In the years since the financial crash in 2008, the finger
of blame has been pointed at a range of targets; one name that keeps cropping
up is that of Alan Greenspan, the former Chairman of the Federal Reserve. That’s
quite a come-down; I’m sure many readers will remember how he was feted as the
rock star of economic policy, the man who kept the boom rolling on through the
1990s and into the early years of this century, assuredly navigating the ship
of monetary policy even through the stormy waters of the dot com bubble and its
bursting. Now, he’s largely reviled as – amongst other epithets – “one of the
twenty-five people to blame for the financial crisis” (Time Magazine). Plenty
of people who heaped praise on him before 2008 as they banked their chunky
salaries and bonuses have now discovered that, actually, they disagreed all
along and sub-prime was an accident waiting to happen. That is of course true,
but not so many of those who now trumpet that did in fact appreciate it at the
time.
Hindsight
With the benefit of hindsight, playing with interest rates
in such a way as to encourage (in some ways, almost, oblige) lenders to follow
a policy of lending money to what objectively would be called bad credit risks
on the back of an assumption that ever-rising property prices would prevent
default, without considering that if, at any time and for any reason, interest
rate then began to rise, was a pretty stupid policy. There were some –
honourable exceptions to my generalisation – who did indeed point this out at
the time, but they were in a minority.
Ayn Rand, Objectivism and the Gold Standard
But how did Greenspan get to that point? I was recently sent
an article that he wrote for Ayn Rand’s ‘Capitalism: the Unknown Ideal’
(published in 1966), in which he praised the gold standard. The piece is worth
reading and can be found here: http://bit.ly/1kBtoGq
. Greenspan was of course during the 1950s and 60s an ardent supporter of Rand and her doctrine of Objectivism and this essay
articulates very clearly his enthusiasm for the case supporting the gold
standard. I’m not going to rehash the entire article here, but essentially he
outlines how fractional reserve banking based on a universal gold standard
works. Interest rates are driven by the availability of credit and imbalances
are resolved by the free movement of gold from one country to another. That’s
probably – in its pure form – an unachievable utopian ideal, and indeed through
the twentieth century, governments realised that actually, if they could
increase reserves to fill in periods when the availability of gold was restricting
activity – in other words, when the readjustments were taking place – they
could, they thought, create indefinite growth. In simple terms, since only a
small fraction of depositors are likely to want to withdraw their assets at any
given time, you can safely increase the availability of credit and beyond that,
you can create new ‘assets’ to allow you to expand lending even further. Keep
that going, and, as if by magic, you can have everlasting growth.
Except it doesn’t really work like that; constantly
increasing the supply of money in the end leads to inflation and that inflation
erodes value and destroys savings. The Greenspan of 1966 put it like this:
“In the absence of
the gold standard, there is no way to protect savings from confiscation through
inflation. There is no safe store of value. If there were, the government would
have to make its holding illegal, as was done in the case of gold. If everyone
decided, for example, to convert all his bank deposits to silver or copper or
any other good, and thereafter declined to accept checks as payment for goods,
bank deposits would lose their purchasing power and government-created bank
credit would be worthless as a claim on goods. The financial policy of the
welfare state requires that there be no way for the owners of wealth to protect
themselves.
This is the shabby secret of the welfare statists' tirades against gold.
Deficit spending is simply a scheme for the confiscation of wealth. Gold stands
in the way of this insidious process. It stands as a protector of property
rights. If one grasps this, one has no difficulty in understanding the
statists' antagonism toward the gold standard.”
Changing Views?
Now, one may or may not agree with that analysis, but it’s interesting that
the Greenspan of Federal Reserve Chairman times seems in many ways to have been
responsible for a policy which was very close to the one he dismissed as a
shabby secret in 1966. Why would he have done that?
First, I think one has to
acknowledge the undoubted political pressure of the times; after the 11th
September attacks, the economy had to be supported. Thus a reduction of
interest rates was probably logical. However, the continuation of that policy fuelled
the boom in borrowing, sowing the seeds of disaster that would blossom as rates
were increased later to cool the overheating.
Secondly, hubris; I suspect that
he followed that policy because it was meeting great acclaim. It was
successful, right up until the moment when it wasn’t, and by then it was too
late.
Thirdly, the massive rise in complex financial derivative products, that
was itself a result of the huge increase in computing power, facilitated
multi-dimensional trades and risk-taking that would even ten years earlier have
been almost impossible.
Fourthly, pragmatism. Theories work up to a point.
Beyond that point, the reality of the situation kicks in, and the world is too
chaotic a place for the majority of ‘soft’ theories - I exclude maths and
science here; economics likes to consider itself a science, but it’s not. It’s
an attempt to describe chaotic systems and predict how they may work, no more
than that.
Surprising Shift?
So should we be surprised to see Mr Greenspan seemingly espouse the
very policy in 2001 that he condemned in 1966? Not really; the world changed a
lot in those 35-odd years; he was just trying to adapt to changing
circumstances. That’s why the economic rock star became one of the people
responsible for the crisis of 2007/08. Given the information available, without
the benefit of hindsight, who’s to say we wouldn’t all have done the same?