Greenspan Passes the Buck
Jude Wanniski
November 22, 2004


Fed Chairman Greenspan’s remarks Friday morning at the European Banking Congress were significant only in that he clearly has run out of reasons why Fed policy is not stabilizing the value of the dollar against anything, gold, commodities or foreign exchange. Instead of questioning the idea that higher interest rates will lower commodity prices and strengthen the dollar, he is passing the buck. He finds that all those policies that are outside of his jurisdiction are responsible for the problems of the dollar in the world. The consummate politician, Greenspan has done this before any number of times when inflation or deflation have surfaced on his watch.

What is most surprising is that he now says the current account deficit is the bogeyman, which runs contrary to positions he has taken all summer in congressional hearings, i.e., that the federal budget deficit is a bogeyman, but the trade deficit is something that will take care of itself. Now he warns that foreign investors may soon tire of financing the current account deficit and that the Fed will be required to raise interest rates to sustain their appetites. This is a rough equivalent to his 1996 verbal joust at the efficiency of the capital markets when he found they were being afflicted with “irrational exuberance.” Back then, the markets grumbled for a while before deciding there was good reason to bid up the value of financial assets. It was March 2000 before the market skidded, having nothing to do with a sudden realization that it had been irrational.

The most worrisome aspect of Greenspan’s European remarks is that he is in denial, and as long as the most powerful central banker in the world is kidding himself that he knows what he is doing, we all have to fasten our seatbelts. The markets brushed off his 1996 remark at the time because he was not then embarked on a forced march to some unknown higher federal funds rate that he promises will cut off dollar inflation.  It is much different now because he is behaving as if he is covering his behind on the errors he has been steadily making in recent years. He is now prepared to tell Congress that if only this fiscal imbalance or that trade deficit had been addressed properly by people who do not work for him the dollar would not be sinking to record lows and the inflation that is already underway would not have happened.

Treasury Secretary John Snow’s almost non-existent experience with monetary policy is now most evident as he struggles to keep up with the dollar’s fall, obviously having no idea it is the result of the Fed’s decision to slow the economy down with higher interest rates. At the G-20 meeting in Berlin Sunday, he promised the U.S. would cut its trade and budget deficits in order to strengthen the dollar and pleaded with the finance ministers of the other 19 nations in attendance to do more to grow their economies. What would he have them do in order to cut the U.S. deficits? On that score, he revived talks with China’s representative hoping to get them to float the Yuan – on the theory that it will cause the U.S. to buy less from China and lower our trade deficit. But wouldn’t that slow China’s economy? The contradictions are stupefying, but that’s what to expect when Washington, D.C. turns macroeconomics over to Greenspan and he goes off the rails. I’m sending these commentaries to several Fed governors and officials, and I know they are reading them as they recognize the contradictions, but heaven knows when this will turn around.

Several clients have queried us in recent days on this topic. Please keep them coming:

Q. I remember very, very well your analysis and concerns leading up to the October 19th crash in 1987. In fact, I remember being in the lobby of a San Francisco hotel the Saturday morning before and seeing the NY Time`s headlines regarding Baker`s threat to the Germans. It was that precise moment that I knew that we would crash on Monday just as you had feared. When I reviewed Greenspan`s nearly inane comments in yesterday`s NYTimes, I got that sick feeling again:  the money establishment has once again gone wayward. Your thoughts?

A. Remember the 1987 situation was complicated by capital gains taxation. It had been raised to 28% from 20% in 86 while income tax rates had been lowered to 28%. The Louvre Accord provided assurances that there would be no inflation to cause the capgains tax to climb to much higher effective rates. What we have now is relief from capgains on real property and a 15% rate, not 28%. The problems of gold going up will not bring on a Crash, but we do have to worry about a steady erosion of real values. Some upward movement in the stock market is pure inflation. Translate the DJIA into gold instead of dollars and it is way down this year. Then the problem... How to get gold down before the general price level catches up with it?

Q. Why aren’t you telling Greenspan to reduce liquidity? What would you do if you were Greenspan?

A. Greenspan & Co. know what I think, but it does no good for me to yap at them as long as they still think they can halt inflation with higher interest rates. They have had too much support on that argument from the universe of economists… Keynesians, monetarists and supply-siders. It was nice to see Bear Stearns, a supply-side shop, today confess that it had been wrong in thinking the administration preferred a strong dollar to a weak one. But the Bear still hasn’t apologized for insisting the Fed has to raise the funds rate faster and higher.

What would I do if I were Greenspan? I’d ask for a meeting with the President and Treasury Secretary and admit I was on the wrong track, and that we had to change the Fed’s goal and its operating mechanism to get there. I’d tell Mr. Bush that I think I should alert the markets that our goal is to get the gold price to $400 oz from $450, or it might go to $500 sometime relatively soon. The President would ask what would that do to the markets and the economy. I’d tell him gold would quickly fall to $410 on its own and wait to see if we were serious about $400, which we would do with our operating mechanism, selling bonds in transparent fashion, mopping up liquidity until we hit the mark. And then managing the Fed’s balance sheet to keep it there.

Q. Don’t we have to get to $350 gold in your model, where you say it is in equilibrium?

A. Getting to $400 would be very easy and would cause no problems to the economy, only to people who were long gold. That’s because gold was recently at that level and there has been very little inflationary catch-up to these higher levels. Now is the best time to change course because we have not gotten very far in the wrong direction. It would not take the markets more than a few minutes to figure out that Greenspan knew what he was doing, stabilizing gold at a non-inflationary level instead of slowing down the economy to beat inflation. There would be great rallies in stocks and bonds and the dollar.

Q. Your reports have now been saying gold could go to $500. Do you think this will happen quickly?

A. Not in weeks, but certainly we could get there in a matter of months. Remember 1971 when gold was officially $35 in August and by year’s end it was at $70. The market assessment was that the Nixon administration really did not know what it was doing in closing the gold window. Even then it took awhile before the bond market was hammered, as there was always some chance policy would be corrected. Instead, gold kept going up and up and up, as policy got worse and worse and worse, with the Nixonians fitting the description of the fanatic who doubles his speed when he loses sight of his goal. From equilibrium of $350, we’re now a long way from a double to $700, and if we could change direction now and get to $400, I’d be a happy man, and so would the financial markets… all around the world.

PS. At my virtual “Supply Side University” this last weekend, I wrote a primer on the Fed, covering lots of ground that might interest you as well as my SSU students. You’re never too old to learn. I’m 68 and learning something new every day.

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