WASHINGTON -– With a recession looming, if not already here, and stocks still languishing, all eyes were on Federal Reserve Chairman Alan Greenspan today to come to the rescue again with yet another interest-rate cut, and he did not disappoint.
Greenspan, long a media darling, has been portrayed as the white knight in the slump, saving overextended companies from their supposed orgy of greed during last decade’s Internet-powered bull market.
But data show that he is merely trying to return the punch bowl to a party he ended –- for no good reason.
At today’s meeting here, the Fed lowered its benchmark interest rate just a quarter percentage point, throttling back from the half-point cuts it had made five times previously this year.
Still, the flurry of cuts marks the most aggressive action by the central bank in nearly 20 years -– and the sharpest reversal in monetary policy since Greenspan took over the Fed reins in 1987, a period that includes his rush during the 1990-1991 recession to reopen the credit window he’d slammed shut.
More, the Fed indicated it stood ready to cut rates again if the economy continues to flag, meaning its shift from tightening to easing may turn out to be one of the most dramatic ever.
It didn’t have to be that way.
As this chart of the effective federal funds rate shows, the Greenspan Fed is desperately trying to correct action it took throughout 1999 and into 2000, when it relentlessly raised rates to preempt inflation – a problem that most economists now agree didn’t even exist, for reasons that escaped Greenspan and other old-school economists.
Source: Federal Reserve
After backing out volatile food and energy prices, the core Producer Price Index rose 0.9 percent in 1999, much slower than its 2.5 percent rise in 1998. In some sectors of the economy, in fact, deflation posed a bigger threat than inflation. Core consumer prices
also were tame.
Yet by late 2000, Greenspan had pushed the real fed funds rate – which excludes the consumer inflation rate – to a level higher than it was in February 1990, just before the last recession.
In other words, the central bank had taken back all the stimulus it had given the economy since the recession, and then some.
By the second half of 2000, Greenspan’s tightening began to suffocate the record-long expansion.
After expanding at a blistering 5 percent clip in the first half of 2000, real GDP slowed to 2 percent in the third quarter and then crawled to 1 percent in the fourth quarter, and 1 percent again in the first quarter of this year. The past three reported quarters are the weakest since 1993.
Many economists predict second-quarter growth will come in lower than 1 percent. Some say the economy is no longer growing at all, and has already dipped into a recession.
Fed tightening also caused the bear market.
As the cost of money climbed, borrowing slowed, crimping capital-equipment spending. In turn, corporate profits fell, and the stock market – which moves primarily on profit news – crashed, wiping out nearly $5 trillion in wealth since early last spring (much of it in preciously held retirement funds) and starving promising Internet companies of start-up capital. While the Microsoft ruling and speculation in overhyped dot-com IPOs helped bring down the market, Wall Street analysts agree that Fed action had the greatest impact.
Employers over the past two months alone have shed some 200,000 jobs, many of them high-tech.
But it’s not just dot-com workers who have suffered. About 500,000 manufacturing jobs have been cut this year.
Never saw it coming
As in 1989 and 1990, Greenspan never saw the slowdown coming. By the time he reacted, it was too late.
He and other Fed governors have tried to place the blame for the current pain on consumer and business reaction – or overreaction.
And the press has gone along with the spin. Recent stories blame “companies,” and not Washington policy wonks like Greenspan, for the slump, while heaping praise on Greenspan for aggressively intervening.
“By lowering interest rates for the fourth time in less than four months, Alan Greenspan and his colleagues have made it less expensive for businesses to invest in new equipment and for consumers to buy cars and houses,” the New York Times reported in April, after the Fed surprised the markets by cutting rates half a point between its Federal Open Market Committee meetings.
Left out of the analysis is the fact that Greenspan spent the previous two years making it more expensive for businesses to invest in new equipment, and more expensive for consumers to buy cars and houses.
“But it may not be enough to end the thousands of job cuts that companies are making,” the Times article continued, “and it will not persuade businesses, many of which spent too much money during the bull market of the 1990s, to buy more equipment when they already own too much.”
Again, Greenspan is merely erasing his earlier rate hikes. If companies took on too much inventory, he’s the reason, economists point out. He dampened consumer demand – and unnecessarily so, it turns out. Inflation proved a phantom.
“Fed tightening is the No. 1 cause of current economic problems,” said Brian S. Wesbury, vice president and chief economist at Griffin Kubik Stephens & Thompson Inc., a Chicago-based investment firm.
“Greenspan unnecessarily pushed up rates, particularly in early 2000, and then reacted too slowly to the economy’s problems and was forced to cut rates faster than at any time since 1982,” said Wesbury, who fears the economy has fallen into a recession.
So how did Greenspan, who’s widely hailed as a genius, get it so wrong?
First, you have to understand how Greenspan developed his strong ideas – some call it obsession – about inflation.
As a member of the late philosopher Ayn Rand’s New York “collective” in the 1950s and 1960s, Greenspan, then a budding private economist, sat at the knee of Rand during intellectual all-nighters. Rand, an unapologetic capitalist, held court about the evils of
big government and inflation. To hear her, inflation was the root of all economic ills in America.
Greenspan, a Keynesian liberal at the time, who had been introduced to Rand through his first wife, quickly adopted Rand’s views.
He wrote articles for her “Objectivist” periodical. In one 1966 piece, he said, “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.” He also lectured on Rand’s economic ideas at the erstwhile Nathaniel Branden Institute in New York.
Upon prodding from Rand, he hopped aboard Richard Nixon’s 1968 campaign. Nixon promised him a tough stand on inflation. Greenspan later became President Ford’s top economist. He urged him to make inflation the nation’s top priority, and led Ford’s 1974
inflation summit and “Whip Inflation Now” campaign.
Rand died before she could see her star acolyte take over the Fed. There, Greenspan launched a policy of “zero inflation.”
Old economist, new economy
Greenspan picked up where his predecessor, Paul Volcker, left off in wringing the 1970s inflation premium out of the economy.
But then the economy changed.
By the mid-1990s, suddenly, the old rules about strong growth and tight labor markets fanning inflation didn’t apply at all anymore.
Thanks to computer networking, strong productivity gains – unusual so late in an economic expansion – helped keep a lid on wages and prices, a phenomenon lost on the depression-born Greenspan, who still hewed to the old economic models and assumptions.
Greenspan may have been a good economist for the old economy, but in the new economy he’s just an old economist still fighting the ghost of galloping inflation.
That may sound ageist, but you can’t discount Greenspan’s past. His father, a stock broker, lost his shirt in the 1929 crash. It’s something that no doubt still haunts Greenspan, who thinks a bull market is a bubble that needs to be pricked or else it will fan inflation – even though the data don’t support a correlation between stock prices and inflation.
Take the transcript of a 1994 Fed meeting. It quotes Greenspan saying he raised rates that year partly because he “very consciously and purposely tried to break the bubble and upset the markets in order to break the cocoon of capital-gains speculation.”
And last year, in the midst of raising rates, he said in a speech that the booming stock market may well be looked back on as “just one of the many euphoric speculative bubbles that have dotted human history.”
Of course, Greenspan has the power to make that a self-fulfilling prophesy.
Most of the time, Greenspan’s words alone have had a negative effect on the markets, an analysis by Ph.D business historian David B. Sicilia shows.
“In roughly seven out of ten times, when Greenspan moves markets, the direction he moves them is downward,” said Sicilia, co-author of the book, “The Greenspan Effect: Words That Move the World’s Markets.”
“This violates the law of averages, of course, but it makes even less sense in light of the economy’s spectacular performance over the last eight or nine years,” he added.
If you believe the markets follow fundamental economic trends, this shows probably better than anything else just how out of touch Greenspan is.
Obviously, the markets – made up of millions of investors with real money on the line – know something Greenspan doesn’t about the new economy, particularly when it comes to the inflation outlook.
Because of Greenspan’s stubbornly hawkish take on inflation, the markets – including even inflation-sensitive bond investors – have had to worry more about Greenspan worrying about inflation than inflation itself.
That’s not healthy for the markets. Nor is it healthy for the economy, as we’re seeing now.
With things as vital as nest eggs, jobs, living standards and even the future of Social Security at stake, it’s instructive to review what really caused the derailment of the new, high-tech economy and booming stock market so that it doesn’t happen again.
The media, which crowned Greenspan the “Maestro” of a high-productivity, low-inflation boom he didn’t fully understand, are still playing catch-up.
They’re still wondering how much lower Greenspan will cut rates, instead of asking why he raised them so high in the first place.
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