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Greenspan's longevity may be desirable, but will cheap money haunt him?
May 23, 2004
Longevity is a desirable characteristic for central bankers, partly to ensure that there is an embedded memory of bear markets and bull markets, busts and booms.
Until he or she has gone through a couple of full economic cycles, a central banker hasn't much hope of judging the dangers and opportunities ahead. And by the same token, punters cannot judge a central banker before seeing them perform in bad times as well as good.
There are several reasons to welcome the reappointment of Alan Greenspan as chairman of the Federal Reserve board. These include, depending on your view of the world, the need for continuity in troubled times, or conversely the desire to see him dig his way out of the inflationary bubble that his policy of very low interest rates has created.
But appointing a 78-year-old, albeit a sprightly one, to the top monetary job in the world does test the case for longevity. The appointment is for another four years. Will he really go on until 2008 and what would be the consequences of that?
First, by the middle of 2006 he would be the longest-serving Fed chairman of all time. William McChesney Martin served nearly 19 years. Greenspan was appointed in August 1987.
So let's make the working assumption that Greenspan will serve another two years. What then? I suggest that it means cheap, or at least cheapish money for another two years. You want to leave the job on a high note.
Sure, cheap money may be stacking up trouble in the future and rates will have to rise a bit. But Greenspan's reputation has been built on bringing the US through the early 1990s recession in good shape, setting in train the longest-ever boom, and making the 2001 recession the least serious of recent times.
The costs? Well, the next chairman can cope with those. If the prime task of a central banker is to deliver monetary stability, in conditions that make it possible for economies also to deliver steady growth, then it is a pretty fine achievement.
US prices, excluding food and energy, peaked in 1990 but then have pretty consistently fallen so that underlying inflation by the end of last year was down to a little more than 1 percent.
Not bad, eh? Well yes, but go back and see what has happened to the price of durable consumer goods. Since 1995 inflation has plunged and has been strongly negative for the past couple of years. So the overall price level has been depressed by one particular group of products. And the reason for that is largely that cheap imports from China have been exerting a huge downward pressure on prices.
Half the fridges imported into the US come from China. If you greatly increase your imports from low-cost producers you hold down prices but at the cost of a deteriorating trade balance.
It would not be fair to lay all the blame for the deteriorating current account balance on the Fed. Fiscal policy has played a part in boosting demand, particularly since the present administration's tax cuts.
But the main deterioration started in 1998, under the Clinton administration and just at the time when arguably the Fed should have started tightening policy if it was to prick the share market bubble early.
Indeed, too-cheap money in 1999 helped underwrite a surge in US retail sales.
It is far too early to be judging Greenspan's term, and not just because he has at least another two more years in post. But I do think when the economic history books are written they will focus as much on the failure to tighten policy in 1999 as on the use of very low interest rates to pull the US through the 2001 recession.
But it is not too early to be asking questions about the costs of cheap money - actually free money, since the US has negative real interest rates - and whether these costs will become more evident in the next couple of years.
There are several questions about inflation. You should not blame the Fed for the rise in the price of oil, but you can blame it for home-generated inflation in the US. That seems now to be becoming more evident.
You can blame it for inflated property prices. There are hot-spots where prices have been almost as frothy as in the hot-spots in the UK. There is the concern that the US has been able to hold down inflation by a surge in imports of cheap goods and that surge is unsustainable.
There are several questions about the other distortions of cheap money. There is the way it has forced cash into unwise investments in the search for yield. There is the extent to which it has worsened the current account. Then there is the damage to household savings.
And then there are questions about the dollar. The US has got away with only modest weakening of the dollar because Japan and China have been prepared to finance the US current account deficit by buying dollar securities. At some stage they will have to pare back their purchases, maybe soon.
So cheap money is a policy where, in the US case at least, the benefits are obvious and immediate and the costs less obvious and longer term. If I'm right and there will be another two years of cheap money then some of those costs will become more evident - even if Greenspan does get his name on a building after all. - The Independent, London
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