Dr. Greenspan and Mr. Hyde
Jude Wanniski
July 21, 1993


Fed Chairman Alan Greenspan's testimony before a House Banking subcommittee yesterday was extraordinary, at times spectacular. As usual, the press corps presented us with garbled reports that focused on the warts that remain in Greenspan's public presentation -- particularly the impression he leaves that the bond market will respond positively to almost any $500 billion deficit reduction plan. I taped the hearing, which C-Span ran at 1 a.m., and watched all three hours this morning from 5 to 8. Greenspan would have been even better if the members of this monetary subcommittee were better at asking questions -- a problem that may be remedied when he goes before the full Senate Banking Committee tomorrow. Here are the most encouraging notes that he struck:

1. For the first time in his six years at the Fed, he advanced the idea that gold is the most important single commodity signal of inflation expectations in the market. He did this first in his prepared testimony, which demonstrates the confidence he has on this issue with the other Fed governors. In an answer to a question about gold, he was even clearer in rejecting arguments that gold has jumped above $390 an ounce because of supply considerations. In noting that the world more or less knows the whereabouts of all the gold mined "since antiquity," Greenspan gave the perfect answer to the current, conventional argument that mining flows in Russia and/or higher demand in China have caused the run-up. He should have been asked what gold price would satisfy him that the market is not worried about the currency losing purchasing power.

2. Also for the first time, Greenspan made clear why he so ardently believes the government must change the tax treatment of capital gains -- either through retroactive indexation, rate reduction, or preferably elimination of capital gains taxation altogether. In his prepared statement, he argued: "Risk-taking is crucial in the process that leads to a vital and progressive economy. Indeed, it is a necessary condition for wealth creation." In the question period, he argued that whereas "all taxation suppresses economic activity" to some degree, "imposing it on risk-taking does it in spades." He volunteered that he hoped capital gains would be dealt with after the budget is behind Congress. My inference is that Greenspan is aware that the present package in conference can't reach his concerns, which is why the President would have to go back to the drawing board if he wants to include capgains. Nobody asked Greenspan why he was so emphatic in mentioning retroactive indexation, a line of questioning that would lead directly to his support of Wayne Angell's indexing idea and put a spotlight on the bipartisan alternative to the Clinton budget being readied by Rep. Charles Rangel and Sen. Malcolm Wallop.

The press corpx remains hopeless in conveying Greenspan's thinking to its readers. Under a sub-headline "Backs Clinton Plan," Steven Greenhouse of The New York Times writes that "the Fed chairman used his testimony to badger Congress to approve the Clinton Administration's plan to cut the deficit by $500 billion over five years." The wires said as much yesterday. Yet when Rep. John LaFalce [D-NY] congratulated Greenspan for "backing the Clinton plan," Greenspan raised his hand, shook his head, and clearly said, "Of course, you are being facetious." LaFalce grinned and said, "Well, I tried." The Times was of course not alone. The Dow Jones and Reuter wires were just as befuddled, and it is no wonder the bond market got wacked, recovering in the early afternoon when word-of-mouth straightened out Wall Street. 

What Greenspan did say was that he didn't think Congress should lower the $500 billion deficit reduction target, because he thinks the bond market would react adversely if the target were lowered (although he couldn't say by how much). Here, Greenspan and I disagree, but not by all that much. He was too glib in conveying the impression that any combination of tax increases and spending cuts would have positive effects as long as they added to $500 billion, which he certainly does not believe. In agreeing with a questioner that a weak economy tends to lower long-term interest rates, he was careful to say "everything else being equal," but such nuances were lost in the reporting. It should have been instructive, in light of his forceful remarks on the taxation of risk-taking, that he would point out "there has been far less economic expansion because of lower interest rates than historical experience would suggest." This practically cried out for a question about the stock market as a signal of economic growth relative to bonds, as Greenspan is well aware the Great Depression ran in parallel with 2% interest rates. But no dice. I've argued the bond market has been strong because Greenspan has been successful in keeping the White House off his back, not because of the Clinton tax bill, but Greenspan could not say this even if he believed any part of it. 

To be sure, there is an old Mr. Hyde aspect that haunts the new Dr. Greenspan. It was for this reason that I opposed his nomination by President Reagan in 1987. His austerity streak contributed to the unsuccessful economic policies of Presidents Nixon and Ford. Then, he aligned himself with David Stockman in 1981, when they persuaded President Reagan to defer his tax cuts even as the Volcker Fed was deflating the economy. Yesterday, Greenspan went out of his way to criticize the "rosy scenarios" of the Reagan years and praise the "more credible" budget estimates of the Bush years. Incredibly, he also praised the 1990 budget deal, because of its spending restraints. He did so when deflecting a question about its adverse tax impact, one he should have knocked out of the park. I guess he will go to his grave rationalizing mistakes he's made over the years. We'll have to live with that. Fortunately, his contributions now outweigh his subtractions. As his testimony reveals, he's now 90% supply-side and only 10% Hyde.

This came through when the subcommittee chairman, Rep. Paul Kanjorski [D-Pa], complimented Greenspan on uniting two Nobel Laureates, Milton Friedman on the right and Paul Samuelson on the left, both of whom have been blasting Greenspan for being too tight. They are both fine economists, he said, but "I do think they are wrong." He dismissed their criticism on the grounds that they are relying on monetary aggregates whose usefulness has "broken down." Greenspan's confident advocacy of gold yesterday is probably giving both of them conniptions. He did say he hopes the monetary aggregates someday become useful once again, which is easy to say if you know this can only happen when the dollar is once again pegged to gold -- thereby keeping the velocity of money constant, as it was for centuries under the gold standard.

It was actually useful for Greenspan to reaffirm a commitment to the $500 billion deficit target, as it will be impossible to hit that target unless capital gains is dealt with. In addressing the Democratic Senate-House conferees yesterday, President Clinton once again pulled out all the phony class warfare statistics The New York Times fed him early last year, trying to whip up enthusiasm for his plan. Behind the scenes, all of Congress is aware of the fantasy world he has spun -- promising conservative Democrats they won't have to raise taxes, promising liberal Democrats they won't have to cut spending, and promising Wall Street he will raise taxes and cut spending to hit the $500 billion bullseye.

What should Greenspan be asked tomorrow, to help the President out of this fix? Senators should ask him to develop the economic growth arguments in his House testimony. Why index capgains retroactively? How would this produce growth in the present and future? Would the Angell plan lose $14 billion in revenue over five years, as the Joint Tax Committee says it would, or would it invite risk-taking, economic growth, and a flood of tax revenues at every level of government? Could a deficit reduction plan of less than $500 billion be welcomed by the markets if it were scored by Greenspan rather than Joint Tax? Would such growth be bad for the bond market, or, everything else being equal, good? If the elimination of a capgains tax would maximize risk-taking and economic growth, is it conceivable such a step could produce so many jobs that the federal deficit would fall without the painful measures the President is now asking? Would such rapid growth be inflationary, even if the Fed were keeping down the price of gold? What gold price would make him happy, balancing out inflationary and deflationary impulses? If he's worried about gold at $393 and has the authority to tighten, what's holding him back? To what price does gold have to rise before he acts? How low does he think long-term interest rates could get by careful management of monetary policy alone? By pegging to gold at $350? What would be the revenue implications of gold/dollar interest rates? If these monetary and tax policies were to produce 5% economic growth as far as the eye could see, instead of 2% or 3%, would it not be possible to stay ahead of the escalating costs of health care? I'm getting to the end of this page, or else I could go on with questions that Alan Greenspan could answer in a way that would make it clear that he knows how to make life easier for President Clinton and the rest us. Dr. Greenspan, that is.