UNITED STATES: by Colin TeeseNews Weekly
Greenspan hoists the white flag on economic policy
, September 21, 2002
The cat, we may now conclude, is well and truly out of the bag, at least as to the US Federal Reserve Bank's ability to guide the economy.
Remember all those years ago when the world was being told with such confidence that freeing up its economies along the lines of the United States was the key to everything; do that and the economic trolley would roll harder and faster and all of us would become richer than ever before?
At the very heart of this new approach was the deregulation of financial markets. Nothing else would follow unless financial flows could be freed from the cloying influence of government restriction - or so we were told. And especially, the unrestricted movement of investment funds into the new technologies would become the generating force of the new economy.Optimism gone
If we ignore all the downsides, it seemed to work for a while - at least for the US. Not any more. All that optimism is now gone. After what has happened in the US over the last two years, nobody any longer believes in financial deregulation tempered only by Central Bank's manipulation of interest rates.
Since the US stock market bubble burst, Alan Greenspan and his US Federal Reserve seem incapable of arresting the steady slowing of the US economy.
Greenspan, along with his predecessor, Paul A. Volcker, had, until a few years ago, been assumed to be the miracle men of US financial management. They had kept inflation under control, and, at the same time, by the clever manipulation of interest rates, had sustained economic prosperity for the longest period in post World War Two experience.
Volcker was lucky enough to retire before things got out of hand, and with his reputation intact. Greenspan, unfortunately, had been left to carry the can. His magical capacities appear to have deserted him. And the US economy seems unable to shake off the burden of tumbling share prices.
In the process, as so often happens with the demise of leading figures, Greenspan's confidence suddenly appears to have disappeared. That much, at least, is clear from the Australian Financial Review
's report from Washington of two remarkable statements from Greenspan.
The Federal Reserve Chairman recently felt compelled to make a speech in which he reminded his audience of the success of the Bank's economic management, and the long period of uninterrupted prosperity it had brought to Americans in the latter part of the 20th Century.
His audience were not impressed; of course nobody questioned past successes, but that was then, and, as many of them insisted, now is now.
At the height of the boom, Greenspan made no attempt to contradict those who ascribed the buoyant economic conditions entirely to his capacity to interpret and apply the principles of economic rationalism. Neither did he, apart from one occasion in 1997, criticise what he called Americans' "exuberant enthusiasm" for buying stocks.
Now, it seemed to his listening audience, that he wanted to back away from responsibility for both the stock market bubble and its subsequent explosion.Gains wiped out
Chairman Greenspan was reminded, that - on his watch - share values on Wall Street skyrocketed: an increase was recorded of US$10 trillion
from the late nineties until March 2000. Since that time US$8 trillion of that gain has been wiped off.
Furthermore, those in the know believe it may yet have another 30% to fall. (Based upon the fact that the price/earnings ratio of US stocks - that is the price of the shares compared with their earning capacity - is still unrealistically high.)
In an effort to defend himself the Chairman of the Reserve made two startling comments. He claimed that the Federal Reserve had no way of knowing that a bubble had formed in stock prices; furthermore, even if it had diagnosed a bubble, the Fed could not have done anything about it.
Its only response could have been to raise interest rates which would have brought on a recession similar to that which followed the bursting of the bubble.
These observations are truly breathtaking! Above all else they stand as testimony that the Chairman of the US Federal Reserve is incapable of any response to trends in the economy which threaten its health, except to raise (or lower) the interest rate. And apparently this is so even if he knows
moving interest rates is the inappropriate response.
What follows from this is that the Federal Reserve has no capacity to control the economy it is supposed to manage. Why should this be? Because - though Greenspan is unlikely to concede it - the Reserve has ceded up financial controls to the markets. All effective means of controlling credit creation, previously available to Central Banks, have - save for interest rate changes - been swept away with financial deregulation.
One such right is to insist that share buyers borrow less to fund share purchases. Certainly Greenspan could have resurrected that power. He didn't. Not for any lack of authority, but presumably because he would not risk offending the financial market operators. And, perhaps, because it went against his ideological grain.Undermined own authority
The matter of Central Bank power is well addressed in Peter Warburton's book Debt and Delusion
, first published in 1999.
He points out that, for reasons associated with inflation management and budgetary control, the world's important Central Banks (including the US Federal Reserve), "have played a pivotal role in manoeuvring the global financial system away from conventional banking towards capital market finance". In doing so they have helped undermine their own authority and have contributed to the destabilising of the world financial system.
While the consequences of financial deregulation are not in doubt, is Greenspan credible when he maintains that the Federal Reserve could not have anticipated the bubble, or, further, if it had known, nothing helpful could have been done about it?
The Fed must have known that rising share prices linked to the availability of over generous credit facilities rather than to production outcomes, were unsustainable. (As mentioned earlier, back in 1997, Greenspan himself had hinted as much.)
Cheap and easy credit, for what is always a fixed volume of shares, can have no other outcome than to push up share prices - in this case to a point far in excess of the real earning capacity of the stock. (Price earnings ratios - that is, dividends compared to share price - reached the mid-thirties when a realistic level is in the vicinity of fourteen to eighteen. Significantly, at present prices, the P/E ratio of US stocks is still well above eighteen.)
All of this Greenspan and the Federal Reserve knew about; furthermore, they had before them the recent example of the collapse of the value of dot.com. stocks for the very same reason.
Greenspan was correct to point out that the bubble could not be pricked with the management tools at his disposal. What he did not tell us is that the fault lies not with the Bank, but with the policy of deregulation of financial markets in which he and others had invested such blind faith.
In that circumstance bubble and bust was inevitably part of the correction procedure now being experienced. And, if the experts are to be believed, it still has some way to go.Australian fallout
What are the consequences of all of this for Australia? Well, our Central Bank has embraced the same philosophy as has failed the US. Fortunately, easy credit has not produced the same rush into equities as in the US - perhaps because our equities market can never have the attraction of the US market. It is, however, true that some brokers, working on the US example, have suggested that Australian stocks are undervalued. Thankfully, they have not been listened to.
That, of course, is not to say that the effects of a depressed US economy will not be felt in Australia. They will. And the longer the US economy remains depressed the worse it will be for us. Most likely, any downturn here will be a general spin off from what has happened in the US, and, therefore, be different in impact.
And it should be less damaging. But given that our Reserve Bank has chosen to constrain itself within the same ideological straitjacket as has the US Federal Reserve, will it be any better at managing it?
- Colin Teese was Deputy Secretary of the Department of Trade