A Muddled Greenspan
Jude Wanniski
July 24, 2001


On the second leg of his mid-year testimony, Greenspan this morning removed all hope that he is concerned about monetary deflation. He flatly told the Senate Banking Committee there was no deflation in the system and even seemed much more upbeat about the prospects for economic expansion later in the year than he did last week. He specifically rejected the deflation idea as presented in a question from Sen. Bob Bennett [R UT], who said a Utah copper producer told him that when copper is scarce, the price of copper goes up, and when the dollar is scarce, the price of copper goes down. Bennett did not mention gold, although he knows the arguments, but he did note that commodity prices generally are down. Greenspan said he does not look at commodity prices in making monetary policy, for when they are weak it is generally a problem of a weak economy, not scarcity of liquidity. (Huh???) He pointed to the M2 money-supply as an indication that there is plenty of liquidity in the economy, but neither Bennett nor anyone else on the Banking Committee was able to point out that M2 is more likely to grow in a deflation as its velocity declines.

When Bennett asked if we might follow Japan into a deflation, he said that was not likely because Japan's problems were bad loans held by its banks, which will not be a problem here. Indeed, Greenspan is banking heavily on the real-estate market holding up the economy this fall and preventing the kind of declines that would follow a net decline in household wealth held in capital gains of real property. It would be a problem if he now saw a net decline, as households are borrowing against their homes, but values are still rising faster. Curiously, he said the tide of immigration is partly responsible, implying immigrants need a place to live and must be able to find the credit to buy at least mobile homes.

The Fed chairman has lunch once a week with Secretary Paul O'Neill and it is clear that he dominates the thinking of O'Neill, who also dismisses the deflation argument, sees a rebound on the way, practically uses the same words to cite real estate as the ace in the hole, and pooh-poohs adverse effects of an Argentina crisis on Latin America. In the current Economist, O'Neill flatly dismisses Argentina as something he should worry about. Greenspan almost certainly assured him on that score, sayin yes, we are all inter-related, but there is much less "tinder" in the world today than there was in 1997, when the Asian crisis hit, because there are not so many fixed exchange rates!! This is the first backdoor explanation from Greenspan on how Asia was crippled by fixing its currencies to the dollar, although again there is not enough expertise on the committee or its staff to nail him on these issues. Of course, economies like Argentina and Brazil to do not have to be linked by fixed exchange rates to be hammered in a regional decline triggered by one that does have a fixed peso/dollar rate.