Brad DeLong’s Erroneous Defense of Greenspan

Mises Daily by Robert P. Murphy

Even as the Austrian critique of Greenspan's housing bubble gains more adherents, some economists have tried to exonerate the former Maestro. Previously on these pages, I have responded to Henderson and Hummel's defense of the former Fed chairman, and I also took on Greenspan's own list of excuses.

In today's article I'll go through Brad DeLong's recent defense of Greenspan's policies.[1] DeLong's argument is of particular interest to Austrian economists, because he relies on Wicksell's "natural rate" of interest, a concept that Ludwig von Mises adopted for his own explanation of the business cycle.

As we'll see, I find DeLong's defense somewhat perplexing. Even on the Wicksellian criteria that DeLong sets up, Greenspan failed and should be held at least partially accountable for the housing boom.

Greenspan, Wicksell, and the "Natural Rate" of Interest

To his credit, DeLong admits that, "In hindsight, Greenspan was wrong." However, DeLong argues that perhaps Greenspan took a proper gamble when he began slashing interest rates following the dot-com crash. At the very least, DeLong claims, the conventional critique of Greenspan misses its mark:

People claim that Greenspan's Fed "aggressively pushed interest rates below a natural level." But what is the natural level? In the 1920s, Swedish economist Knut Wicksell defined it as the interest rate at which, economy-wide, desired investment equals desired savings, implying no upward pressure on consumer prices, resource prices, or wages as aggregate demand outruns supply, and no downward pressure on these prices as supply exceeds demand.

On Wicksell's definition…the market interest rate was, if anything, above the natural interest rate in the early 2000s: the threat was deflation, not accelerating inflation. The natural interest rate was low because, as the Fed's current chairman Ben Bernanke explained at the time, the world had a global savings glut (or, rather, a global investment deficiency).

You can argue that Greenspan's policies in the early 2000s were wrong. But you cannot argue that he aggressively pushed the interest rate below its natural level. Rather, Greenspan's mistake — if it was a mistake — was his failure to overrule the market and aggressively push the interest rate up above its natural rate, which would have deepened and prolonged the recession that started in 2001. [emphasis added]

Before looking at the substance of DeLong's claims, let's pause to note a rhetorical trick. Remember, we are talking about Alan Greenspan, who was the head of a nationwide cartel of banks established by the government in 1913. From January 2001 to January 2004, Greenspan wrote electronic checks backed up purely by his charisma, in order to expand the monetary base $140 billion — a 23 percent total increase over the three-year period. Now whether you think Greenspan acted wisely or foolishly, surely we can agree that his behavior should not be classified as a "failure to overrule the market"!

The very existence of the Federal Reserve is a slap in the face to the purely free market. Back in 1913, when the Fed was established, the big bankers' propagandists told the American people that a central bank (though they didn't use such a scary term) was necessary to (1) avoid business fluctuations and (2) preserve the value of the dollar. The Fed's record on those two counts is about as good as the record of any other massive government program. No matter what happened since 1913 — and that includes the Great Depression as well as our current crisis — it is on the heads of Fed officials. They said they had the expertise to steer the market, and they were frequently proven wrong by a crashing economy.

Did Greenspan Really Follow Wicksell's Advice?

I know that some Austrians historians of economic thought have, in private email discussions, challenged DeLong's interpretation of Wicksell.[2] I am not an authority on the subject, so I leave that question aside.

What's ironic is that even if we accept DeLong's reading of Wicksell at face value, he still hasn't exonerated Greenspan. According to the portion I italicized in the block quotation above, if Greenspan had actually kept the market rate of interest equal to the Wicksellian natural rate, then consumer prices, wages, and resource prices would have remained stable throughout the years when the housing bubble really took off.

Yet this is obviously not what happened. All three categories of prices rose during the period of ultralow interest rates. Thus, even if DeLong's interpretation of Wicksell is correct, Greenspan still fails the test. Let's give some examples to see with our own eyes.

The following chart shows the year — year percentage increase in the Consumer Price Index over the last twenty years:

Clearly, Greenspan didn't obey Wicksell's dictum when it came to consumer prices. They rose throughout his tenure, even during the early 2000s when he was allegedly removing upward pressure on prices.

Perhaps DeLong would argue that the rate of consumer price inflation was lower than usual during the housing boom years, but even there the 2002 experience was not qualitatively different from the 1998 experience, and by 2003, annual price inflation was back up to 3 percent, which is a far cry from zero percent — the target that DeLong's own test requires.

The situation is more extreme when it comes to commodity prices. First let's look at oil prices as an example:

Here, it looks like Greenspan generally followed Wicksell's advice until the housing boom really kicked in. Now in DeLong's defense, he could point out that oil prices fell sharply following the dot-com crash, and they remained flat into 2002.

But then they took off like a rocket. From June 2003 to June 2004, Greenspan held the federal funds target at an unusually low 1 percent, so this is where the action would occur, if we want to test just how "natural" his policy was. The annual average price of oil jumped more than $10 a barrel from 2003 to 2004, a whopping 34 percent increase in a single year. As the chart shows, there was no looking back. Oil zoomed ever upward, finally peaking at more than $140 per barrel in July 2008.

Greenspan fared no better at containing gold prices, either. From June 2003 to June 2004 — the period when he pinned the fed funds target at 1 percent — gold increased more than $35 per ounce, an annual increase of almost 10 percent.

As the chart above illustrates, there were large portions of Greenspan's tenure when he held gold prices steady, or even allowed them to fall — but not in the low-interest rate years of the housing boom.

Rather than crediting him with maintaining stable commodity prices, the chart above shows that we should accuse Greenspan of setting off a boom in gold prices as early as 2001.

Conclusion

The evidence against Alan Greenspan continues to mount. Brad DeLong's invocation of Knut Wicksell in an attempt to defend Greenspan turns out to be just one more indictment of him. No matter how you slice it, the former Maestro spawned housing, commodity, and stock booms with his reckless policies.

Darth Greenspan

Mises Daily by Dan O'Connor

The former chairman of the US Federal Reserve shares a lot in common with one of the most famous villain characters in the history of Hollywood, Darth Vader, who was first a member of the Jedi coalition when his name was Anakin Skywalker.

Anakin Skywalker was a tremendously talented young boy discovered by Obi Wan Kenobi, who initially believed that Anakin was the "Chosen One" foretold by a Jedi prophecy to bring balance to the Force and restore harmony to the universe.

As a youth, Anakin Skywalker received close training from Obi Wan Kenobi and fought many great battles as a member of the Jedi league, but he developed a few dangerous qualities as he grew older — specifically a desire for power, a belief that a central authority was capable of controlling society, and a misplaced confidence in the "Dark Side" of the Force.

After Anakin became taken over by the desire for power and the belief that he as an individual had the ability to control the universe, he renounced his allegiance to the Jedi, turned to the Dark Side and began to control the operations of an entire galaxy as the republic had been transformed into an empire. The decisions of Darth Vader now affected everything and everyone in the galaxy, rather than all creatures being able to live their lives free from the influence of one central authority.

As a youth, Alan Greenspan was a diligent student of economics and a close friend and colleague of Ayn Rand, as they were both stern supporters of the tenets necessary for a free society, which requires a commodity-based currency. In fact, in 1966, Greenspan wrote a famous article advocating the need for a gold standard in America in which he stated,

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

In the 1970s, he became involved with members of the US federal government. He initially began as an advisor to those who aim to bring about the most effective economic and monetary policy for an entire nation. Perhaps, it was during this stage in Mr. Greenspan's life when he began to develop a strong desire for power, a skewed view that governments can effectively dictate economic policy, and a misplaced confidence in the role of the Federal Reserve.

In 1987, Alan Greenspan was officially appointed to his position as chairman of the Fed, where he became one of (if not) the most powerful men in the world. Although he was appointed by the president of the United States and ostensibly obeyed the orders of the president, in many ways Alan Greenspan went on to govern the Fed with almost no oversight. With his newly granted authority, the chairman was now able to determine the interest rates of an entire nation (which influence the interest rates of the entire world) and expand and contract the nation's money supply however he and his constituents deemed necessary — an ominous power, indeed.

"In the absence of the gold standard, there is no way to protect savings from confiscation through inflation."

– Alan Greenspan, 1966

The policies of the Federal Reserve Bank had an enormous impact on our current crisis; and the American people have come to realize how destructive the force of the Fed can be. By expanding the supply of credit, inflating the currency, and keeping interest rates artificially low and fixed for an extensive period of time (a form of price fixing), the country — and globe — became plagued by malinvestment: people and banking institutions were encouraged by this dark and opaque monolith in Washington DC to buy and spend. Although many politicians conveniently blame the banks and the borrowers for the turmoil that Americans are faced with, most of the nation's top economists are pointing their fingers at the Fed.

The only way to prevent this sort of disaster from reccurring is to take this powerful and insidious authority out of the hands of the Fed and restore the Republic, whose founders understood the evils of a central authority controlling a nation's money supply. This is the reason that the word "coin" was specifically written in the Constitution over 200 years ago. When the United States was on a bimetallic -currency system during most of the 19th century, it was much harder for politicians to shell out cash to friends and those with whom they shared a vested interest.

In Return of The Jedi, Luke Skywalker confronted Darth Vader in an attempt to save the galaxy, destroy the Dark Side, and restore the republic that once was.

In the midst of a fierce light-saber battle with his son, Vader becomes wounded and can no longer fight back.

Ultimately, the good side of Darth Vader re-enters his soul. He lifts up the evil emperor and throws him into a deep, dark hole. The Dark Side is destroyed and balance in the republic is restored.

Over the past few years, Alan Greenspan has undergone widespread criticism for the disaster that he created. Although he has not yet accepted blame for the harm caused, nor publicly acknowledged the damaging effects of centralized control over money and credit, his reputation has been severely wounded by his critics around the world.

It is not too late for redemption. Alan Greenspan still has the power to expose the Fed for all of its evils. He knows its operations inside and out. He knows how powerful and damaging this force is on the economy and the world at large. Perhaps he is the "Last Hope" — the "Chosen One" who can expose the Fed's inner workings to the American people and bring back a monetary system free of government manipulation and control.

Mr. Greenspan, expose the Federal Reserve Bank for all of its evils. Help to restore the republic that once was!

Did Greenspan Cause The Housing Bubble?

Jeffrey Rogers Hummel and David R. Henderson

His role is exaggerated.

Critics across the political spectrum are having a field day blaming the current economic crisis on former Federal Reserve Chairman Alan Greenspan, who they allege carried out an excessively expansionary monetary policy following the recession of 2001. But a careful examination of his record shows little support for this view.

Greenspan, however unintentionally, came close to freezing the domestic monetary base. He therefore still stands out as the only truly successful chairman of the Fed, which, by the way, is one good reason among many for abolishing it. We simply can't depend on his like coming to the fore again, as Ben Bernanke's disastrous tenure is making clear.

Why do people now believe Greenspan was an "inflationist?" Mainly for one reason: they note the low interest rates from 2002 to 2004. But this ignores the simple fact that interest rates can change as a result of real factors involving supply and demand. As Greenspan, among others, has repeatedly (and again recently) demonstrated, these unusually low interest rates were due primarily to a massive flow of savings from emerging economies in Asia and elsewhere.

Although the broader measures of money have become an unfashionable way to gauge monetary policy, their behavior during the period of low interest rates should still make us skeptical of the idea that Greenspan had opened the floodgates. The annual year-to-year growth rate of money with zero maturity (MZM) actually fell from over 20% in 2001 to nearly 0% by 2006.

During that same time, growth of the M2 money supply (includes currency, checking accounts, time-related deposits, savings deposits and non-institutional money-market funds) fell from over 10% to around 2%, and M1 (currency plus checking accounts) growth fell from over 10% to negative rates. Admittedly, the Fed's control over the broader monetary aggregates has become quite attenuated, for reasons elucidated below. But even the year-to-year annual growth rate of the monetary base, which the Federal Reserve directly controls, fell from 10% to below 5% between 2001 and 2006.

The real key to what was going on is revealed by the components of the monetary base. It consists of reserves held by the banks and other depositories, either in their accounts at the Fed or as vault cash, plus currency in circulation among the general public. Between December 1986, eight months before Greenspan became Fed chairman, and December 2005, nineteen years later, the monetary base rose from $248 billion to $802 billion (figures are not seasonally adjusted). True, that doesn't sound like a freeze, but virtually the whole increase was in circulating currency.

During those same 19 years, total bank reserves (including all vault cash) grew from $65 billion to $73 billion, for an average annual growth rate of a mere 0.65%. In some years, aggregate reserves rose, in others they fell, with the major bump surrounding the year 2000. Total reserves are also the one monetary measure with growth showing a temporary uptick into 2003, when interest rates were down.

Currency in circulation exploded even faster than the base, at an annual rate of 7.54%. But most of this new cash went abroad, as a stable dollar became an international currency. These growing foreign holdings of Federal Reserve notes became an additional factor increasing money demand and keeping U.S. inflation in check during the 1990s. On the other hand, Greenspan's virtual freezing of reserves is the most salient yet ignored feature of his tenure. After adjusting for currency going abroad, it means he approximated a de facto freezing of the domestic base.

Greenspan also helped deregulate the broader monetary aggregates: M2, MZM, and M3 (the broadest measure of money). The Depository Institutions Deregulation and Monetary Control Act of 1980 had begun phasing out interest-rate ceilings on deposits and modified reserve requirements in complex ways.

Combined with subsequent administrative deregulation under Greenspan through January 1994, these changes left all the financial liabilities that M2 adds to M1--savings deposits, small time deposits, money market deposit accounts, and retail money market mutual fund shares--utterly free of reserve requirements and allowed banks to sweep a large portion of M1 checking accounts into M2 money market deposit accounts. M2 and the broader measures became quasi-deregulated aggregates with no legal link to the size of the monetary base.

One result, which the late Milton Friedman noted in 2003, is that fluctuations in the velocity of M2 were automatically offset by fluctuations in the amount of M2. Interestingly, this is exactly what monetary economists George A. Selgin and Lawrence H. White predict would happen under free banking, that is, a market-determined monetary system without any government involvement.

They argue that free banking would automatically adjust the quantity of money to changes in velocity. If velocity rises, signaling a fall in money demand, market mechanisms would cause banks to reduce the quantity of money they created. And if velocity falls, signaling a rise in money demand, banks would enlarge the quantity of money.

Thus, during the dot-com boom of the '90s, M2 velocity rose as people shifted into stocks. But this was perfectly offset by the declining growth rate of M2, which fell to near zero between 1994 and 1996. Assorted Fed-watchers reached opposite conclusions, depending on which variable they focused on.

Those who looked at M2 warned that Greenspan's policies were deflationary, while those who looked at the higher growth rates of the base and M1 predicted higher inflation. Both were wide of the mark, but not because of Greenspan's miraculous central-bank discretion; the result was a product of market process, and when the collapse of the dot-com boom burst the M2 velocity bubble, it induced a new spike in M2 growth.

If Greenspan almost froze total reserves, why, in a growing economy, wasn't there deflation? The reason is the free market's enormous capacity for innovation. Because bank reserves in the U.S. paid no interest until October of last year, banks had a strong incentive to economize on their use. Each dollar of reserves was standing behind more and more dollars of M2.

So what caused the current financial crisis? Economists will probably not know the full answer until many years from now. Minor blips in total reserves under Greenspan may have played some role. Because Greenspan only imperfectly implemented Milton Friedman's proposal of freezing the monetary base, without intending to do so, his policy may have ended up slightly too discretionary. But that possibility hardly justifies the widespread claim that the Fed could have pricked or prevented the housing bubble.

Jeffrey Rogers Hummel is an associate professor of economics at San José State University and the author of Emancipating Slaves, Enslaving Free Men: A History of the American Civil War. David R. Henderson, a research fellow with the Hoover Institution and an associate professor of economics at the Naval Postgraduate School, is the editor of The Concise Encyclopedia of Economics (Liberty Fund, 2008).

Don't Blame Greenspan

John Tamny

The housing bubble was driven by a weak dollar, not low rates.

When economic problems reveal themselves, a great deal of finger-pointing inevitably ensues. For quite some time now economists and commentators have sought to place blame for the housing crisis, and quite a lot of it has been heaped on former Federal Reserve Chairman Alan Greenspan. But when it comes to housing, both Greenspan's critics and Greenspan are wrong about what really happened.

The general consensus among Greenspan's critics (including the Wall Street Journal's editorial page, along with Nobel Laureate Gary Becker), is that his 2003 decision to keep the Fed funds rate at 1% for a year led to the rush into housing. Intuitively this makes sense, but if true there would presumably exist a great deal of empirical or anecdotal evidence supporting the notion that housing does best when nominal rates of interest are low. The problem here is that very little evidence supports the claims made by Greenspan's detractors.

Indeed if true, housing would have been an awful asset class in the early part of the 1970s. But despite 450 basis points worth of increases in the Fed funds rate from 1971 to 1973, housing emerged as the top asset class during President Nixon's second term, according to Rice University historian Allen Matusow. Moving to Jimmy Carter's presidency, the Fed funds rate rose over 800 basis points, but according to George Gilder's 1981 book, Wealth and Poverty, during the Carter years "America's middle class was doing better in the housing market than all of the shrewdest investors in the financial and capital markets of the world."

And to show that this seemingly contrarian rate phenomenon is not unique to the U.S., we can look to England in the early 1970s, along with Germany in the aftermath of World War I. The bank rate in England rose from 5% to 9% in 1972, but in a 1978 retrospective on the early '70s English property boom in the Bank of England Quarterly Bulletin, it was written that "There was no other general area of economic activity, which seemed to offer as good a prospective rate of return to an entrepreneur as property development."

Regarding post-WWI Germany, despite rising rates of interest in the war's aftermath, economist Benjamin Anderson recounted in Economics and the Public Welfare that "the wise thing to do was to go heavily into debt, purchase any kind of real values--real estate, commodities, foreign exchange--hold them for a time, then sell a small part of the purchases and pay off the debt."

On an empirical level, my H.C. Wainwright Economics colleague David Ranson has found even more evidence that calls into question the claims made by Alan Greenspan's critics. Indeed, while intuition would once again suggest that housing does best when rates are falling, what he's found is that nominal U.S. home prices since 1976 have increased the most when Treasury bill rates have risen over 200 basis points, and they've declined the most when those same rates have fallen more than 200 basis points.

Where it gets interesting is that in defending himself, Greenspan basically confirms the arguments made by his critics, all the while selling down the river one of his intellectual mentors, Joseph Schumpeter. According to Greenspan's March 11 Wall Street Journal op-ed, an "excess of savings propelled global long-term interest rates progressively lower between early 2000 and 2005." The decline, according to him, led to a "global housing price bubble."

The first problem there is that the notion of an "excess of savings" is a logical impossibility. As Schumpeter observed in Capitalism, Socialism and Democracy, "It is not conceivable that wants some day may be so completely satisfied as to become frozen." More to the point, it's an economic reality that human wants are limitless, and as such, there always exist opportunities for entrepreneurs to fulfill those same wants through the accession of capital.

But it's in the area of rates that Greenspan truly missed the chance to prove his critics wrong. Indeed, despite intuition suggesting otherwise, there's no historical correlation between low nominal rates of interest and housing vitality either in the U.S., or around the world. If there was, housing would have slumped stateside in the 1970s, and it would have boomed in the 1990s in Japan, to use but two examples.

There is, however, a strong correlation between weak currencies and nominal housing strength. Ludwig von Mises referred to this phenomenon as a "flight to the real," while his sometime intellectual nemesis John Maynard Keynes was more to the point in observing that when currencies are weak, the "practice of borrowing from banks is extended beyond what is normal."

In that case, and with the U.S. Treasury serving as the dollar's mouthpiece, Treasury secretaries John Connally and W. Michael Blumenthal (under presidents Nixon and Carter respectively) used the value of the Japanese yen as a way to communicate to the markets their desire for a weaker dollar in the '70s. This decade, Treasury secretaries Paul O'Neill, John Snow and Henry Paulson (and now apparently Tim Geithner) jawboned China on oversight of the yuan as a way of communicating their own desire for a weaker greenback.

Housing is a great place to be when currencies are in decline, and just as they did in the high interest rate '70s, Americans rushed to housing to hedge the dollar's decline.

And when we bring the rest of the world into the equation, foreign currencies this decade were only strong insofar as the dollar was very weak. Measured in gold, there was a worldwide run on paper currencies that led people around the world into the safe harbor that housing represents. Basically, worldwide monetary authorities mimicked U.S. monetary mistakes, and there was a rush to housing. As Gilder observed, housing is an inflation shelter in which individuals can actually live.

Back to the present, it's fashionable to blame low rates of interest fostered by the Greenspan Fed as the cause of the housing boom, but the real reason had to do with weak currencies, which historically have revealed themselves when rates of interest are in fact high. Greenspan had the chance to make this point but failed to. Still, just because Greenspan proved unequal to his critics doesn't mean his policies were at fault.

In short, there was a housing boom this decade thanks to weak-dollar policies favored by the U.S. Treasury, which Greenspan did not control. His interest-rate policies did not cause the housing boom, no matter the evidence-free efforts used by his critics to prove otherwise.

John Tamny is editor of RealClearMarkets, a senior economist with H.C. Wainwright Economics and a senior economic advisor to Toreador Research and Trading. He writes a weekly column for Forbes.

Greenspan Not Reserved About His Innocence

By The Mogambo Guru

03/23/09 Tampa Bay, Florida Bloomberg.com had Alan Greenspan, disastrous former chairman of the Federal Reserve – who is the one person directly responsible for all of our economic woes with his bizarre monetary insanity Every Freaking Day (EFD) during his demented chairmanship of the Federal Reserve from 1987 to 2006, being indignant that he should be blamed for anything, and insists that nothing is his fault, except for maybe having too much faith and trust in his fellow man, which would explain the complete lack of regulatory scrutiny, or even a minimal due diligence attention, to any of the glaring excesses in the banking system, for which he was responsible.

He is reported to have said, “Given the decoupling of monetary policy from long-term mortgage rates, accelerating the path of monetary tightening that the Fed pursued in 2004-2005 could not have prevented the housing bubble.” Hahahaha!

I was at first going to make sport of Mr. Greenspan and cast aspersions on both his intellect and degree of mental illness that would turn a former gold-bug into the monetary inflation monster that he became, but soon I realized the gem of a philosophy that we have here!

Hastily, I scheduled a meeting with my boss, who thinks that my poor job performance, the hostility of customers (morons) and mutiny among my employees (more morons) has something to do with my terrible cost-center numbers that were provided.

To the contrary, I plan to stress that these are mere statistical artifacts by a bunch of hateful accountants (pencil-neck geek morons) who are probably lying just to get me in trouble.

I know that my boss will laugh dismissively at my conspiracy theory, like she always does – but this time I have proof! It was provided by Alan Greenspan himself, lying former chairman of the Federal Reserve – which is itself a Big Fat Lie (BFL) because the Federal Reserve is not a part of government, but is, instead, just a name picked by the true owners of the Fed; shadowy figures creeping around in the shadows, which is why I called them “shadowy” in the first place…

I am not, as you would expect, going into a loud, Screaming Fit Of Outrage (SFOO) at the sheer, outlandish corruption of the banking system, Congress, government in general and everything it touches, or the unbelievable corruption and stupidity in everything else, both here in America and around the world.

Instead, I have been galvanized to action to, hopefully, prevent being fired from my stupid job. Now, that task has been made easier after reading that Mr. Greenspan said, “If we are dealing with global forces beyond the control of domestic monetary policy makers, as I strongly suspect is the case, then we are facing a broader issue.” Hahahaha! I can’t believe my eyes at this unexpected bonanza!

Excitedly, I am planning to say to my boss, like Mr. Greenspan has now famously said, that not only is nothing my fault, but that the true culprits may be forces – perhaps strange, malevolent-yet-evil forces – at work, which are already sinisterly creating excess money and credit “beyond the control of monetary policy”; so it could also be controlling people’s thoughts, probably with some kind of secret, super ray-gun, or some new chemicals that they put into the water so that the strange molecules get into our blood streams and go to our brains to make us think, “Don’t pay attention to Austrian/classical economics, common sense, the entire history of economics for the last 4,500 years or the Lunatic Mogambo Loudmouth (LML)! And for crying out loud don’t buy any gold, silver or oil, which is the only smart thing to do, with special emphasis on ‘smart’, especially since ‘everything else is stupid and you will lose your butt, big time.’”

And speaking of losing one’s butt, Agora Financial’s 5-Minute Forecast reports, “The seldom-reported net long-term and total Treasury International Capital (TIC) flow came in way worse than expected.”

Like most reports, this is complete gibberish to me, and I am soon fascinated with the idea of finding out if I can get a whole burrito in my mouth at one time, and I am halfway out of the office to grab an early lunch to test my new theory when I am stopped by their news that, “in English” for dummies like me, “foreigners – and not just the Chinese – are losing their taste for U.S. debt. Global investors sold $148 billion more U.S. debt than they bought”, which I assume was for the year.

In response, I have written a blues song about it, and the four lines of lyrics go:

“Oh, I’m so blue because foreign devils are selling my debt.
“Oh, I don’t know what to do.
“This comes at a particularly bad time since the Obama lunatics and the brain-damaged halfwits in Congress are committed to deficit-spending almost $2 trillion this year, a sum so staggering that it is not only eye-popping, head-spinning and/or heart-stopping, it is also more than 14% of GDP, and we desperately need these damned foreign devils to buy that new towering mountain of American Treasury debt to fund that suicidal, low-IQ orgy of deficit-spending, and not for them to sell the Treasury crap they already have.
“Baby, oh baby, I’m so blue, blue, blue.”

Okay, I realize this is not my best work and it needs some polishing, so don’t bother writing to me about the usual bad reviews (“He is stupid and so is his stupid song!” – Chicago Sun), but the sentiment is perfectly correct: Foreigners refusing to use the dollars they receive, as a result of America’s $820 billion per year trade-deficit, to buy more Treasury debt is terrible news to a bunch of socialist/communist dirtbags like Obama and Congress; and the rest of us worthless morons around the world are apparently desperate and willing to sacrifice everything on a long-shot that for once, in all the times it has been tried in all of history, expanding a fiat money supply so that the government can buy its way out of bankruptcy will not, hopefully, end in inflationary tragedy like it always – with stress on the “always” – has before! Hahahaha! We’re freaking doomed!

So, as I explain to the kids, all of this is why I am always buying gold and am always on your nasty little butts to buy gold, too, when a government is acting as insanely as this. Whee! This investing stuff is easy!

The Fed Did It, and Greenspan Should Admit It

by Frank Shostak

In his Wall Street Journal article from March 11, 2009, former Fed chairman Alan Greenspan rejects the idea that the Fed's low-interest-rate policy between December 2000 and June 2004 fueled the housing bubble, which in turn laid the foundation for the current economic crisis.

(The federal funds rate was lowered from 6.5% in December 2000 to 1% by June 2003. It was kept at 1% until June 2004 when the rate was raised by 0.25%.)

Greenspan holds that what matters for the housing market is long-term and not short-term interest rates. The Fed, however, doesn't control long-term rates, argues the former Fed chairman.

According to Greenspan, the decline in long-term rates and mortgage rates took place while the Fed had been tightening its interest-rate stance. The federal-funds-rate target was raised from 1% in June 2004 to 4.25% in December 2005.

Yet in June 2005 the yield on the 10-year Treasury note fell to 3.92% from 4.58% in June 2004. The 30-year fixed-mortgage rate closed at 5.58% in June 2005 against 6.29% in June 2004.

How in the world, asks Greenspan, can the Fed be blamed for the housing bubble and the current economic crisis?

Who, then, is to blame for this fall in long-term interest rates and for the present economic crisis?

According to Greenspan, the culprit is the savings glut from emerging economies, such as China. This glut of savings was channeled to long-term US Treasuries and other US financial assets thereby depressing their yields, argues the former Fed chairman.

Ben Bernanke concurs. In his speech at the Council on Foreign Relations on March 10, 2009 he said,

Like water seeking its level, saving flowed from where it was abundant to where it was deficient, with the result that the United States and some other advanced countries experienced large capital inflows…

What Greenspan and Bernanke call "savings" is nothing more than the amount of US dollars that emerging economies accumulated.

The accumulation of these dollars by emerging economies cannot increase the pool of dollars. The accumulated dollars are part of the existing pool of US money.

When a Chinese exporter sells goods to an American importer, he is paid with dollars. This means that the ownership of dollars is changed here, not their quantity.

With all other things being equal, a sustained decline in long-term yields requires an increase in the pool of dollars. The increase in the pool of dollars means that more American dollars will be employed as the medium of exchange. As a result, the prices of goods and assets move higher, while yields on assets are pushed lower.

However, if the accumulated dollars of emerging economies are only invested in US Treasuries, then it is tempting to suggest that a sustained fall in long-term rates without an expansion in the pool of dollars is possible.

We suggest that this is highly unlikely. If the pool of dollars remains unchanged while the quantity of goods and assets continues to expand, then this will lead to the fall in the average price. (Remember, a price is the number of dollars per unit of a good or asset.)

This means that explicit and implicit yields will come under upward pressure. (As a result, investors from emerging markets are likely to shift their funds from less-yielding Treasuries to a higher-yielding asset if the pool of dollars remains fixed, thus pushing yields on Treasuries higher.)

It is only the monetary policy of the Fed — and not the accumulation of dollars by emerging economies — that can set in motion changes in the pool of dollars. Hence, the fall in long-term interest rates and mortgage rates has to be the result of the Fed's loose monetary stance.

If what we are saying is valid, then how are we to reconcile the fact that in 2005 long-term rates had been falling while the Fed was tightening its stance?

Historically, the 30-year fixed-mortgage rate and the federal funds rate have had a tendency to display a very good visual correlation. This doesn't mean that the correlation is perfect — a discrepancy in the movements between the federal funds rate and long-term rates can occur.

The emergence of a discrepancy doesn't imply that suddenly the Fed's policies have nothing to do with the housing bubble or boom-bust cycles.

(Recall that, because of a discrepancy during June 2004 and June 2005 between the federal funds rate and long-term rates, Greenspan has concluded that his loose monetary policy between December 2000 and June 2004 had nothing to do with the housing bubble.)

Various discrepancies between the movement in the federal funds rate and the mortgage rate are the result of a variable time-lag effect from changes in monetary policy on various markets.

Because of the variable time lag, a situation can emerge where long-term rates may ease despite the central bank's tighter interest-rate stance.

Despite a tighter-interest-rate stance, the previous loose-interest-rate stance may still dominate economic activity. Consequently, in order to maintain a given interest-rate target in the midst of still strong economic activity, the Fed may be forced to push more money into the economy to prevent the federal funds rate from overshooting the target. (For instance, an increase in the federal funds rate from 1% to 2% is a tighter stance, yet the 2% rate can still be too low — strong economic activity pushes the federal funds rate above the target.)

As a result, more money becomes available for financial markets, which puts downward pressure on long-term rates, all other things being equal.

In November 2004, the yearly rate of growth of the Fed's balance sheet jumped to 6.9% from 4.3% in June 2004. Note that this increase in the pace of monetary pumping took place while the federal-funds-rate target was lifted from 1% in June to 2% in November.

Also note that between December 2004 and June 2005 the average yearly rate of growth of Fed assets stood at a still-elevated 6%.

Contrary to Greenspan and other commentators, we suggest that what sets in motion a boom-bust cycle is not a boom in a particular market such as the housing market but the increase in money supply out of "thin air."

Now let us say that the dollars accumulated by emerging economies were to be invested solely in Treasuries. while this might push long-term interest rates temporarily lower, all other things being equal, it is not going to set in motion a boom-bust cycle as long as the pool of US dollars remains unchanged.

If, as a result of lower interest rates, too many dollars are invested in the housing market, it means that fewer dollars are invested in other goods. As a result, the housing market will become overvalued while other goods will become undervalued. This will set in motion an outflow of money from the housing market to other markets.

If, as a result of lower interest rates, too many dollars are invested in the housing market, it means that fewer dollars are invested in other goods.

In our writings we have shown that the main source of boom-bust cycles is the Fed itself. Thus, by aggressively lowering interest rates between December 2000 and June 2004 — and accompanying this with monetary pumping — the Fed set in motion an economic boom.

The boom gave rise to various nonproductive (bubble) activities that emerged on the back of the loose monetary stance of the Fed. The increase in money supply led to the diversion of real funding from wealth-generating activities toward various nonproductive activities.

(Note that these activities cannot stand on their own — they cannot fund themselves. They are funded by diverting — by means of new money created "out of thin air" — real savings from wealth-generating activities.)

From June 2004 through September 2007, the Fed adopted a tighter stance, which slowed the diversion of real funding to nonproductive activities.

As a result of this, various nonproductive activities came under pressure. (Without real funding, these activities are forced to go under.)

Now, when money is injected, it doesn't instantly affect all the activities in an economy. The money starts with the first recipients and then moves to other recipients. It moves from one market to another market — there is a time lag.

This means that various nonproductive (bubble) activities are spread across all the markets — the boom is everywhere. Once the Fed tightens its stance it starts a bust, and this weakens various nonproductive activities across all the markets. The severity of the bust is dictated by the size of the boom.

(The percentage of nonproductive activities — the product of the boom — determines the severity of an economic bust in a particular sector of the economy.)

It follows, then, that a bubble in a particular market cannot emerge without the preceding increases in money supply. This in turn means that a bubble cannot emerge without a preceding loosening of monetary policy, which means it cannot occur without money pumping by the Fed. Hence, what matters for the economic boom, i.e., the emergence of bubbles, is the creation of money "out of thin air" and not the level of long-term interest rates.

Contrary to Greenspan, we can conclude that it is not long-term rates as such that fueled the bubble but the loose monetary policy of the Fed.

We can also conclude that the so-called savings glut in emerging economies had nothing to do with the last economic boom or the current economic crisis.

The only institution that can set in motion the expansion of money and a false boom is the Fed.

Greenspan Forgets Where He Put His Bubble

Greenspan Forgets Where He Put His Asset Bubble: Caroline Baum

Commentary by Caroline Baum

-- “Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.”

Even if one missed the headline (“The Fed Didn’t Cause the Housing Bubble”) and the byline (Alan Greenspan) on the op-ed in yesterday’s Wall Street Journal, there could be no confusion over authorship: That “Master of Garblements” and former Federal Reserve chairman was back to defend his legacy.

Greenspan lays out his case that the Fed’s easy money policies can’t possibly be to blame for “the U.S. housing bubble that is at the core of today’s financial mess.” It is long-term interest rates that determine “the prices of long-lived assets,” such as housing, he writes. And those rates, which stayed low as a result of a “global savings glut,” are out of the Fed’s control.

Control, yes. Influence, no.

“Why not try raising short rates if long rates are too low?” asks Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “The recession was over in 2001. Why did he take so long to start to raise the funds rate?”

Greenspan is selective in arguing his case. By any measure, the overnight fed funds rate was too low earlier in the decade. The real funds rate, which is the nominal rate adjusted for inflation, was negative for three years, from October 2002 to October 2005, a longer stretch than in the mid-1970s. And we know how well that turned out.

Now we have additional evidence of the effect of negative real rates. When financial institutions are being paid to borrow, borrow they will.

Free-Money Policy

Banks and other mortgage lenders were happy to arbitrage the spread between the free money provided by the Fed and the rate they charged for an adjustable-rate mortgage. The share of ARMs as a percentage of total mortgage loans averaged 10 percent in 2001; by 2004, it was 32 percent, according to the Mortgage Bankers Association. The dollar volume swelled to more than 50 percent that year.

It was Greenspan who sang the praises of ARMs from his Fed pulpit in a Feb. 23, 2004, speech. American consumers “might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” which may be “an expensive method of financing a home,” he said.

Greenspan’s op-ed avoids any incriminating evidence of his role in what he calls “the most virulent (crisis) since the 1930s.” (No 100-year flood this!) Instead, he focuses exclusively on what he, as Fed chief, called the “conundrum:” that long-term interest rates barely budged in the face of gradual increases in the funds rate.

Bubble Asymmetry

“If only the Chinese hadn’t been saving so much in the U.S., there would have been no problem,” says Bill Fleckenstein, president of Fleckenstein Capital in Seattle and author of “Greenspan’s Bubbles.” That analysis “flies in the face of all the evidence” that Greenspan took interest rates too low and held them there for too long; that he “cheerled all the securitization products and ARMs; that he told us not to worry about a real estate bubble.”

Even worse, Fleckenstein says, Greenspan “doesn’t discuss the fact that it was Fed’s stated policy to act asymmetrically in regard to asset bubbles,” allowing, or encouraging, them to inflate and cleaning up afterwards.

The clean-up is proving harder than Greenspan imagined.

There were other measures that shouted -- yes, shouted -- “monetary policy is too easy” in 2003 and 2004. Apparently Greenspan wasn’t listening.

Spreading Evidence

The spread between the overnight rate and the 10-year Treasury note ballooned to an historically wide 365 basis points by the middle of 2004, when the Fed started to raise the funds rate in baby steps. A steep yield curve is a sign of an expansionary monetary policy.

Rising long-term rates reflect an increased demand for credit. That same increased demand would push up the overnight rate, too, except when the Fed intervenes, creating as much credit as the banking system demands to keep the rate at the designated target.

The spread between the funds rate and nominal gross domestic product -- a proxy for the difference between the cost of borrowing and the return on investment for the overall economy -- was also emitting a warning sign that policy was too easy. The gap reached a three-decade high of 6 percentage points in 2004, creating an incentive to borrow and lend.

Greenspan’s op-ed is full of explanations, correlations and obfuscations. He defends himself against accusations by “my good friend,” Stanford economist John Taylor, who has argued that “monetary excesses” were the main cause of the boom and resulting bust.

No Mea Culpa

He also ignores the literature on asset bubbles.

“Greenspan is a student of history,” Kasriel says. “Surely he’s read (Charles) Kindleberger’s book on asset price bubbles.”

One element common to all bubbles, according to “Manias, Panics and Crashes,” is cheap credit. With so much cheap credit coming from abroad, Greenspan didn’t need to add to it.

And that’s the point. If he’s satisfied with his explanation of a savings glut -- the idea that there was too much credit being supplied from the rest of the world -- why not reduce the supply of Fed credit? That raises the price and reduces the quantity demanded.

Victim isn’t a role Greenspan plays particularly well, especially when it’s an attempt to exonerate himself from responsibility.

Greenspan Forgets Where He Put His Asset Bubble

Greenspan Forgets Where He Put His Asset Bubble: Caroline Baum

Commentary by Caroline Baum

March 12 (Bloomberg) -- “Counterfactuals from such flawed structures cannot form the sole basis for successful policy analysis or advice, with or without the benefit of hindsight.”

Even if one missed the headline (“The Fed Didn’t Cause the Housing Bubble”) and the byline (Alan Greenspan) on the op-ed in yesterday’s Wall Street Journal, there could be no confusion over authorship: That “Master of Garblements” and former Federal Reserve chairman was back to defend his legacy.

Greenspan lays out his case that the Fed’s easy money policies can’t possibly be to blame for “the U.S. housing bubble that is at the core of today’s financial mess.” It is long-term interest rates that determine “the prices of long-lived assets,” such as housing, he writes. And those rates, which stayed low as a result of a “global savings glut,” are out of the Fed’s control.

Control, yes. Influence, no.

“Why not try raising short rates if long rates are too low?” asks Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “The recession was over in 2001. Why did he take so long to start to raise the funds rate?”

Greenspan is selective in arguing his case. By any measure, the overnight fed funds rate was too low earlier in the decade. The real funds rate, which is the nominal rate adjusted for inflation, was negative for three years, from October 2002 to October 2005, a longer stretch than in the mid-1970s. And we know how well that turned out.

Now we have additional evidence of the effect of negative real rates. When financial institutions are being paid to borrow, borrow they will.

Free-Money Policy

Banks and other mortgage lenders were happy to arbitrage the spread between the free money provided by the Fed and the rate they charged for an adjustable-rate mortgage. The share of ARMs as a percentage of total mortgage loans averaged 10 percent in 2001; by 2004, it was 32 percent, according to the Mortgage Bankers Association. The dollar volume swelled to more than 50 percent that year.

It was Greenspan who sang the praises of ARMs from his Fed pulpit in a Feb. 23, 2004, speech. American consumers “might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” which may be “an expensive method of financing a home,” he said.

Greenspan’s op-ed avoids any incriminating evidence of his role in what he calls “the most virulent (crisis) since the 1930s.” (No 100-year flood this!) Instead, he focuses exclusively on what he, as Fed chief, called the “conundrum:” that long-term interest rates barely budged in the face of gradual increases in the funds rate.

Bubble Asymmetry

“If only the Chinese hadn’t been saving so much in the U.S., there would have been no problem,” says Bill Fleckenstein, president of Fleckenstein Capital in Seattle and author of “Greenspan’s Bubbles.” That analysis “flies in the face of all the evidence” that Greenspan took interest rates too low and held them there for too long; that he “cheerled all the securitization products and ARMs; that he told us not to worry about a real estate bubble.”

Even worse, Fleckenstein says, Greenspan “doesn’t discuss the fact that it was Fed’s stated policy to act asymmetrically in regard to asset bubbles,” allowing, or encouraging, them to inflate and cleaning up afterwards.

The clean-up is proving harder than Greenspan imagined.

There were other measures that shouted -- yes, shouted -- “monetary policy is too easy” in 2003 and 2004. Apparently Greenspan wasn’t listening.

Spreading Evidence

The spread between the overnight rate and the 10-year Treasury note ballooned to an historically wide 365 basis points by the middle of 2004, when the Fed started to raise the funds rate in baby steps. A steep yield curve is a sign of an expansionary monetary policy.

Rising long-term rates reflect an increased demand for credit. That same increased demand would push up the overnight rate, too, except when the Fed intervenes, creating as much credit as the banking system demands to keep the rate at the designated target.

The spread between the funds rate and nominal gross domestic product -- a proxy for the difference between the cost of borrowing and the return on investment for the overall economy -- was also emitting a warning sign that policy was too easy. The gap reached a three-decade high of 6 percentage points in 2004, creating an incentive to borrow and lend.

Greenspan’s op-ed is full of explanations, correlations and obfuscations. He defends himself against accusations by “my good friend,” Stanford economist John Taylor, who has argued that “monetary excesses” were the main cause of the boom and resulting bust.

No Mea Culpa

He also ignores the literature on asset bubbles.

“Greenspan is a student of history,” Kasriel says. “Surely he’s read (Charles) Kindleberger’s book on asset price bubbles.”

One element common to all bubbles, according to “Manias, Panics and Crashes,” is cheap credit. With so much cheap credit coming from abroad, Greenspan didn’t need to add to it.

And that’s the point. If he’s satisfied with his explanation of a savings glut -- the idea that there was too much credit being supplied from the rest of the world -- why not reduce the supply of Fed credit? That raises the price and reduces the quantity demanded.

Victim isn’t a role Greenspan plays particularly well, especially when it’s an attempt to exonerate himself from responsibility.

Economics focus

Banks need more capital

In a guest article, Alan Greenspan says banks will need much thicker capital cushions than they had before the bust

Alan Greenspan was the chairman of the Federal Reserve Board from 1987 to 2006. He is now president of Greenspan Associates

GLOBAL financial intermediation is broken. That intricate and interdependent system directing the world’s saving into productive capital investment was severely weakened in August 2007. The disclosure that highly leveraged financial institutions were holding toxic securitised American subprime mortgages shocked market participants. For a year, banks struggled to respond to investor demands for larger capital cushions. But the effort fell short and in the wake of the Lehman Brothers default on September 15th 2008, the system cracked. Banks, fearful of their own solvency, all but stopped lending. Issuance of corporate bonds, commercial paper and a wide variety of other financial products largely ceased. Credit-financed economic activity was brought to a virtual standstill. The world faced a major financial crisis.

For decades, holders of the liabilities of banks in the United States had felt secure with the protection of a modest equity-capital cushion, allowing banks to lend freely. As recently as the summer of 2006, with average book capital at 10%, a federal agency noted that “more than 99% of all insured institutions met or exceeded the requirements of the highest regulatory capital standards.”

Today, fearful investors clearly require a far larger capital cushion to lend, unsecured, to any financial intermediary. When bank book capital finally adjusts to current market imperatives, it may well reach its highest levels in 75 years, at least temporarily (see chart). It is not a stretch to infer that these heightened levels will be the basis of a new regulatory system.

The three-month LIBOR/Overnight Index Swap (OIS) spread, a measure of market perceptions of potential bank insolvency and thus of extra capital needs, rose from a long-standing ten basis points in the summer of 2007 to 90 points by that autumn. Though elevated, the LIBOR/OIS spread appeared range-bound for about a year up to mid-September 2008. The Lehman default, however, drove LIBOR/OIS up markedly. It reached a riveting 364 basis points on October 10th.

The passage by Congress of the $700 billion Troubled Assets Relief Programme (TARP) on October 3rd eased, but did not erase, the post-Lehman surge in LIBOR/OIS. The spread apparently stalled in mid-November and remains worryingly high.

How much extra capital, both private and sovereign, will investors require of banks and other intermediaries to conclude that they are not at significant risk in holding financial institutions’ deposits or debt, a precondition to solving the crisis?

The insertion, last month, of $250 billion of equity into American banks through TARP (a two-percentage-point addition to capital-asset ratios) halved the post-Lehman surge of the LIBOR/OIS spread. Assuming modest further write-offs, simple linear extrapolation would suggest that another $250 billion would bring the spread back to near its pre-crisis norm. This arithmetic would imply that investors now require 14% capital rather than the 10% of mid-2006. Such linear calculations, of course, can only be very rough approximations. But recent data do suggest that, while helpful, the Treasury’s $250 billion goes only partway towards the levels required to support renewed lending.

Government credit has in effect acted as counterparty to a large segment of the financial intermediary system. But for reasons that go beyond the scope of this note, I strongly believe that the use of government credit must be temporary. What, then, will be the source of the new private capital that allows sovereign lending to be withdrawn? Eventually, the most credible source is a partial restoration of the $30 trillion of global stockmarket value wiped out this year, which would enable banks to raise the needed equity. Markets are being suppressed by a degree of fear not experienced since the early 20th century (1907 and 1932 come to mind). Human nature being what it is, we can count on a market reversal, hopefully, within six months to a year.

Though capital gains cannot finance physical investment, they can replenish balance-sheets. This can best be seen in the context of the consolidated balance-sheet of the world economy. All debt and derivative claims are offset in global accounting consolidation, but capital is not. This leaves the market value of the world’s real physical and intellectual assets reflected as capital. Obviously, higher global stock prices will enlarge the pool of equity that can facilitate the recapitalisation of financial institutions. Lower stock prices can impede the process. A higher level of equity, of course, makes it easier to issue debt.

Another critical price for the return of global financial stability is that of American homes. Those prices are likely to stabilise next year and with them the levels of home equity—the ultimate collateral for global holdings of American mortgage-backed securities, some toxic. Home-price stabilisation will help clarify the market value of financial institutions’ assets and therefore more closely equate the size of their book capital with the realities of market pricing. That should help stabilise their stock prices. The eventual partial recovery of global equities, as fear inevitably dissipates, should do the rest. Temporary public capital injections into banks would facilitate this process and arguably provide far more benefit per dollar than conventional fiscal stimulus.

Even before the market linkages among banks, other financial institutions and non-financial businesses are fully re-established, we will need to start unwinding the massive sovereign credit and guarantees put in place during the crisis, now estimated at $7 trillion. The economics of such a course are fairly clear. The politics of draining off that much credit support in a timely way is quite another matter.