The One-Eyed Chairman
When Alan Greenspan retires as Federal Reserve chairman early next year, we can expect waves of adulation for his extraordinary eighteen-year reign over the American economy. The financial press is already offering nostalgic retrospectives on the highlights: the crash of '87 and rapid rebound, the chairman's total victory over price inflation, his swift interventions to avoid financial panics and to reverse the stock market's massive meltdown of 2000-01. In tempestuous times, this Fed chairman acquired a godlike aura--the inscrutable wizard with a nerdish charisma, his wisdom cloaked in financial doubletalk. How will the nation get along without him?
A different assessment was expressed last winter by the Senate minority leader, Harry Reid. "I'm not a big Greenspan fan," the Nevada Democrat allowed. "I think he's one of the biggest political hacks we have in Washington." His harsh comment was politely overlooked in governing circles, like an off-color joke told at a Washington dinner party.
When the adulation fades and people begin to understand the full weight of Greenspan's legacy, however, they should be able to see that Reid had it right. Indeed, the Senator's critique did not go far enough. The central banker is a hack, yes, but also a man of conviction.
Alan Greenspan is the most ideological Fed chairman since the 1930s. Without ever acknowledging his intentions, he enlisted himself and the awesome governing powers of the central bank in advancing the "reform" agenda of the Republican right. The chairman thus became an important actor in achieving the profound transformations that occurred during the last generation: the retreat of government, the rise of market ideology and the financialization of American economic life. The "money guys" gained hegemony over the "real economy" of production and work--the people and businesses who make things. The consequences imposed on society are often described as "the tyranny of the bottom line." In numerous ways, the Greenspan Fed helped make it happen. However, the chairman did not produce what conservative doctrine promises--stable and secure prosperity.
Greenspan crossed a line previous Fed chairmen had always gingerly honored: the appearance of political neutrality. That's what angered Reid--this chairman made himself a player on highly partisan matters, using his status as the influential arbiter of "sound economics" to prod Congress and the public to accept the right's larger goals. After years of hectoring Democrats to cut spending and eliminate federal budget deficits, the chairman turned around and endorsed George W. Bush's massive, regressive tax cuts. Democrats fumed, since they had been snookered by Bill Clinton and his Treasury Secretary Robert Rubin into accepting the Fed's agenda, with never a complaining word. But Wall Street loved the wizard, who had gratuitously embraced the GOP plan to deform Social Security by turning over its trillions to the private investment houses.
Trespassing in party politics is not a trivial offense. The so-called "independent" Federal Reserve, from its origins in 1913, has in theory been a cloistered, technocratic institution that has stayed above the fray, making "scientific" decisions on money and credit, acting like a "governor" that regulates the engine of economic growth for long-term stability. The notion of a depoliticized central bank is illusory, of course, since banking interests have always hovered intimate-ly around the Fed's policy decisions. But the myth is useful cover and necessary to sustain the Fed's privileged status as a government agency exempted from normal scrutiny and criticism, deliberately shielded from accountability to the voters--that is, shielded from democracy.
But if the Fed chairman is acting as an errand boy for special interests--in this case for concentrated financial power and wealth--why should the central bank continue to be granted its protected status? Why not bring the institution out into full sunlight, scrub away the pseudo-scientific mystique, make it accountable to elected officials and let Americans learn how to engage with the political-economic issues that govern their lives?
Like other good questions prompted by Greenspan's distinctive performance, this debate is unlikely to be heard, not yet anyway. The bipartisan deference to the central bank remains too strong. Reform-minded politicians have dwindled to a handful. Someday, however, the partisan question might come back to haunt the Federal Reserve and the right-wing Republicans, too.
From Active Government to Laissez-Faire
The ideological shift executed by the Greenspan Fed is more extreme than generally recognized. There has been nothing like it since the New Deal years, when Marriner Eccles was Fed chairman and collaborated closely with FDR to reform the central bank and convert it to the economic understandings grounded in Keynesian liberalism. Eccles and Greenspan are like historic bookends on the long, gradual transition in economic thinking from left to right, from active government intervention to the current faith in laissez-faire markets.
Eccles was a Republican Mormon banker from Utah who became a leading architect of New Deal reforms (including issues beyond monetary policy). In the crisis of the Great Depression such odd political convergences occurred. The self-taught Eccles (he never went to college) personally intuited what John Maynard Keynes developed as a formal theory: The national government, including the Fed, must become the intervening balance wheel in a modern industrial economy--the stabilizing force that, when necessary, stimulates the economy to encourage faster growth and full employment, while at other times it puts the brakes on economic activity to avoid inflation. Eccles essentially invented the modern Federal Reserve, liberating the central bank from the 1920s hard-money orthodoxy of banking and finance, an inflexible doctrine that gravely worsened the Depression.
Greenspan, one might say, devoted his tenure to eliminating vestiges of Eccles and FDR. He resurrected the financier's lost religion, now dignified by conservative economists as the new theory of "efficient markets." Keynesian demand-side stimulus, they contended, produces no lasting effects for the economy, so nothing will be gained by worrying about wage incomes and the consuming power of workers. Wages should be determined by the marketplace and are none of the government's business, except when it wants to squelch price inflation.
The best government can do for the economy, conservatives argued, is to boost the "supply side"--that is, favor wealth holders so they will have more capital to invest in new factories and production. This logic led to huge tax cuts for high-end citizens and for business. It meant liberating and protecting financial markets to do their thing: distributing capital for productive uses in the most efficient (and often ruthless) manner. It convinced Greenspan's Federal Reserve, though a principal regulator of banking and finance, to no longer believe in regulation.
In that sense, Greenspan was the perfect chairman for this era. His monetary policy directly supported all of the various doctrinal strands of the right's ascendant ideology. He deliberately restrained economic growth for many years, effectively suppressing employment and wages. The economy, he argued, cannot grow faster than 2-2.5 percent without igniting price inflation, so the Fed was duty bound to prevent it. (That's not exactly laissez-faire policy, but never mind the contradictions.) Capital gained in value as a result. Labor took it in the neck. Economic ideologies are often elaborate rationales to justify taking care of some folks and neglecting others.
Meanwhile, protecting the supply side of the economy, the chairman came to the rescue of the financial system and financial firms again and again, whenever they encountered serious peril or the stock market seriously wilted. The 1998 collapse of Long Term Capital Management was interpreted as threatening the safety of the financial system so the Fed stepped in (what happened to the therapeutic effects of market discipline?). Likewise, the Fed reacted aggressively to the Russian debt crisis that year and the jitters over the "Y2K crisis" of 2000, and Greenspan provided quick liquidity or interest-rate cuts to calm other financial-market upsets.
Greenspan did not formally try to deregulate the banking system, but simply declined to use the Fed's regulatory powers to enforce regular order or discipline fraudulent behavior. In the name of greater efficiency he engineered legal approval for new megabanks like Citigroup even before Congress changed the law. These "too big to fail" financial conglomerates promptly rewarded the chairman's faith by engineering their own massive scandals--the Enron-style corporate frauds and dishonest balance-sheet maneuvers that bilked investors.
Bubbles and Meltdowns
Greenspan's finance-friendly passivity was demonstrated most fatefully when the stock market developed its infamous "price bubble." The chairman refused to take preventive action. Some $6 trillion was lost by investors in the meltdown, but Greenspan treated it like an unfortunate act of nature. Government does not know enough, he insisted, to intervene in such situations. All it can do is clean up the mess afterward. Greenspan was frequently compelled to do so.
The governing culture at the Fed was also changed dramatically under Greenspan's tutelage. Libertarian clones were appointed to various top positions--officials who take principled pride in their refusal to act as vigilant regulators. The president of the Richmond Federal Reserve Bank warns of the danger of policing the banking industry's "predatory lending" practices too stringently. The Chicago Fed president attacks public schools as a government monopoly. A Federal Reserve governor (and former bank lobbyist) testifies on the need for the Fed to provide larger subsidies for the major banks.
The contrast with Greenspan's predecessor, Paul Volcker, is instructive. Volcker was a savvy and imperious career regulator, adept at befogging politicians and willing to impose harsh discipline on the economy (his long, brutal recession in 1980-82 launched the process of disinflation that Greenspan completed). But Volcker also distrusted the lemming-like behavior of bankers and the faddish enthusiasms of financial markets. He managed his monetary policy close to the vest, hoping to keep the "money guys" off balance and a little intimidated by the Fed's power. Greenspan wanted markets to trust him, even like him. If he provided ample "information" and sprung no surprises, he thought financial-market participants would behave in reasoned, responsible ways. Never happened. But they did like him. They knew he was on their side.
While many contradictions accumulate around Greenspan's governance, none are more obvious than this: The chairman ruled like a one-eyed king, who chose to see only half of the reality before him. He applied rigorous discipline to the real economy, always ready to slow things down to block any price inflation in goods and services, especially in wages. Often he erred deliberately on the side of pre-emptive toughness--tamping down economic growth even when there was no price inflation at all.
Yet the king simultaneously ignored the truly ferocious price inflation under way in financial markets during his long tenure. If working-class wages rose smartly, that was a sign of inflation threatening prosperity. If stock prices rose explosively, that was evidence of good times ahead. For true believers in the conservative orthodoxy, there was no contradiction--capital was growing, unions were being decimated. If you embraced "efficient markets" theory, you would naturally be reluctant to go against the stock market's soaring valuations. If you thought markets were self-regulating, you could count on them to correct themselves. In a way, they did--eventually and violently--by succumbing to a massive "correction"--much to the sorrow of millions of hapless investors, pension funds and others who had gotten no timely warnings from their government about what was ahead.
Greenspan could not claim ignorance. In private meetings with Federal Reserve Board colleagues as far back as 1996, he was repeatedly warned of the dangers posed by the growing stock-price bubble. He declined to take any action or even warn the public. Yale economist Robert Shiller, whose book Irrational Exuberance impressively predicted the coming bloodbath, was a rare critic. A public official who fails to alert investors to such risks "is no better than a doctor who, having diagnosed high blood pressure in a patient, says nothing because he thinks the patient might be lucky and show no ill effects," Shiller wrote.
The Price of 'Sound Money'
The lopsided focus of Greenspan's Fed--exalting financial markets over the real economy--is perhaps his greatest ideology-driven error, and it caused the deepest damage to society. Congress by law instructs the Federal Reserve to pursue twin goals--stable money and full employment--and there is always a natural tension between those two objectives. Maintaining low price inflation gets much more difficult when the economy expands more vigorously, so the central bank traditionally tried to sustain a rough balance. Greenspan resolved the tension easily (as most conservatives probably would) by tipping the scales in favor of sound money.
The strategy produced very low price inflation, as close to zero as possible, which boosted prices for financial assets, stocks and bonds but also pumped up the financial bubble even further. Soaring stocks encouraged "New Economy" fantasies that the good times would last forever. His fans call Greenspan's era "the great moderation" because there were fewer and shorter recessions, but that leaves out the deeper-running consequences of his reign. In reality the Fed was acting as a principal source of the growing inequalities in American society.
Greenspan's ultimate dilemma--his essential governing failure--was that he didn't know how to handle "success." He had pushed too far in one direction, hardening money's value year after year, but he couldn't push price levels any lower without igniting a destructive deflationary spiral. How to turn around? Conservative orthodoxy provided no good answers to this dilemma, since it claims that zero inflation is a state of perfection. In fact, it is the most dangerous terrain in capitalism. Preventing deflationary calamities was one of the main reasons the Federal Reserve was created.
After years of doing the opposite, the chairman belatedly took his foot off the brake pedal and decided to let the economy grow faster. His shift generated full employment and rising wages--the chairman was celebrated as an economic genius--but booming relief for the real economy came too late to last, given the other imbalances Greenspan had fostered. Faster growth perversely expanded the stock market's delusions, and the price mania spiraled to new heights. Remember the predictions of Dow 35,000? Instead of confronting the real problem, the financial excesses, Greenspan once again turned on the real economy and hammered it with increased interest rates, deceitfully claiming he was attacking wage-price inflation. He lost his gamble on both fronts. The financial bubble did not moderate; it collapsed. And so did the short-lived boom. The national economy was deeply wounded by these events and it is still struggling to recover.
Beware of economic policy-makers who go to extremes in defense of ideological convictions. Essentially, that is the nature of Greenspan's grave failure. The real world did not cooperate with his right-wing beliefs, but he persisted anyway. In the hydraulics of monetary policy, his posture set in motion deep waves of economic extremes: fabulous personal wealth alongside a deeply indebted populace; extraordinary corporate profits alongside stagnant wages and surplus labor; too much capital and not enough consumer demand. These exaggerated waves, and some others, are still sloshing back and forth in the US economy. They will for years ahead, with more crises to come. Greenspan collected much praise for his swift and daring rescue missions--the nimble fireman rushing from blaze to blaze, putting out fires before they destroyed the economy. What many people did not understand is that it was Greenspan who lit the match.
The great irony of the Greenspan era is that conservative ideology turned out to be not conservative at all. It was instead recklessly experimental, testing out its new theories in the human laboratory and ignoring any negative results. Who can still believe in "efficient markets"? Not the folks who lost $6 trillion in the stock market. Who can seriously argue that capital investors need still more "supply side" favors from government, when even Bush's economic adviser complains of a "global savings glut"? Who still wants to liberate the fraud-happy bankers and financiers from the dead hand of government regulation?
My point is, the market ideology is in deep trouble--intellectually, if not politically. If you go behind the mystique and examine Greenspan's performance, there is abundant evidence that demonstrates in real terms the right's economic fallacies, never mind its moral failings. It is premature to talk of an ideological crackup--the right still holds power--but it is not too soon to develop the case for counter-reformation. Most academic economists wouldn't touch it, but maybe some young grad students will decide their right-wing professors are full of crap and undertake the search for alternative thinking. That is how reigning economic ideologies often crumble--when the next generation sees that the old orthodoxy can no longer cope with the facts.
The prospects for political reform are gloomier. Democrats tossed away their populist credentials years ago, and with few exceptions are utterly subservient to the Fed mystique. But there's strong, critical material for the reform-minded citizens and public officials who are not intimidated. What might they say? That the Federal Reserve has violated its basic obligations to democracy and it's time to revise its peculiar charter. It is wrong for a government institution to sit by silently and watch a slow-motion disaster unfold for citizens, as Greenspan did. It is also wrong--both politically and economically--to ignore the legal mandate and simply serve one realm of the economy over everyone and everything else. In a democracy, government at least owes citizens fair notice--a timely warning of what it's doing to them. The Fed never, never honors this obligation, for obvious reasons; but then neither do many politicians. That's the basic reason democratic discourse and accountability are so necessary--the hope that somebody somewhere in the government will have the decency to tell the people.
What He Leaves Behind
Which brings us to current circumstances. The Greenspan era, unfortunately, will not end when he departs. The instabilities and ruptures he sowed will still be with us, and he would be wise to get out of town before people recognize the full depth of his destructive legacy. The US economy is not strong and self-confident or even especially efficient. It is stumbling along under subnormal conditions, losing ground and taking on enormous debt from abroad. Nor is the United States free of the follies and risks generated during Greenspan's reign, including financial delusions and the threat of deflation. His successor will presumably be a right-winger too, but one hopes for a more supple, flexible intellect.
The weak-willed economy is an apt illustration of where Greenspan's lopsided policies have led. Four years after the 2001 recession ended, the economy is still struggling to overcome its "jobless" recovery (or "job-loss" recovery, as manufacturing unions call it). Corporate profits have rebounded to extraordinary levels, but companies are reluctant to invest the capital. Wages, meanwhile, remain flat or falling, especially for working-class occupations. Forty-six months into this expansion cycle, the total hours worked in nonsupervisory jobs have risen only 2 percent since the recession ended--compared with rebounds of 9-16 percent after the four previous recessions. Manufacturing, once the vital core of US prosperity, is still losing jobs every month. Its total working hours are down 9 percent since 2001.
This is the most sluggish recovery on record, which seems to puzzle the Fed chairman. But it reflects the Greenspan style of running things; he presided over a similarly tepid recovery in the early 1990s. Tom Schlesinger, director of the Financial Markets Center, a monetary-policy watchdog, thinks the lopsided economy is the most disturbing hallmark of Greenspan's governance. "The Fed has said almost nothing about this, except [vice chairman] Roger Ferguson says there's nothing the Fed can do particularly," Schlesinger complains. "The jobless recovery appears to be a new feature of the US business cycle. Yet the principal agent of economic management says nothing."
In fact, Americans seem to be confronted with the very conditions Keynes warned against: an economy performing, more or less permanently, far below its potential. That situation proves satisfactory for the affluent and for business enterprise, since wage pressures are muted, but it makes life insecure or miserable for most everyone else. The logical response is a fundamental policy shift in favor of work and wages--boosting incomes and demand--but that approach would require taboo measures from the Keynesian past that even most Democrats don't understand or support.
Meanwhile, the financial froth of speculative bubbles--and their dangers--are another enduring legacy of the Greenspan era. "Irrational exuberance really is still with us," Robert Shiller wrote in the new, revised edition of his book. Notwithstanding the earlier meltdown, the stock market remains dangerously overvalued by historical measures, Shiller warns, and is now accompanied by dramatic price inflation in real estate. These two bubbles are false valuations by markets and will burst sooner or later. Shiller urges investors to recognize the "risk that in 2010 or even 2015, the stock market will be lower still in real, inflation-corrected terms, than it was in 2005."
Why do these financial delusions keep arising among investors? Shiller describes many causes, and they include Alan Greenspan's Fed. The chairman's earnest solicitude for financial markets, Shiller explains, contributed to the "gold rush" psychology, convincing financial players that the central bank would always come to their rescue and never turn against them. Their sloppy exuberance is the opposite of the manly competitive ethos and market discipline preached by Greenspan and the right. Worse, it is bound to injure innocent people. "Things happen during a speculative bubble that can ruin people's lives," Shiller noted. "Little will be done to stop these things if public figures consider themselves beholden to some overarching efficient markets principle and do not even recognize over-speculation as a real phenomenon."
The specter of deflation is, meanwhile, still hanging over the United States. Greenspan initially took dramatic action to avoid the same fate Japan suffered after its financial bubble collapsed in 1990--a low-grade depression and a decade of sputtering stagnation. Cutting interest rates to near zero, the Fed succeeded, at least for the short run. But unless the economy gains more normal balance and energies in the next year or so, the United States may yet be facing the same ditch. The problem, explains William Gross, managing director of PIMCO, a major bond investment house, is that long-term rates have already fallen about as far as they can in real terms. "The Fed may soon be running out of fuel," Gross warns. "If the asset pumps run dry and the kerosene cans empty, the inevitable path of the US economy will reflect slow growth at best and recession as a realistic alternative."
Greenspan, meanwhile, is once again targeting the real economy, raising interest rates to gain some leverage but also flirting with a recession of his own making. He appears to be slyly hoping that higher rates will moderate the speculative bubbles without crashing the economy. Let's hope he wins the gamble this time.
The one-eyed king is in a corner and running out of moves, yet sticking with his failed convictions. Like it or not, we are still living in the lopsided world he made. And this half-blind king is still scary.