Alan Greenspan, Deflationist Jude Wanniski October 29, 1997

Wall Street responded positively to Alan Greenspan’s opening comments this morning before the Joint Economic Committee. The DJIA jumped 125 points as Greenspan noted the sell-off in the market as having taken the froth off its recent exuberance. This was clearly taken as meaning he would not advocate raising interest rates on November 12 on the grounds of froth. The longer he talked in answering committee questions, though, the more the market lost those gains. The message today was clearer than ever that Greenspan is in a DEFLATIONIST mode, which means he only brought those arguments that support the idea that inflation, not deflation, is the problem we now face. Rep. Maurice Hinchey [D-NY] was the only committee member to flatly disagree, but instead of throwing facts in the Fed Chairman’s face, Hinchey simply argued that the economy will not grow more than 1½% next year, which will be bad for the workingman. Greenspan, feeling cheerful about the market’s recovery yesterday, told Hinchey his argument was reasonable and legitimate, and that in 18 months we would know if he or Hinchey turned out to be right.

Nobody on the committee was smart enough to ask Greenspan if he is concerned about the price of gold being at a lower level than it has been since he became chairman a decade ago, given the fact that Greenspan over the years has repeatedly cited gold as the best single indicator of incipient inflation. Now, because it has fallen by $70 in the past year while he has been warning about inflation, it seems to have lost its meaning to him as a signal. The prices of precious and base metals have been following in gold’s footsteps, and will continue to do so if gold remains where it is. Wayne Angell, who also cited gold as a reason to raise interest rates when gold was rising, is now making the argument that gold’s decline is not deflationary and is no reason to lower interest rates. Greenspan did say his goal is price stability, and he did not want prices to fall any more than he wanted prices to rise, but true to form, members of the Joint Economic Committee are too dense to cite falling prices and ask how he can justify his posture. He simply cites potential concerns about the unemployment rate getting too low, wages outrunning productivity, and the economy growing faster in aggregate than he would like it to grow. In his testimony he several times celebrated the marvels of the free market, except when he disagrees with its outcome. 

What we have gained this week is Hong Kong’s successful defense of its currency, which remains pegged to the deflationary U.S. dollar. As we noted last week in “Asian Flu,” a devaluation of the HK dollar would have pulled China’s yuan with it. The financial risks would be compounded by the political risks associated with economic decline on the mainland. As it is, this latest test of the HK/dollar peg provides a tenuous anchor for the region. It remains worrisome that both the Bank of Japan and the Bundesbank seem determined to deflate the yen and DM even faster than the dollar, which would be fine at $350 gold but not at $312. The froth really has come off the equity markets, with risk-takers everywhere pulling in their horns. Greenspan does not see recession yet, but that’s only because he does not see the economic declines getting started around the world. Now we have to wait for the weakness to show up in government statistics here before Greenspan will consider an end to his deflation.