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.

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