If Alan Greenspan had died at age 80, obituaries would’ve lauded the former Federal Reserve chair as one of the greatest-ever economics practitioners. Instead, history will record Greenspan, who died aged 100 earlier this week, as a brilliant, contradictory figure whose self-admitted flaws paved the way for the global financial crisis of 2008 and the ongoing collapse in credibility central banks everywhere continue to suffer.
An acolyte of libertarian Ayn Rand in his younger years, Greenspan became more like John Maynard Keynes, whose interventionist ideas most shaped postwar economic policy. Like Keynes, Greenspan was a polymath who became very rich as a shrewd investor before bursting into public life as chair of the Federal Reserve – an institution he’d earlier called “one of the historic disasters in American history”, courtesy of Ronald Reagan in 1987.
Both men’s careers were buoyed by stockmarket crashes whose impacts on the broader economy were vastly different. Correlation is not causation, yet the minimal impact of the Black Monday crash on the broader economy was put down to Greenspan’s wise provision of liquidity. It was a playbook he returned to repeatedly after the collapse of the massive hedge fund Long Term Capital Management in 1998 and the dotcom collapse in 2001, when Greenspan slashed the official Fed funds rate to 1 per cent.
The infamous “Greenspan put” was born: the risk of economic collapse and severe financial losses that most – especially small businesses – faced wouldn’t apply in financial markets, at least for the big players.
The powerful Wall Street elite who happened to be the Fed’s clients would be rescued collectively by ultra-low interest rates and behind-the-scenes pro bono co-ordination. But the “long and variable lags” of monetary policy taught to economics students at university had been forgotten by his admirers by the time Greenspan retired after 19 years, in 2006.
His tenure had overlapped with arguably the most halcyon period of US economic history: booming productivity growth alongside relatively low inflation without any of the severe economic downturns that blotted earlier periods. But as US economist Rudiger Dornbusch once remarked, “things take longer to happen than you think they will and then they happen faster than you thought they could”.
Artificially easy money and the Greenspan put combined to trigger a massive financial crisis and recession from late 2007, which put millions out of work, destroyed trillions of dollars of household wealth, and prompted a litany of execrable bailouts of financial institutions.
His successors, Ben Bernanke and Janet Yellen, took Greenspan’s interventionist bent to new heights, launching successive rounds of “quantitative easing” that encouraged governments to rack up massive public debts that would’ve made Keynes blush.
The Covid pandemic brought still more radical interventions that finally shattered what remained of central banks’ hard-won reputation for maintaining price stability. Perhaps it was Greenspan’s famous love of Delphic utterances that has aged less well. “I’ve learned to mumble with great incoherence. If I seem unduly clear to you, you must have misunderstood what I said,” he once joked before congress. It was the kind of colourful behaviour you wouldn’t expect from central bankers today. He even refused to bind the Federal Reserve to an explicit numerical inflation target after most other central banks had, arguing judgment was superior to mechanical rules. Again like Keynes, he placed greater faith in the discretion of exceptional policymakers than the rigours of the free market.
Yet old habits – despite all the obvious economic destruction caused since 2008 – die hard. Even free-market economists who would condemn government interference in any other part of the economy still assume it’s perfectly natural for bureaucrats to set the rate of interest. The Reserve Bank of Australia also operates in this world bestowed by Greenspan, whose “put” will prove very difficult to unwind without a major economic collapse. No financial institution in Australia, even a small one, would be allowed to wobble, let alone fail. Indeed, for all the talk of the need to reduce inflation, the RBA’s real target appears to be keeping dwelling prices high, credit flowing and the banking system profitable. Underlying inflation is headed to 4 per cent yet analysts are already pencilling in cuts in the knowledge inflation is in fact a secondary consideration.
“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,” Greenspan wrote in a 1966 essay.
After the GFC he had “found a flaw” in the worldview he had trusted for four decades. Perhaps in his twilight years watching central banks struggle to achieve any mandate, Greenspan came to return to his earlier views.
