed fears that post-bubble, post-9/11 America would resemble post-bubble Japan, which experienced a decade of economic stagnation following the 1991 collapse of the Nikkei. He has also done his best to boost the election prospects of George W. Bush. With four months left until Election Day, employers are finally creating jobs in significant numbers—more than a million of them in the past four months, according to the Labor Department. The rise in business productivity that began in 1995 appears to have accelerated since 2001, with the annual growth rate approaching five per cent. Since productivity ultimately determines wages and living standards, this is an important development.
Nevertheless, Greenspan’s claim of vindication is premature. Although the recovery looks genuine, there are serious questions about its sustainability. Between the start of 2001 and the middle of 2003, the Fed cut its target interest rate from 6.5 per cent to one per cent, the lowest level since the Eisenhower Administration. With the cost of borrowing lower than the rate of inflation, the Fed was essentially giving money away. At the same time, the Bush Administration cut taxes by trillions of dollars. This one-two dose of stimulus boosted spending throughout the economy, as such a stimulus usually does, but it left the nation’s finances chronically unbalanced, with consumers and the federal government both spending well beyond their means.
The President’s fiscal policy, most of which Greenspan publicly endorsed, has been widely criticized, but the consequences of the Fed’s cheap-money policy have largely escaped attention. Tempted by unprecedentedly low interest rates, Americans have taken on unprecedented levels of debt, particularly in the realestate market, which has replaced the stock market as the favored vehicle for get-rich-quick schemes. For many families, the soaring value of their home offset the slump in their stock portfolio, but, with one-bedroom apartments in Manhattan selling for more than half a million dollars, and with California banks being forced to introduce forty-year mortgages so that their customers can afford to buy a house, even some of Greenspan’s colleagues are concerned that one bubble has given way to another.
In addition, over-all inflation is rising, albeit from a low base, with prices for some middle-class staples, such as gasoline and health-care premiums, increasing especially sharply. Most worrying of all is the prospect of a currency crisis—a phenomenon practically unknown to Americans but familiar to citizens of many other countries whose governments have pursued irresponsible economic policies. For years, Americans lent more money to foreigners than they lent us. Now we owe the rest of the world about two and a half trillion dollars, and the debt burden is rising every day.
History demonstrates that countries can increase their foreign borrowing only so far before creditors start to lose confidence that they will be repaid in full. The limit tends to come when the trade deficit reaches about five per cent of G.D.P., which is about where the United States’ trade deficit is now. Once lenders’ confidence disappears—as it did in Britain in 1967, in Mexico in 1994, and in Russia in 1998—panic selling ensues, precipitating a collapse in the currency. Interest rates rise, the stock market plummets, and the economy enters a severe recession.
Greenspan refuses to contemplate such a catastrophe. On Capitol Hill recently, he insisted that the economy “seems to be on track,” while conceding that the task of weaning it from its addiction to cheap money is “not a gimme putt.” Last week’s interest hike will probably be the first of many, as the Fed raises the federal funds rate to a more normal level. Since Greenspan prefers to move slowly, the process of policy tightening will almost certainly extend into the second half of next year, and maybe into early 2006, when, around the time of his eightieth birthday, he is expected to retire. By then, it will be easier to judge whether Greenspan deserved all the plaudits he received or whether he was ultimately more of a cheerleader than a responsible central banker.
— John Cassidy
Issue of 2004-07-12 and 19
Next March, Alan Greenspan will turn seventy-nine. Sound health persisting—he plays tennis and golf regularly—he will be well into his eighteenth year as chairman of the Federal Reserve Board and, depending on what happens in November, will be serving his fourth or his fifth President. Greenspan’s lugubrious face and nasal monotone are as familiar and as comforting to ordinary Americans as Prozac and “The Simpsons,” both of which débuted in 1987, the same year President Reagan appointed him to office. Greenspan’s absence, like that of Lord Palmerston in Victorian Britain, has come to seem unthinkable.
But, in our system of checks and balances, Greenspan’s position is an anomaly. The Fed is at once an independent institution and part of the government. Its chairman is Presidentially nominated and senatorially confirmed, but he takes orders from no one. The Fed’s decision last week to raise short-term interest rates by a quarter of a point cannot be appealed—not to the White House, not to Capitol Hill, not to the Supreme Court. Although Congress obliges the Fed chairman to report to it twice a year on the conduct of monetary policy, politicians rarely challenge his authority. Last month, when the Senate Banking Committee endorsed Greenspan’s nomination for a fifth four-year term, Senator Jim Bunning, Republican of Kentucky, cast the only vote against him. (Bunning objected to Greenspan’s voicing opinions on subjects such as tax cuts and the budget deficit, which he believes are outside the Fed’s jurisdiction.)
Given Greenspan’s role in promoting and prolonging the stock-market bubble that burst in 2000, the deference that surrounds him seems a little overdone. A few months ago, he argued that the unusually mild recession in 2001, and the subsequent recovery, however uncertain, had vindicated the Fed. “There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful,” Greenspan told a meeting of economists. Perhaps. It’s true that he has quashed fears that post-bubble, post-9/11 America would resemble post-bubble Japan, which experienced a decade of economic stagnation following the 1991 collapse of the Nikkei. He has also done his best to boost the election prospects of George W. Bush. With four months left until Election Day, employers are finally creating jobs in significant numbers—more than a million of them in the past four months, according to the Labor Department. The rise in business productivity that began in 1995 appears to have accelerated since 2001, with the annual growth rate approaching five per cent. Since productivity ultimately determines wages and living standards, this is an important development.
Nevertheless, Greenspan’s claim of vindication is premature. Although the recovery looks genuine, there are serious questions about its sustainability. Between the start of 2001 and the middle of 2003, the Fed cut its target interest rate from 6.5 per cent to one per cent, the lowest level since the Eisenhower Administration. With the cost of borrowing lower than the rate of inflation, the Fed was essentially giving money away. At the same time, the Bush Administration cut taxes by trillions of dollars. This one-two dose of stimulus boosted spending throughout the economy, as such a stimulus usually does, but it left the nation’s finances chronically unbalanced, with consumers and the federal government both spending well beyond their means.
The President’s fiscal policy, most of which Greenspan publicly endorsed, has been widely criticized, but the consequences of the Fed’s cheap-money policy have largely escaped attention. Tempted by unprecedentedly low interest rates, Americans have taken on unprecedented levels of debt, particularly in the realestate market, which has replaced the stock market as the favored vehicle for get-rich-quick schemes. For many families, the soaring value of their home offset the slump in their stock portfolio, but, with one-bedroom apartments in Manhattan selling for more than half a million dollars, and with California banks being forced to introduce forty-year mortgages so that their customers can afford to buy a house, even some of Greenspan’s colleagues are concerned that one bubble has given way to another.
In addition, over-all inflation is rising, albeit from a low base, with prices for some middle-class staples, such as gasoline and health-care premiums, increasing especially sharply. Most worrying of all is the prospect of a currency crisis—a phenomenon practically unknown to Americans but familiar to citizens of many other countries whose governments have pursued irresponsible economic policies. For years, Americans lent more money to foreigners than they lent us. Now we owe the rest of the world about two and a half trillion dollars, and the debt burden is rising every day.
History demonstrates that countries can increase their foreign borrowing only so far before creditors start to lose confidence that they will be repaid in full. The limit tends to come when the trade deficit reaches about five per cent of G.D.P., which is about where the United States’ trade deficit is now. Once lenders’ confidence disappears—as it did in Britain in 1967, in Mexico in 1994, and in Russia in 1998—panic selling ensues, precipitating a collapse in the currency. Interest rates rise, the stock market plummets, and the economy enters a severe recession.
Greenspan refuses to contemplate such a catastrophe. On Capitol Hill recently, he insisted that the economy “seems to be on track,” while conceding that the task of weaning it from its addiction to cheap money is “not a gimme putt.” Last week’s interest hike will probably be the first of many, as the Fed raises the federal funds rate to a more normal level. Since Greenspan prefers to move slowly, the process of policy tightening will almost certainly extend into the second half of next year, and maybe into early 2006, when, around the time of his eightieth birthday, he is expected to retire. By then, it will be easier to judge whether Greenspan deserved all the plaudits he received or whether he was ultimately more of a cheerleader than a responsible central banker.
— John Cassidy
