October 25, 2008

Greenspan contra Greenspan

Long before his admission this past week that he just might have made a miscalculation or two as Fed Chariman, Allan Greenspan has said quite a few fascinating things over the years, including this:

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates.

The ?Fed? succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market?triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930’s.

The quote comes from Greenspan?s ?Ayn Rand groupie” years. Read today, it weirdly stands as a kind of blueprint for his actions as Fed chairman. After the bursting of the dot-com bubble (the inflation of which Greenspan bears no small responsibility) and the 9/11 attacks, Greenspan drastically cut Fed interest rates, reaching a low of 1 percent. (Compare this with the modern high of 19 percent during Paul Volker’s tenure.) Greenspan?s intent was, of course, to stave off a recession. The result, however, was that ?the excessive credit spilled over,? this time into the housing market. The reckless speculation on derivatives, the “gambling with other peoples? money”, and all the rest that Tom rightly condemns never would have been even possible without a government/Fed-induced expansion of the money supply. What we should be doing now, it would seem to me, is arguing for a greater decoupling of state and economy, not blaming Greenspan for his deregulation of a still highly regulated industry. We were wrong to worship at the feet of High Priest Allan over the course of the ‘90s boom. Let’s not repeat the error by putting our faith in those brilliant economists in Congress and the DC bureaucracies who now want to “save capitalism,” or by relying on the public spiritedness of those former Goldman Sachs employs who’ve made their way to Washington in recent weeks to regulate the financial industry.   

UPDATE:Ron Paul makes a similar point here. Cablenews’s renewed interest in the Texas congressman has been one of the few good things to come about during the financial crisis. During the height of Greenspan worship during the late ‘90s, any one talking about a return to the gold standard would be publicly ridiculed. Now even the MSM is starting to wonder whether this Paul guy might not be so crazy after all…   

[hat tip: Lester Holt]

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