National Post, Canada
Tuesday, June 22, 1999
Has Alan Greenspan finally signalled the end of the party? We think so. A paradigmatic shift has occurred in the Fed chairman's thinking, a watershed in monetary policy-making.
Before we dissect his carefully crafted June 17 testimony to the Joint Economic Committee, we should note that Wall Street does not share our opinion. In fact, bond and stock markets rallied with gusto, relieved that a modest quarter-point tightening was all that was going to be. This was inferred from his statement that "when we can be pre-emptive, we should be, because modest pre-emptive actions can obviate the need to more drastic actions at a later date." Even on their interpretation, however, one ought to pay attention to the calculated use of the plural actions. Will it be a number of quarter-point actions?
That Mr. Greenspan is gravely concerned with stock market and real estate speculation is undeniable. His speech is littered with such references. Why should he care about asset price inflation when prices and costs remain so well behaved? The answer is that the Fed has singled out home and equity speculation as prosperity's main source of potential destabilization. His truncated logic runs as follows: The pool of available job seekers is dwindling as "labour productivity has not grown fast enough to accommodate the increased demand for labour induced by the exceptional strength in demand for goods and services." This, in turn, has been produced by "an inclination of households and firms to increase their spending on goods and services beyond the gains in their income from production." In other words, consumers have been running down their savings.
How did this happen? The answer is that the "propensity to spend" has been "spurred by the rise in equity and home prices . . ." We have come full circle: Rising stock and home prices have spurred people to go on a spending binge, which, in turn, is straining an already tight labour market. This will lead, eventually, to "significant increases in wages, in excess of productivity growth." No wonder the Fed has been uncomfortable with the proper "weight to place on asset prices."
But if Mr. Greenspan brings the party to an end, in the interest of reducing this "propensity to spend," won't that bring about a depression? Not to worry, he reassures us: "Even if this period of rapid expansion of capital gains comes to an end, shortly, there remains a substantial amount in the pipeline to support outsized increases in consumption for many months into the future." Adding immediately that "of course, a dramatic contraction in equity prices would greatly reduce this backlog of extra spending," he may be signalling that a mere correction may not do the job, and that something a bit more dramatic may be required to reduce the extra or excessive spending.
After dealing, rather ambiguously and inconclusively, with the concept of bubbles ("a large number of analysts have judged the level of equity prices to be excessive," and "bubbles generally are perceptible only after the fact") he consoles us for what is about to happen: ". . . while bubbles that burst are scarcely benign, the consequences need not be catastrophic for the economy." Neither the bursting of the Japanese bubble a decade ago nor the 1929 Crash led to depressions; rather, it was the "ensuing failures of policy," or so he thinks.
Rather belatedly, Mr. Greenspan is here preparing us for what will happen anyway -- or, more likely, for what he is about to bring about: a stock market crash. Hopefully, it will be handled properly, perhaps in the same manner as the Fed dealt with the aftermath of the 1987 crash -- providing enough liquidity to forestall widespread systemic failures. He must have had something like that in mind when he added that "certainly, the crash of 1987 left little lasting imprint on the American economy." A few lines later, he confirms this idea: "Should volatile asset prices [read: collapsing stock prices] cause problems, policy is best positioned to address the consequences when the economy is working from a base of stable product prices." In other words, if inflation is still benign at the time of the coming crash, the Fed will be able to contain the damage by easing money once again.
Significantly, he ended his testimony with the following words: "It is the job of policy-makers to mitigate the fallout when it occurs, and hopefully, ease the transition to the next expansion." Why would he close his remarks by referring to a fallout, unless that was a foregone conclusion? In other words, will he persist in tightening -- one quarter at a time -- until he eliminates the source of the naughty propensity to spend?
We referred earlier to Mr. Greenspan's truncated logic. Indeed, he should know better than to characterize asset price inflation as the destabilizing element. Asset price inflation is not an endogenous phenomenon. Rather, it is the result of years of excessively easy money, itself the consequence of a monetary policy that has lost contact with the true demand for money. Fiat money has been managed by a well-meaning -- but misguided nonetheless -- team of technocrats, not gratuitously called central bankers. They have fixed the "price" of money much as the former centralized economies fixed the price of shoes or bread -- in complete disregard to the laws of economics. Little wonder, then, that they have manufactured too much money.
The numbers bear it out: The growth of the broad monetary aggregates has been accelerating ever since the Mexican crisis, hitting recently the fastest pace since the very early '80s, a time of serious inflation. Our own favourite, M1, after due weight is given to rising money velocity, has been flashing red for well over two years. The Fed's adjusted monetary base -- the one variable totally under its control -- has been exploding upward, at 9% year-over-year and at 14% in the most recent two months, all but proving that the price of money has been fixed too low.
It is not just asset price inflation that threatens the stability of the economy. More fundamentally, it is a fiat money system that has, predictably, lost its way. One, two or even three hikes in fed funds will do little to remedy the situation, though they will certainly begin to unwind the speculative excesses of the past decade. When it is all over, let us hope we will all concur that money is too important to be left in the hands of central bankers.