Tuesday, September 18, 2007
By JAMES GRANT
September 18, 2007
At one point during his long interview on "60 Minutes" Sunday evening, Alan Greenspan could be seen autographing dollar bills for his smiling fans. Meanwhile, off camera, unautographed greenbacks continue to depreciate against a variety of metals and foreign currencies. A century ago the pound sterling anticipated the dollar's role today as the pre-eminent global monetary brand. But the pound was exchangeable into gold at the bearer's demand. Not since 1971 has the dollar been collateralized by gold or exchangeable at the U.S. Treasury into anything except nickels, dimes and quarters.
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 first reports of the book's contents trumpeted Mr. Greenspan's criticism of the current administration's spending habits and his (approving) sense that the Iraq war had something to do with crude oil. But the real news in "The Age of Turbulence" is what it reveals about the greenbacks to which Mr. Greenspan affixed his celebrity signature and the ways in which the currency has been managed and, especially, mismanaged.
A more self-knowing memoirist might have titled this book "The Age of Credulity." The great public drama of Mr. Greenspan's life is, of course, the work he performed as chairman of the Federal Reserve from 1987 to 2006. That work, in all but name, was price fixing. It consisted (and, under his successor, Ben S. Bernanke, still consists) of setting an interest rate and shoving it down the throat of the world's largest economy. It is a mighty strange work for a "libertarian Republican," as the Maestro styles himself here, let alone a former worshipful member of the inner circle of the radical individualist Ayn Rand. "It did not go without notice," the author writes of his swearing-in as chairman of the President's Council of Economic Advisers in 1974, "that Ayn Rand stood beside me as I took the oath of office in the presence of President Ford in the Oval Office."
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. The closest he comes to acknowledging it is his description of how the Fed looked to him from the outside. It was, he writes, a "black box." 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." A deeper kind of libertarian might have added: "Maybe nobody can know enough to set interest rates for an entire economy."
So Mr. Greenspan, a consulting economist of no special attainments (on the eve of the 1974 stock-market collapse, he was quoted in the New York Times saying "it is rare that you can be as unqualifiedly bullish as you can now"), agreed to perform the impossible. Succeeding Paul A. Volcker, he became America's monetary central-planner-in-all-but-name. Mr. Greenspan ruled the roost in 74 fiscal quarters, of which recession darkened only five.
Under his direction, the Fed became a kind of first responder to the scene of financial and economic distress. It soothed taut nerves following the 1987 stock-market break, nourished a crisis-ridden banking system with cheap money in 1990-92, helped to lead the Clinton administration's rescue of the Mexican economy in 1994-95 and engineered the so-called soft landing of the U.S. economy, also in 1995. It famously trimmed its interest rate three times during the Long-Term Capital Management crisis of 1998, succeeding so well in one artfully timed intervention that the stock market, in the final hour of a single session, leapt by 7%. And the market kept right on leaping, all the way to the Nasdaq's own Mount Everest in March 2000. One of those rare recessions followed, after which came the campaign to scotch what Mr. Greenspan was pleased to call "deflation." To fend off the peril of low and lower everyday prices, the Fed pressed its interest rate all the way down to 1% in 2003 and kept it there until mid-2004. Now it was house prices that went into orbit. They were just beginning to return to Earth when Mr. Greenspan retired from public life.
Readers who got one of the fancy new teaser-rate mortgages in 2003 or 2004, and who have lived to rue the day, are unlikely to find much nourishment in Mr. Greenspan's discussion of the theory of financial bubbles or in his self-exculpating account of the Fed's role in financing them with artificially low interest rates. Nobody can identify a bubble as it is inflating, Mr. Greenspan has long insisted -- though, as you will not read in these pages, Mr. Greenspan was so certain that he detected a stock-market bubble in 1994 that he tried to prick it by pushing interest rates up. Strangely, the author's bubble-sensor failed him later in the decade. He did, in 1997, utter the innocuous phrase "irrational exuberance," but that was as far as he went in attacking sky-high equity valuations.
Mr. Greenspan now writes that the enlightened central banker will let speculation take its course. Following the inevitable blow-up, he will clean up the mess with low interest rates and lots of freshly printed dollar bills -- thereby gassing up a new bubble.
Only one of the troubles with this prescription is that it requires an enlightened central banker to carry it out. Nowhere in this book does Mr. Greenspan own up to his role of underestimating the severity of the credit troubles of 1990, or of cheering on the tech-stock frenzy in 1998-2000, or of dangling the most beguiling teaser rate of all during the mortgage frolics of 2004 -- i.e., that 1% federal-funds rate. In February 2004, only months before the Fed started to raise its rate, in a speech titled "Understanding Household Debt Obligations," Mr. Greenspan demonstrated next to no understanding. His advice to American homeowners was not that they lock in a fixed-rate mortgage while the locking was good, but rather that they consider an adjustable-rate model. He who set the rates got it backward.
An only child of divorced parents growing up in New York City in the 1930s, Mr. Greenspan had seemed destined for better things than a career in interest-rate manipulation. He was an exceptional clarinetist, a Morse code enthusiast and the developer of a personal system for scoring baseball games. The boy who would date Barbara Walters, marry NBC's Andrea Mitchell and be knighted by the queen of England was, above all things, lucky. In 1944, a dark spot on the X-ray of his lung made him undraftable. He spent the late war years in the reed section of the Henry Jerome orchestra. Luck still with him, he gravitated to economics, thence to Ayn Rand and thence -- what could Rand have thought? -- to the security of the federal payroll.
Admirers or detractors of Mr. Greenspan's central banking record will turn the pages of the first half of this book -- the story of his life, his loves and his economics -- without once having to stifle a yawn. But few will remain alert while toiling through the public-policy ruminations that pad out the final 200 pages. As Fed chairman, Mr. Greenspan had a habit of inflicting on captive audiences his not always original views on such topics as rural electrification, education in a global economy and the bright promise of technology. Such ponderations are no more scintillating now that he is out of office.
"As Fed chairman," Mr. Greenspan writes, "I was queried by fellow central bankers with large holdings of U.S. dollars about whether dollars were safe investments." The monetary bureaucrats will find no reassurance in these all-too-many pages.
Mr. Grant is the editor of Grant's Interest Rate Observer.
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Even as the central bank starts to cut rates aggressively, many of the risks for the U.S. economy are beyond its reach.
NEW YORK (CNNMoney.com) -- Problems in housing, the financial markets and the first job decline in four years - as well as a 50 basis point Federal Reserve rate cut Today. But it has also raised talk about a recession - and whether the Fed is able to prevent one.
While most economists still don't believe the nation will fall into a recession, there is general agreement that the economy now faces a greater risk than there was only a month or two ago.
But many economists also say that the Fed can do little at this point to address many of the factors threatening continued economic growth. Some economists even argue that rate cuts could make matters worse.
The mortgage market would seem to be where the Fed could have the most effect. Most directly, a rate cut will reduce the rates for adjustable rate mortgages, one type of loan that has caused the problems for lenders and subprime borrowers, those with less-than-perfect credit.
An estimated 2 million homeowners face sharply higher mortgage payments when their current loans reset over the next year. So a Fed rate cut could possibly stave off a wave of foreclosures.
That's key since more foreclosures could have the potential to hurt consumer spending as a whole, said David Wyss, chief economist for Standard & Poor's.
"About 1 or 2 percent of the population is going to be seriously affected by these resets. That's not trivial," said Wyss. "One thing a Fed rate cut will do is reduce that reset shock fairly quickly."
But others say a rate cut won't solve the problem for those who have been paying low teaser rates on their mortgages with the expectations that they would be able to refinance before rates reset. The fact that investors no longer are willing to buy securities backed by such non-traditional mortgages could make it impossible for hundreds of thousands of those homeowners to refinance.
"A rate cut even down to zero percent doesn't make those attractive investments," said Edward Leamer, director of the UCLA Anderson Forecast, which now puts the chance of recession at about 30 to 35 percent. "The Fed is in the situation where they should not be thinking about saving housing. They should be thinking about isolating the problem strictly to the housing sector."
The mortgage problems have clearly led to a broader credit crunch in financial markets, which has already put a crimp on the financing of some proposed mergers.
While a Fed rate cut may help get those markets functioning more fluidly once again, there is debate among economists about how great a risk the credit crunch poses to the overall economy.
"It's pretty hard to draw strong lines between the credit crunch on Wall Street and the economy, except in real estate," said David Kelly, economic adviser for Putnam Investments. "If there are some deals delayed, it's not a problem for real economic activity. In fact, usually mergers and acquisitions cost jobs. They don't create jobs, except with Wall Street firms. Outside New York, there shouldn't be much impact."
But Gus Faucher, director of macroeconomics for Moody's Economy.com, said that getting the credit markets working again is important for business confidence, which is a key driver in decisions by companies whether to hire new workers and invest in plants and equipment.
"Businesses are still sitting on a ton of cash. The question is if they are going to go out and use that," he said. And he believes this is an area where a Fed rate cut can have the most positive effect.
"They need to know if the Fed is on the job and ready to respond," he said.
But Putnam's Kelly said that if the Fed signals that next week's cut is the first of a series of many, it could put some needed spending by businesses and consumers on hold, as they wait to see how low the rates will fall, and how much the economy is going to slowdown.
"The Fed could contribute to the problem while fixing it if they're not careful," said Kelly. "If the Fed promises further cuts, it gives people reasons to have doubts about the economy and a reason to wait to make investment decisions. If you're trying to pick up a house at a bargain, will you do it now or wait six months? You'll wait six months."
Another risk to the economy would be a drop in foreign investment here, according to some economists. And a Fed rate cut might cause more problems than it fixes because lower rates would make some U.S. investments, such as government-issued Treasurys, less attractive to foreigners.
Leamer and Wyss said a steeper drop in foreign investment would be a big problem for the economy because that flow of funds has been key to keeping long-term rates low.
"Last year we had $1 trillion come in net foreign investment, most of it into the bond market, and most into private bonds, not Treasurys," said Wyss. "If that money stops coming in, that's going to be a big increase in borrowing costs."
A sharp drop in foreign investment would also feed into the slide in the value of the dollar, which hit a record low against the euro on Thursday. While that would make U.S. exports more competitive, it also would likely raise the price of imported goods and hurt the spending power of U.S. consumers, who have come to count on low-price imports for everything from food to clothes to cars.
Wyss and Leamer say they're not predicting a sharp drop in foreign investment, but that it is a concern. And economists say there's relatively little the Fed can do to keep investors from outside the United States from pulling back on U.S. assets if it is cutting rates.
"The Fed has to make its primary concern what is happening to the domestic economy," said Wyss. "You can't focus on the dollar."
The Fed also has little ability to affect another risk to the economy: high oil prices. Crude oil prices hit $80 a barrel for the first time Wednesday.
While the economy has kept growing with oil in the $60s and $70s, economists say rising prices are a bigger risk now given how vulnerable the economy is. High oil and gas prices would be just one more thing for an already nervous consumer to worry about.
"I think if this lasts for two to three months, it's going to be a problem," said Faucher about oil prices. "If this was happening when the economy was going great guns, I wouldn't be as concerned. But more than just the costs, this can affect consumer psychology. If it shows up at the pump, then we've got some problems."