The Annotated Greenspan
By Greg Nyquist
GSNyquist@aol.com
A week ago last Friday, Alan Greenspan, Chairman of the Federal Reserve, gave a speech in San Francisco. It was the first time Greenspan had spoken in public since his Congressional testimony a month after the terrorist attacks on September 11. Since Greenspan is famous for speaking in garbled generalities which do not appear to convey anything specific or useful, I thought that, as a public service, I would provide my own “annotated” version of the speech, relating what I thought was its salient points and underlying subtext.
Greenspan began his oration by commenting on the main effects of the 9-11 terrorist attacks on the U.S. economy:
In the period immediately prior to September 11, there were tentative signs that some sectors of the U.S. economy had begun to stabilize, contributing to a hope that the worst of the previous cumulative weakness in world economic activity was nearing an end. That hope was decisively dashed by the tragic events of early September. Adding to the intense forces weighing on asset prices and economic activity before September 11 were new sources of uncertainty and risk that began to press down on global demand for goods and services.
Here Greenspan is suggesting that, prior to 9-11, things were looking up for the economy. This is a bit of a stretch, to say the least. In fact, by all objective criterion, the economy was clearly getting worse prior to the terrorist attacks. Any glints of “stabilization” that might dimly shine here or there are irrelevant. All the essential facts pointed to recession. What Greenspan is trying to do in this passage is blame the negative growth of the last quarter of 2001 on 9-11. It’s as if he’s saying: “Don’t blame me or the Bush administration for the negative economic growth of the last quarter. The terrorists are the
ones to blame.”
Greenspan continues:
In almost all areas of the world, economies weakened further, a cause for increasing uneasiness. The synchronous slowing in activity raised concerns that a self-reinforcing cycle of contraction, fed by perceptions of greater economic risk, could develop. Such an event, though rare, would not be unprecedented in business-cycle history.
This is a very cryptic remark. The “event” he is alluding to is a deflationary crisis, which are rare nowadays but were not rare earlier in American economic history. The subtext behind this remark would appear to be: “Things could’ve been worse. We could’ve had a deflationary collapse. So stop complaining.”
After this disturbing allusion, Greenspan changes his focus to the economy’s future prospects:
But, arguably, our economy has not been weakening cumulatively in recent weeks. In fact, indications of stabilization, similar in many respects to those observed in the period immediately preceding September 11, have been appearing with greater frequency. A possible significant contributor to this emergence of
stability -- if that is what it is -- may be the very technologies that have fostered coincident global weakness: those that have substantially improved access of business decision-makers to real-time information.
Following the collapse in technology and internet stocks, you would think that all this “new era” talk would finally come to an end. But not at all. Faith in productivity still reigns supreme among the economic
cognoscenti. (Or at least Greenspan hopes so.) Never mind that this very faith in a “new era” is partially responsible for
getting us into this mess. It seems we are expected to believe that the cause of our disease will also be its cure!
During the late nineties, the “new era” crowd went around telling everybody that the business cycle had been abolished. This has been refuted by subsequent events. Greenspan, in an effort to save the theory, amends it as follows:
Today, businesses have large quantities of data available virtually in real time. As a consequence, they address and resolve economic imbalances more rapidly than in the past. At the same time, firms are largely operating with the same information set, and thus resolution of imbalances induces parallel movements in activity. Contractions initially may be steeper, but because imbalances are more readily contained, cyclical episodes overall should be less severe than would be the case otherwise.
In other words, business cycles can occur in the “new era,” but the “contractions” won’t be as bad as they used to be. Technology will enable us to get the economy
turned around much faster than in the bad old days, when the gold standard provided some discipline to the credit excesses of the banking industry.
Greenspan goes on in this vein for several paragraphs more. Then abruptly he switches gears and brings up another very interesting subject—home mortgages:
For the household sector, which had been a major stabilizing force through most of last year's slowdown, the outlook for demand is mixed. Low mortgage interest rates and favorable weather have provided considerable support to homebuilding in recent months. Moreover, attractive mortgage rates have bolstered both the sales of existing homes and the realized capital gains that those sales engender. They have also spurred refinancing of existing homes and the associated liquefaction of increases in house values. These gains have been important to the ongoing extraction of home equity for consumption and home modernization.
Here Greenspan is referring to the undeniable fact that the only thing that has kept the economy from going into a free fall in recent months is mortgage refinancing, which has provided the liquidity to keep consumption from descending to levels that would trigger widespread panic in the business economy. Greenspan’s next comment has ominous undertones for those who are banking on mortgages to continue providing fresh influxes of consumption liquidity:
The recent rise in home mortgage rates, however, is likely to damp housing activity and equity extraction. It is already having an effect on cash-outs from refinancing. Cash-outs rose from an estimated annual rate of about $20 billion in early 2000 to a rate of roughly $75 billion in the third quarter of last year. But the pace of cash-outs has likely dropped noticeably in response to the recent decline in refinancing activity that has followed the backup in mortgage rates since early November.
In other words, if Greenspan is right, the mortgage bubble has reached the end of its tether. This is not good news for the economy. Without the money generated through mortgage refinancing, it is difficult to see how the still overvalued stock market can be kept from suffering another major collapse.
Greenspan, apparently unaware of the ominous implications of his statements, blithely turns to the subject of energy prices:
The substantial declines in the prices of natural gas, fuel oil, and gasoline have clearly provided some support to real disposable income and spending. These price declines added more than $50 billion at an annual rate to household purchasing power in the second half of last year. However, a decline in energy prices provides, in effect, only a one-shot boost to consumption, albeit one that is likely to take place over time. To have a more persistent effect on the ongoing growth of total personal consumption expenditures, energy prices would need to continue to decline. Futures prices do not suggest that such a decline is in the immediate offing, but the forecast record of these markets is less than sterling.
Greenspan is basically telling us that we should not expect the drop in gas and oil prices to save us from our economic woes. As a matter of fact, regardless of futures prices, there is little reason to expect energy prices to decline much further.
But what about the labor market? Is there any good news to report on this front? Greenspan comments:
Perhaps most central to the outlook for consumer spending will be developments in the labor market. The pace of layoffs quickened last fall, especially after September 11, and the unemployment rate rose sharply. Over the past month or so, however, initial claims for unemployment insurance have declined markedly, on balance, suggesting some abatement in the rate of job loss.
All that Greenspan is saying here is that the unemployment is rising at a slower pace
than it did a few months earlier. There is, however, no reversal in sight. Unemployment continues to rise, even if it has
not been rising as fast in recent weeks as it was a few months ago.
Greenspan, nearing the end of his speech, brings up the issue of fiscal stimulus:
Finally, economic policies will have an important influence on household spending in the period ahead. No doubt, we will continue to benefit from the tendency of our tax and entitlement systems to buffer cyclical swings in income. Moreover, despite the failure of Congress to enact further tax cuts and spending increases, the continued phase-in of earlier reductions in taxes and the significant expansion of discretionary spending already enacted should provide noticeable short-term stimulus to demand.
Some of this stimulus has likely been offset by increases in long-term market interest rates, including those on home mortgages. The recent rise in these rates largely reflects the perception of improved prospects for the U.S. economy. But over the past year, some of the firmness of long-term interest rates probably is the consequence of the fall of projected budget surpluses and the implied less-rapid
pay-downs of Treasury debt.
In this passage, Greenspan accomplishes two main objectives. First, he makes a very subtle suggestion regarding the desirability of a fiscal stimulus. He cites Congress’s refusal to lower taxes further as a “failure.” Apparently, Greenspan believes America needs additional tax cuts. But then, curiously enough, he adds a cautionary note which amounts almost to a contradiction to his prior statement. He suggests that the fiscal stimulus provided by the Bush tax cut and the War spending has been partially nullified by “increases in long-term market interest rates.” I regard this passage as the most sinister in the entire speech: for it suggests that Greenspan is aware that the economy is in such bad shape that it might not even respond to additional fiscal stimulus. Yet even if this is so, he does not want to anyone to lose heart. Even if the economy is past all remedy, there is no reason to panic, he is eager to convince us. The reason why a stimulus may not be entirely effective “reflects the perception of improved prospects the U.S. economy. It is therefore a good thing, not a bad thing, if the economy fails to respond to the Keynesian medicine.
This passage, incidentally, is typical of Greenspan. The most disturbing economic developments are, for him, merely evidence of the underlying strength and durability of the American economy. The worse things are, the better the prospects for a complete recovery.
Greenspan concludes:
There are sound reasons for concluding that the long-run picture remains bright, and even recent signals about the current course of the economy have turned from unremittingly negative through the late fall of last year to a far more mixed set of signals recently. But I would emphasize that we continue to face significant risks in the near term. Profits and investment remain weak and, as I noted, household spending is subject to restraint from the backup in interest rates, possible increases in unemployment, and from the effects of widespread equity asset price deflation over the past two years.
This pretty much sums up the overall message of his speech. We will get out of this mess eventually, he is assuring us. But in the meantime, things may not go so well. Greenspan, in effect, is warning us of this, so that we will not panic if the recession doesn’t abate through the Spring and Summer of this year. I suspect that Greenspan knows that the economy is in much worse shape than any of the economic pundits realize or are willing to admit. But
if he said as much it would be disastrous. At the same time, he is worried that all the recent talk of an imminent recovery will create unrealistic expectations which, when they fail to pan out, might lead to a catastrophic panic. He has therefore issued a muted warning as a way of preparing the business community for the inevitable disappointment. His speech, if reduced to its barest essentials, would read as follows: “Yes, there are signs of a recovery out there. But there are also signs of continuing weakness. We should therefore not be too disappointed if the economy doesn’t start improving before Summer. It is nothing to be concerned about, because continuing weakness is only proof of the long-term prospects of the economy in general. Eventually, we will get out of this mess, so don’t panic.”
Greenspan, of course, could not say it so bluntly as this, because people would panic if it were reduced to plain English. That is why he chose to dress up his thoughts in tortured phrases and ambivalent circumlocutions. But if we can penetrate through the cryptic phrases and polysyllabic ambiguities that choke his text, we get a glimpse of a darker truth. Greenspan, I suspect, has some very real forebodings about the American economy—forebodings which he can only hint at. This in itself should be a cause of great concern.
Does this mean that interest rates will be lowered at the next meeting of the Fed? I believe so. Look for the discount rate to be lowered when the Fed’s Open Market Committee meets at the end of January.
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