People of the markets

by Eric Le Boucher

Le Monde, Sunday 22 January 2006,

Perhaps that's him the prototype of great XXIst century leader. Alan Greenspan, the president of the Federal Reserve board (Fed) who, after eighteen years at the helm of the dollar, will leave office at the end the month, is the best representative of keen intuition, informed feeling, a subtle  mixture of mathematics and experience, numerical data and wet finger.

If one reckons that financial markets are the advanced stage of opinion driven democracy, gregarious, easily influenced yet restive, sometimes subtle often stupid, political leaders should draw their inspiration to conduct their peoples from the methods to manage markets developed by the "wizard".

His track record is envied. During eighteen years, inflation was kept under control. The market krachs of 1987 and 2000 were overcome without damage, as well as the Russian monetary crisis and the LTCM fund bankruptcy, even though it pointed a finger at the extreme financial transformation of capitalism. All in all, America  went through the two longest expansion periods of its history, separated by the the two mildest recessions. Who can muster a better record ?

What is "Greenspanism" ? First of all, to keep away from ideology and ready made theories. From the outset, Greenspan rejected "any rule that would have thwarted a flexible answer to events," according to Michel Aglietta and Vladimir Borgy of CEPII (Lettre n251). He chose to follow a pragmatic course, economists use the word "discretionary", made of permanent trade-offs between the two objectives assigned to Fed : keep inflation low, and spur full employement. Free is the man who has two masters, a big difference with the ECB, which was only assigned the objective of maintaining a low inflation rate.

This being said, it is possible to retrace, ex post, the road followed. Monetary policy, steered by Greenspan, was asymmetrical : a rapid decrease of interest rates when recession threatened, and a slow increase of interest rates when inflation threatened (Patrick Artus, IXIS note of January 19).This policy is said to be neutral, but in the long term it is "biased toward expansion", since low rates during the expansion phases spur investments. Whence, abundant money and the recurrent formation of bubbles : the stock market bubble prior to 2000, the current real estate bubble.

In Europe, this policy is stigmatized as being lax. American growth is indeed strong, but it is deeply imbalanced : the heady household consumption is not based on income, but on growing indebtedness, guaranteed by the growing value of their portfolios of stocks, or the growing price of their home. Prosperity does come from real revenues but from an illusory bubble.

Alan Greenspan answered that he was not responsible for bubbles. They are the consequence of an excessive world saving rate, notably in China and Japan. It is the available liquidity which fuels american consumption, not the rates that the Fed supposedly maintains too low. And in fact, are there really bubbles ? And even then, it is enough to manage their bursting, like in 2000, i.e. lower the rates. Did inflation rise in the subsequent years ? No. This proves that everything's fine. So far so good, as Americans say.

Furthermore, adds Alan Greenspan in an explanation where all the differences between American and European policies show up, American policy is not limited to stabilizing the current parameters of the economy. It takes into account the important productivity gains in the United States, which lower the equilibrium level of non inflationary rates. A more restrictive monetary policy "would have reduced inflation even more, without any benefit to the economy", MM. Aglietta and Borgy explain ; and they go on saying :"cost of capital would have been higher and firms would have invested less into innovations", and, in the end, productivity gains would have slowed down.

Here we are at the heart of the question : is it conceivable that globalisation and the technological revolution join their effects (competition lowering prices, and computers increasing productivity) to finally make it possible to put the economy on the tracks of superior growth, while at the same time keeping inflation at bay ? Have we entered a "new era" ? Alan Greenspan thinks so ; his critics, notably at the ECB, don't. To fully appreciate this oppostion of opinions, one must go back to the american cultural trait of "pushing west at any cost", and if need be the wagons will repaired along the way...

Of course, this requires a lead cow-boy with charisma. Alan Greenspan did not lack it. Markets feared him, and cherished him. His successor, Ben Bernanke, is a better theoretical economist than Greenspan. He'll surely have to be follow a less discretionary policy, apply more strictly rules, and be more transparent - before he can win, like Greenspan, a quasi divine credibility to drive the peoples of the markets ahead, toward the holy land of growth without inflation.