Greenspan Speaks

by Gary North

Alan Greenspan's autobiography was released on September 17. He was interviewed by Leslie Stahl on September 16 on CBS's "60 Minutes," for what has to be the most successful book promotional appearance I can remember.

The book's title is The Age of Turbulence. Yawn. The guys in the marketing division should have insisted on Straight Talk – Finally.

Mr. Mumbles at long last has come clean about what I had said for almost two decades: his mumbling was deliberate.

"I would engage in some form of syntax destruction, which sounded as though I were answering the question, but, in fact, had not," Greenspan admits, with a chuckle.

At one hearing, Greenspan said, "Modest pre-emptive actions can obviate the need of more drastic actions at a later date, and that could destabilize the economy."

"Very profound," Greenspan says, after listening to his testimony.

I like the phrase, "syntax destruction." The master of this art – the mixmaster – was President Eisenhower. He was equally deliberate. He was perfectly content to be ridiculed by the press as a verbal incompetent. He played the press like the puppets they really are. Greenspan did the same, with equal success.

In the interview, Stahl referred to his advance on the book's royalties: $8 million. Even I was stunned. If he was paid top royalty – 15% – then at $35 per book, the publisher needs to sell over 1.5 million copies in hardback just to break even. This advance was extraordinary for an autobiography. It indicates just how influential he was and remains.

She asked him which currency he would prefer to be paid in. He said he plans to diversify. That was a way of saying, "I will not stick with the dollar 100%." He has the picture.

I do not begrudge him his $8 million. It was clearly worth that to get him out of the Federal Reserve System. I do begrudge the way he got it: by presiding over the FED and relying on monetary inflation to bail out the stock market in 1987, 1990–91, and 2000–2004.

He said that he did not grasp what was happening in the subprime mortgage market until late 2005. Stahl did not know enough to ask him why he did not recognize that a federal funds rate falling from 6.5% in mid-2000 to 1% in mid-2003 was inevitably going to produce arbitrage opportunities between the short-term rates and long-term, just as yen carry trade did, beginning in the early 1990's. The strategy of "borrow short, lend long" created the savings & loan bust in the mid-1980's in the United States. Why did he think it would be different after 2000?

Both Stahl and Greenspan kept coming back to Greenspan's love of economic statistics. The show's Greenspan segment ended with this:

When he's not working these days, he does what he's always done to relax: he flips through government reports with all those geeky numbers.

"He loves these data. I mean, I mean look at this stuff here," his wife, Andrea Mitchell, tells Stahl, looking at his morning reading, including a report from the Bureau of Labor Statistics.

"I just love getting into the detail of what the . . . say, protein content of hard red winter wheat was because – the differential in price. The differential in price between . . . ," Greenspan says.

"It's very romantic," Mitchell remarks.

." . . Kansas City and Chicago was. . . ," he says laughing. "No, it was romantic to me. That's what the joke is. And I'm still that way. I really just love that stuff."

This was Greenspan's problem for two decades: a preference for data that were separated from a coherent economic theory of the business cycle.

When he was a young economist in the 1960's, he was a devoted advocate of the gold standard. He understood cause and effect in economic theory. He understood how monetary inflation distorts the capital structure, leading to booms and busts. But, at his accession to the Chairmanship of the Board of Governors in 1987, his personal love for, and deep faith in, economic statistics overcame his mid-1960's faith in stable money as a matter of economic principle. He adopted the print-and-spend policies that have plagued every nation that has adopted central banking, which is all of them except Monaco and Andorra.

To begin with statistics is to begin with built-in blinders to economic cause and effect. Statistics are merely what government agencies have sampled in the past. Following statistics rather than a policy of stable money, he spent his career at the FED looking into a government-built rear-view mirror. He got out as Chairman just in time for the day of reckoning to arrive. Bernanke will get to ride the tiger that Greenspan left for him, just as Paul Volcker left Greenspan the tiger – smaller and weaker – in 1987.

MORE INFLATION

Greenspan argued that FED policy in his era did not face the problem of price inflation that Bernanke faces today.

We were dealing in an environment back there where inflation was easing. We could have acted without the fear of stoking inflationary pressures. You can't do that any more. And therefore it's a different world.

If he were Pinocchio, his nose would have grown six inches. Greenspan spent his entire career at the FED warning against price inflation, which was just around the corner. Only once do I recall that he warned against deflation, and he refused even to use the word. That was in his October, 1998 testimony after the New York FED had called together New York banks that had lent billions to Long Term Capital Management, Ltd., which was about to go bankrupt. He warned against cascading cross defaults. But he did not call this what it would have been: mass deflation. Over and over in his career, he warned that inflation was the economy's main threat. Year after year, the FED inflated. Inflation is always the problem because the Federal Reserve System exists.

He thinks we are at long last entering the age of inflation – not the mamby-pamby inflation that the FED has engineered ever since 1982, but the real thing. The present credit crunch is not the main problem.

"We're going to get through this particular credit crunch. We always do. This is a human behavior phenomenon, and it will pass. The fever will break and euphoria will start to come back again," Greenspan says.

This is utter nonsense, and if he does not know that it is nonsense, then he has become an amateur psychologist rather than a professional economist. Credit crunches are not human behavior problems. They are fractional reserve banking problems. They are the inevitable result of prior monetary expansion.

In the very next paragraph, he admitted as much. He predicted rising price inflation.

But he does see clouds on the horizon. "Over the long run, this is not going to be what our problem is. Our problem over the long run is the re-emergence of inflation," he says.

"This is interesting because in your book, your outlook on the broad future is pretty gloomy. Interest rates going up, you say. Inflation going up," Stahl says.

"Yes. Indeed I have a line in the book, 'It looks pretty gloomy,'" Greenspan agrees.

But why is price inflation inevitable? Stahl did not pursue this on-screen. Inflation is inevitable because the FED will create new fiat money in order to overcome the existing credit crunch, as it always does, and as it surely did under Greenspan in 1987, 1990, and 2001.

The coming inflation is no more a problem of human behavior than today's credit crunch is – and no less. Humans behave in terms of signals provided by the external world, and the crucial signals known as prices are deliberately, self-consciously distorted by central bankers.

I am not arguing against Greenspan's prediction of rising prices in general. I merely point out that he refused to blame price inflation on its source: the Federal Reserve System.

THE HOUSING BUBBLE

There is one exception to his prediction of rising prices: real estate.

Asked if he thinks this is going to have a deep lasting effect throughout the economy, in jobs, consumer and spending, Greenspan says, "It's not clear yet. And it will not be clear for quite a while. This is fundamentally, originally caused by the flattening out of home prices. And that is only now just beginning."

"Prices are going to fall further," Greenspan predicts.

So, what are we to make of all this? He says:

1. The FED did not cause a housing bubble. The mortgage issuers did.
2. The present credit crunch is a human behavior matter.
3. Home prices will fall further.
4. This, too, shall pass.
5. We are facing long-term inflation.

Here is my assessment:

1. The FED did cause a housing bubble. The mortgage issuers acted the way they did because the FED had lowered interest rates.
2. The present credit crunch is a human behavior matter – behavior in response to monetary tightening by the FED, beginning the month Greenspan departed: February, 2006.
3. Home prices will fall further.
4. This, too, shall pass.
5. We are facing long-term inflation.

On "60 Minutes," he said housing prices will fall further. He was more specific in his interview in the London Financial Times.

Mr. Greenspan said he would expect "as a minimum, large single-digit" percentage declines in US house prices from peak to trough and added that he would not be surprised if the fall was "in double digits."

The author of the article reminded readers that Greenspan had refused as Chairman to call this market a bubble.

As Fed chairman, Mr. Greenspan had talked about "froth" in the housing sector, but never said there was a bubble in the market as a whole. His successor Ben Bernanke has also avoided the word "bubble."

But Mr. Greenspan told the FT that froth "was a euphemism for a bubble."

He said he still thought froth – a collection of bubbles – was a better description, because of the variation in house price appreciation in different local housing markets. But he said "all the froth bubbles add up to an aggregate bubble."

THE CREDIT CRUNCH

His description of the credit crunch in the Financial Times was far less rosy than on "60 Minutes."

The former Fed chairman said the current turmoil in financial markets was "an accident waiting to happen."

He said the price of risk had fallen to unsustainably low levels beforehand, with investors addicted to asset-backed securities that offered some additional yield over Treasury bonds as if they were "cocaine." Mr. Greenspan said this demand induced the big increase in the origination of subprime mortgages by mortgage brokers.

His audience on "60 Minutes," as well as the interviewer, was not ready for a discussion of asset-backed securities. The issue is risk. The market had failed to assess the level of risk.

Yes, it had. But why? Why should entrepreneurs make such a mistake? The business cycle theory offered by Ludwig von Mises in 1912 gave the answer: the central bank's inflation sent out false signals to entrepreneurs. Low short-term interest rates persuaded them that there was more capital available than there really was. When entrepreneurs at last discover this, there is a credit crunch. This is now happening.

The rise in defaults on subprime mortgages was only the trigger that set off a broad re-evaluation of risk, he argued.

Mr. Greenspan said the off-balance sheet investment vehicles that issued much of the asset-backed commercial paper represented a "savings and loans disaster waiting to happen" because of the mismatch between their assets and liabilities. Mr. Greenspan thought the issuance of asset-backed commercial paper "is probably not going to get back to where it was."

They had "five-year maturity assets financed with 30-day commercial paper," he said.

There it is, in plain English: the capital markets have borrowed short and lent long. Greenspan's comparison was correct. This practice was also the cause of the S&L crisis of the 1980's.

The former Fed chairman said collateralised debt obligations – securities that slice up and repackage loans to meet the risk-appetite of different investors – "will never get back to the levels and structures that they were, because now everybody knows you cannot price them."

CONCLUSION

Alan Greenspan has not come clean. He has not come close to admitting that he presided over the FED as a joint agent of the commercial banking system, Wall Street, and the Federal government. He does not admit that the FED has not attempted to deliver stable money since about 1933. He has never admitted that the FED under his administration constantly returned to monetary inflation as a way to forestall recession. He did not mention that prices doubled under his era as Chairman, and nobody asked him.

He gets softball interviews which help sell his book. He has dropped FedSpeak, but he has not abandoned convenient memory loss. The Establishment media, which are also dependent on commercial banking, the stock market, and the Federal government, play ball with him.

His general assessment is accurate, however. Housing prices will continue to fall, probably in the double digits. The credit crunch will subside, due to FED intervention. Finally, the economy's long-term threat is more inflation, just as it has been since 1914.

September 21, 2007

Gary North [s end him mail] is the author of Mises on Money. Visit http://www.garynorth.com. He is also the author of a free 19-volume series, An Economic Commentary on the Bible .

Copyright © 2007 LewRockwell.com