Playing the Greenspan retirement blues

Alan Greenspan plays golf with just one club, and has only one eye, but has a magic touch. That's if you believe some of the epithets of his chairmanship of the US central bank, the Federal Reserve, over the past eighteen years. He's never missed a putt inside six feet. (OK, I made that one up.)

He certainly plays saxophone, and many blue-moons ago used to tour with jazz legend Stan Getz.

The one-club referred to means monetary policy, which is the Fed's single tool for managing the economy, and the one-eye refers to its priority of controlling inflation. It does have a responsibility also towards growth in the real economy, namely labour and capital, inputs and outputs, goods and services.

In fact, the Fed doesn't 'manage' the economy, although it can have a powerful impact. It is a misperception that either the central bank or government can control the aggregate behaviour of millions of individuals and companies.

Therefore, the Fed cannot sensibly be praised or blamed for exactly how the economy performs, although it can certainly cause problems in some circumstances, and help find solutions in others.

Given those basic ideas, whether Greenspan, who retired yesterday after eighteen-and-a-half years at the helm, has been the greatest central banker ever, as he has been described, is very much open todebate.

The tone for his unprecedented five terms in office was set very early. The stock market crash of October 1987 came two months into his tenure. His response was promptly to cut interest rates (having already raised them), and give clear assurance that there would be enough liquidity to support the system. It was an action, virtually instinctive for a scholar of his background, which stood in clear contrast to the catastrophic events of the Great Depression of 1929, when money supply progressively collapsed and the economy slid into a downward spiral.

Greenspan has been lunching on the back of that intervention ever since. Mind you, he would have done enough of that anyway, simply by holding office.

The 1990s, the central decade of his stewardship, were an uncommonly prosperous and stable era for the American economy. Essentially, ten years of unbroken economic growth, without significant inflation, led to further garlands for the Fed chief.

Particularly, he identified that productivity improvements, deriving partly from globalisation, meant that low unemployment and low inflation could co-exist, and that interest rates did not have to be set habitually higher alongside high growth.

Of course, he was not personally responsible for that happy situation, but can be credited for identifying it for what it probably was, the product of structural change created by increasingly competitive and flexible markets.

As an aside, it needs saying that the Fed, and indeed the world's central banks generally, do not keep inflation under control by force of their own credibility, as some seem to suggest. Declared adherence to the orthodoxy of sound money has great merits, but it does not have that kind of power by itself. It is certainly puzzling how people think central banks can keep inflation down with low interest rates prevailing. They don't. Inflation is contained by other factors, basically supply overwhelming demand.

Much of that supply has come from China. Much of it owes to the global commitment to freer trade, institutionalised in the WTO. Low interest rates follow low inflation, not the other way round. Central banks have been basking in the sunshine of reflected glory.

An argument for Greenspan's fallibility came both in 1998 and in 2000-01. In the first case, the Fed bailed out the hedge fund LTCM following Russian debt default. In the second, it effectively bailed out the stock market as a whole in response to the dot-com crash.

On the face of it, these were responsible actions. The alternative -- potentially severe market chaos -- could have destabilised the financial system (on which everyone depends) and decimated the real economy through 'wealth-effect' reverberations.

The impression created, however, was that the Fed was prepared to underwrite speculation, creating the scope for one-way betting. It can be claimed that the US economy is suffering from that quasi-guarantee, as both stock market and housing market resemble bubble conditions.

Interest rates are now on an upward tack. Yesterday's hike in Fed funds to 4.5 per cent was the fourteenth in succession, while still relatively low historically. Concern is developing that the economy is slowing as consumers (whose contribution dominates GDP numbers) become nervous. US household debt reached $11 trillion last year, while the trade gap is enormous, and unsustainably so.

The dollar, which interest rates have to defend, remains under pressure, creating policy making dilemmas around the world, considering the exposure of other regional blocs to US securities.

Interest rates were probably too low for too long. Real wealth is not sustained by debt-financed spending sprees. Greenspan knows that, and has warned of dangerous trends in both stocks and housing, both recently and in the past.

Perhaps his warnings were not strong enough or plain enough. His public testimonies have been notoriously obscure. He once suggested that if he seemed clear in what he was saying, he was probably being misunderstood. Yet, the Fed has its hands on the controls, and can deliver timely messages in a way people immediately understand, through their pockets.

Equally, inflation is a many-headed monster. The US is not the only country in the world where stock-market and real-estate booms conflict with official inflation figures. Perhaps a broader view of the data should have been taken.

It's truly ironic that, with a hard-money upbringing (as an advocate of gold), Greenspan has conducted such an easy-money episode. His successor, Ben Bernanke, is known to favour a different approach (namely inflation-targeting), based on rules rather than discretion. Whether that would work and achieving relatively stable interest rates might be a measure of its success would still depend on how inflation is defined. On a different note, Alan Greenspan has been criticised by some US politicians for venturing into fiscal and political matters, especially in supporting the Bush presidency's tax cuts and social security reform. Many other Americans are now also coming to the view that the departing Fed chairman is not an outright genius. For some whose retirement funds are under threat, he has apparently even become a hate figure.

That's pretty tough on a guy who's soon turning 80 and, supposedly, has had the world economy on his shoulders for most of the past two decades. But a fair assessment of his record would probably not be quite so gushing as some have been.