In Alan Greenspan's new book, The Map and the Territory, the former Federal Reserve chairman blames low wages and high unemployment on the Obama stimulus of 2009, the too-rapid growth of Social Security, Medicare and Medicaid, and the government forcing rich people to help fund those programs for the poor, which he ties to lower savings and investment.
Reacting to his "shock" at the 2008 financial meltdown, Greenspan accepts "behavioral economics," which blames stock market swings and financial crises, not on the rational decisions he used to assume bankers always made, but on "animal spirits," including humans' "herd instinct," "euphoria", and "especially fear". He says government regulators should force banks to hold more cash in reserve; that too much financial fraud has gone unprosecuted; and that Americans and their divided Congress need to choose between free-market innovation and socialist paralysis -- but also, somehow, to "compromise" more.
In the mid-1990s I used to watch Greenspan's twice-yearly Q&As before then-U.S. Rep. Mike Castle (R-Del.)'s banking subcommittee. Last week he gave me half an hour to ask my own questions. Here's a transcript, which I edited for clarity:
Your new book, The Map and the Territory, states your views clearly. Not like the hard-to-follow answers you used to give Congress as head of the Federal Reserve. What were you trying to accomplish by speaking obscurely? Did it work?
It was a different problem back then. I'm speaking for the Fed Open Market Committee, not myself, in those hearings. There are significant differences among the various members. It's almost necessarily to be vague.
I had to be somewhat ambiguous. Some of that stuff is not made public for five years. I had to be very cautious not to pre-release statements without their permission. It's an odd job to have: Everyone thinks you're speaking for the Fed. You are. But the Fed doesn't speak with one voice. There are differing points of view. I'd be careful not to indicate partiality. I'd emphasize I was speaking for myself as a member, not as a spokesman.
So, half jokingly, I constructed Fedspeak. Makes it sound like you're saying more than you're saying. In retrospect. I'm not sure I was successful
You're known as the architect of the Fed's cheap money policy. But in your book you say, you didn't drive interest rates down, it was worldwide factors, it was the Chinese -- ?
The consensus view is that, when the Fed lowered the Federal Funds rate in 2003 for a year, that set off the housing boom. That rests on the general belief that Fed overnight funds could govern long-term capital investment. As if you could capitalize an office building at that rate.
But that doesn't happen. Starting several years earlier, largely because of the end of the Cold War -- the fall of the Berlin Wall, changes in China -- we got this huge flood of savings. Ben Bernanke and I concluded, for different reasons, that this savings glut was why long-term interest rates were down. I argue further that this created an asset boom and housing boom all over the world. The data shows it happened in at least 20 countries. With the U.S. in the middle. All for the same reason: long-term interest rates, arbitraged across all countries, galvanized a very sharp increase in home prices.
So very clearly the long-term rate in the U.S. was driven by international causes. If that's the case, it cannot also be driven by the Federal Funds Rate. In 2001 (when the Fed and other central banks increased the money supply to fight a threatened slump) the Fed lost its relationship to drive long-term interest rates -- unless (the Fed buys a lot of) securities as Quantitative Easing 1, 2 and 3 are doing. In 2003 (when the Fed briefly boosted short-term rates) long-term rates never changed. The money supply did not accelerate. No other characteristics of a bubble occurred.
Because price inflation was falling rapidly, we argued that the probability we would get serious deflation was small -- but if it happened its consequences would be horrendously negative. So we raised rates -- we took out insurance -- like you take out a fire insurance policy on a building. That's what we did for a year. When inflation ceased falling we went back to the older policies. In retrospect I find nothing wrong. Were I in position to do it again, I'd do the same thing. It wasn't a policy that was a mistake. It was a sensibly argued and consulted policy.
You've embraced behavioral finance, the ideas developed and popularized for example by Yale economist Robert Shiller, who won the Nobel Prize for it, that herds of people misunderstand the price of stocks or houses or money, and bet wrongly, and that this error can be measured, predicted and exploited. Shiller called you out on the dot.com bubble and the subprime bubble while they were happening -- he blamed them in part on Fed policies and cheap money. You don't mention him in your book. You say you accepted behavioral economics and its explanation for bubbles after studying the data, following the "shock" you felt when the financial system froze in 2008?
All over the (Fed Board) transcripts is the concern that, if the Fed became too successful stabilizing the economy, the reward is a bubble. Benevolent, balanced growth with little evidence of instability is exactly the condition for a bubble to occur. People take risks under such an environment. You get bubbles, which may or may not be market tops. The dot.com boom didn't (cause) any major financial company defaults.
So for the Fed to attempt to continue stability creates the conditions for bubbles. (And we haven't found policies to avoid that?) Exactly. It happens all the time.
Can you gradually tighten the monetary position of banks so as to defuse the bubble? We tried precisely that. All we succeeded in doing was showing a 3 percent increase in Fed Funds did not disable the economy. The stock boom just took off after we started tightening. There is no evidence I'm aware of that there is a policy to defuse those bubbles. Well, the only realistic policy is to make sure there is not a lot of leverage. Lehman Brothers only had 3 percent tangible capital. If debtors default, you get contagion (from borrowers to lenders, and the other way around). If it's equity (a stock market panic) there is nothing to default (besides the direct investment, so the damage is limited)
(In the book, Greenspan says the job of finance is to allocate capital to the highest-return investments, and that finance is therefore riskier than other businesses. He argues that financial companies should be forced to hold more capital, but otherwise regulators should ease off and let banks lend. He argues that that very troubled companies should be allowed to go bankrupt -- especially non-financial companies like GM, Chrysler and AIG, which the government bailed out in 2007-8 -- since government bailouts distort the economy, encourage too much risk-taking by favored companies, and discourage competitors by picking winners and naming some companies as too big to fail).
Wasn't a main cause of the subprime bond blow-up that stalled the economy in 2008 actually fraud -- bankers, traders, rating agencies lying about loans and risk -- rather than animal spirits? Do you agree with people like Judge Jed Rakoff, who said that there haven't been enough prosecutions, and that's bad for capitalism?
We do not press our fraud statutes adequately. A necessary condition for a system of trading is that you're trading, all the time, with someone you trust. At a drug store, trust is crucial. If it's misrepresentation, it's a fraud, it's illegal, and it ought to be prosecuted. We don't do enough of that. The increase in (anti-fraud) legislation, in the Dodd-Frank law -- it's already illegal. It's really an issue of how you enforce statutes. (Which, he notes in the book, is mostly not the Fed's role.)
Some of your arguments for limited regulation line up with those made by Charles Plosser, the President of Philadelphia's Federal Reserve Bank (one of the 12 regional Feds whose members rotate on and off the policy-making Board of Governors). When Janet Yellen was up in the Senate testifying for her confirmation in your old job and promising to help the economy and step up hiring, Plosser was before the Cato Institute, warning the Fed can't do much to boost hiring or fix the economy. Is Plosser right, are your successors attempting too much?
The characteristics of the economy, of the Fed Board of Governors, and of how the Board behaves, will change. You'll have times when different views dominate the Federal Reserve. They change.
There's always been one issue (that the Fed has the power to address), stability of prices and the currency. That's what every central bank is required by statute to maintain. But we all went beyond the legal statute and got involved in lots of other things. Mainly because there's no way you can avoid, for example, that when you have a tight money policy and unemployment continues to rise, and you tighten further, most people react negatively.
Plosser is talking from a database with which, if you got in a debate with him, you might find it difficult to find fault. Others with a different database would argue differently.
Let the data tell you what's going on. (But when) you're trying to find out what the economy is doing at a certain point in time, you'll find it's not easy.
Read the transcripts of the Federal Reserve Open Market Committee. You would be hard pressed to find out what political party, if any, they are members of. (Really? Aren't Republicans conservative, and Democrats more activist?) More than half the presidents of banks and Boards of Governors, I couldn't tell the difference. I could presume, if I knew who appointed them. But not even then, necessarily: Obama just appointed a Republican. That's very often done.
It's a malleable institution whose policies can get outside where academic opinion is. The Fed, for example, can meet and conclude it's very important to sharply lower interest rates because there's a deflation coming up. If a Congressional committee thought that was nonsense, even though the Fed is independent and Open Market Committee actions can't be overthrown by another government agency, they can certainly change the Federal Reserve Act. I was acutely aware of the fact, even thought the Fed was independent, it was within very strict political limits. (They'd threaten to audit you, to put you under direct Congressional or Presidential supervision...) Yes. It doesn't go anywhere. But those types of things are hanging over the Fed.
You're a libertarian. Should we go back on the gold standard, like Sen. Rand Paul, R-Ky., says?
Liaquat Ahamed, a very good friend of mine, in his book, The Lords of Finance, explains how the gold standard broke down in the 1930s. Everybody agrees the gold standard worked very well from 1870 to World War I. It created a level of competitive costs, country by country, that measured the extent to which those costs were getting out of line in one country. And the movement of gold (between countries in response to high or low price levels) fixed it.
The problem that occurred, because of issues of prestige, the British did not want to recognize what happened to their Empire in World War I. They didn't go back on the gold standard til 1925, when the pound was trading significantly below $4.85 (the official price). They tried to continue the view that they were still the major international financial power. When they went back on gold, Chancellor of the Exchequer Winston Churchill made the decision to go back to the old parity weight. But the economy was nowhere near that level. The whole thing blew apart.
Those who advocate the gold standard and look at it nostalgically realize we can't have a gold standard in the context of a welfare state. Our societies have been demographically determined to be welfare states. The question is of cultural choice.
I have great nostalgia for the gold standard. But I also believe in the democratic society. And we cannot have the gold standard with the welfare state. And the people (who support and benefit from the welfare state) are in the majority.
Some libertarians and a number of software-company founders divide society into a small group of Makers, creative capitalists who innovate and build and employ others, and a large group of Takers, who are dependent and not creative. Do you see the world this way? Do makers and takers have obligations to one another? Is it enough for the government to help the makers create, and let the takers figure out how to take care of themselves?
This is one of the problems of democracy, ongoing since 1789. We're not going to resolve it soon. It's fundamental.
John Adams raised the issue of the tyranny of the majority. Our society is not wholly a democracy. In our Senate, for example, Delaware has a larger voice (for its small size) than other states. Nobody actually wants pure democracy It means a majority can legally execute the minority. Freedom of the press, freedom of speech, are crucial elements of society. How do you maintain majority vote for public issues when it means a violation of individual minority rights? I don't think we'll ever solve that.
A major argument of your book is that the government spends too much in general, and takes too much in taxes from successful, economically active Americans in particular, to pay for poor people's Social Security pensions and medical care, and this hurts savings and investing, and that's why so many Americans are out of work or earn low wages. But isn't retirement and medical money spent on goods and services from American businesses, where it's been contributing to record profits? Do you really think this nation is starved for investment capital?
I agree (that there is no apparent shortage at the moment of business profits, or investment opportunities). But the data shows, if you cannot produce savings, your capital investment goes down. This turns out to be a very critical factor in productivity growth and standards of living. We're losing our savings and the (GDP) growth rate is falling to 2 percent. We read in the Washington Post this morning that this huge block of people are barely maintaining themselves at low income levels. Their incomes are low because productivity growth is so low.
So you have this extraordinary dilemma of, How do you allocate the funds of the society? The only thing that solves it is economic growth. That is essential. No savings, no economic growth.
This argument rests on two premises: 1) Reducing the rate of consumption over the long run gives you a much higher standard of living. Abstinence, unfortunately, turns out to be a critical necessity for a rising standard of living. 2) The trouble with abstinence means you are foregoing consumption today, and we're not doing that. We see it in slow productivity. A vast proportion of our workforce is barely making it. If we could double the rate of productivity growth we'd solve all the problems.
Should the U.S. tax inherited wealth?
Inheritance creates the issue of inequality of wealth. Immigration (also addresses that question). Without immigration, the economy would collapse. We are educating skilled people in our universities, and then we are keeping them out of the country. We really need them. This growing inequality of income, one way of solving that is to take the H1-B quotas on skilled workers coming into the country and broadening it very dramatically, allowing people like myself to no longer be protected from competition.
Because of (immigration restrictions), I have a higher income than I otherwise would. It contributes to inequality. A ridiculously silly policy. I have no expectation it will change.
You'll be at the Free Library on Friday evening talking about your book. What do you do when you're in Philadelphia?
My wife (TV reporter Andrea Mitchell) is a Trustee of the University of Pennsylvania, and when they meet she insists I come to Philadelphia. It's so easy to come in and out of Philadelphia from New York, from Washington. (Where do you stay?) I don't stay there, it's so easy to get in and out. She stays on campus. She even got me into reading the Wharton Journal. (You learn from that?) I can't complain.