The University Bookman


Spring 2018

Greenspan’s Intermezzo

book cover imageThe Man Who Knew: The Life and Times of Alan Greenspan
by Sebastian Mallaby.
Penguin Books, 2016, 2017.
Paperback, 781 pages, $22.

Gilbert NMO Morris

Biography is an interplay of perceptible and surprising cross-currents, and the life of Alan Greenspan is no exception. Who would have imagined that Alan Greenspan attended high school with Henry Kissinger; mastered two instruments—saxophone and clarinet—so well that he was offered placement and attended Julliard, an institution associated in the imagination with musical genius; or knew that Alan—the baseball-obsessed math genius—played in a swing band for sixteen months, traveling the United States as sax player and tax man—laying musical riffs by night, doing bandmates’ taxes by day; or that he enjoyed a wide reputation as a superlative dancer who, at the beginning of his career as an economist, joined Pat Buchanan in advising President Nixon on race relations; or that Greenspan himself believed that “one of the historic disasters of American history … was the creation of the Federal Reserve system”?

Alan was born March 6, 1926, to Rose and Herbert Greenspan. Rose’s devotion shaped his character as much as his mercurial and sporadically present father, cultivating a relationship of awkward resentment. Despite his mild and intermittent perturbance at his father’s disheveled regard, Rose’s enveloping affections—sharing her love of music and staging larger family exhibitions to display Alan’s facility for adding large numbers in his head—left him feeling “like a conqueror.”

During his successful early career as a data consultant, the thirty-three-year-old Greenspan made his first significant contribution to economic thinking in a 1959 lecture to the American Statistical Association. As Mallaby shows ably, Greenspan “laid out the connections between the financial sector and the real economy … teasing out their interactions” and emphasizing three main points:

  • Stock prices drive corporate investments in fixed assets;
  • Those investments drive many of the booms and busts in a capitalist economy; and
  • Stock prices are not a forecast, but a crucial determinant of economic activity

With hindsight these points are broad, though implicit. At the time they were sufficiently revolutionary that James Tobin took the 1981 Nobel Prize for their explication. Put simply: for Greenspan in 1959, the economy seemed detached from finance. Today, finance seems detached from the economy, a situation that Mallaby, in this intellectual feast of a biography, labels “Greenspan’s Conundrum.”

Throughout his Fed career, Greenspan was constantly caught between data analytics and instinct, between the curious impacts of inaction and the perils of action. He was driven by a “conqueror’s” spirit, infused—for a time—with the individualist ideologies of Ayn Rand, which were ultimately mitigated by the sheer force of practical experience.

Since Adam Smith’s writings in the eighteenth century, political economy has largely been concerned with a single question: Should governments intervene in national economies? Not only has the question led to ideological divisions from socialism to communism on the one hand, or liberalism to neo-liberalism on the other, it is also the question that central bankers try in their various ways to answer. The nexus between government action and market activity is also where Greenspan would attempt to insert his intermezzo: the monetarist tools of the Fed, to work out solutions during his tenure as a Governor and as Chairman of the U.S. Federal Reserve from 1987–2006.

Here is Mallaby’s summation:

Half a century after Greenspan’s [1959 paper], the world succumbed to another violent stock market decline (in 2008) and economists pronounced learnedly on “balance-sheet recessions”—ones that follow a crippling destruction of wealth rather than a mere fall off in spending. The pronouncements were frequently coupled with a denunciation of the Greenspan Fed: if only Greenspan … understood balance-sheet recessions … he … would have acted more decisively as the bubble of 2000 inflated. [But as the 1959 paper revealed that] he had been … aware of [balance-sheet recessions] for longer than many of his critics had been breathing … [the fact] that he nonetheless allowed bubbles to inflate … demands an explanation that goes deeper than his proposed ignorance.

Psychological theories for actions are not persuasive when ontology suggests more robust reasons. For Greenspan, Mallaby’s “deeper” theoretical question seemed to be: was the Federal Reserve part of the “invisible hand” or was it merely the “hidden” or “helping” hand in a market system? Understanding human systems and markets within them requires the right conceptualization: economies are ecosystems of potential and largely unknowable cataclysms. Human administrations impose constraints: rules, laws, and even central banks, which become the tools of regulated markets, overseeing as natural a transactional nexus on the basis of self-interest, without choosing winners or losers. While central banks and politicians should avoid “fatal conceits,” unregulated markets give rise to no market at all; metastasizing wealth in the hands of the few at the expense and inevitable political consternation of the many.

Greenspan’s decisions on the viability of government intervention and the fusion of the financial and “real” economics were teased out through a series of conundrums:

  • Price and financial stability each arrive at points of sharp distinction, then run counter to each other (indeterminacy of the Philips curve)
  • The Fed mandate and fiscal politics arrive at hard distinctions, then run counter to each other (Reagan with tax cuts, and Bush-43 with tax hikes)
  • The Fed’s regulatory or corrective actions to address the above could be rendered indeterminate or redundant, Greenspan mused, either by human ingenuity or criminality (as in 2000–2008)

The latch mechanism for this “trap” was Greenspan’s core animating philosophy, which induced him to hedge on regulation rather than monetarism. On October 23, 2008, facing Congressman Henry Waxman, there came the coup de grace: “I made a mistake in presuming that the self-interest … specifically of banks … were such that they were best capable of protecting their own shareholders and the equity of their firms.” Moreover, under Mallaby’s treatment one witnesses Greenspan’s constant struggle with this “supervening conundrum” that hedged about every attempt at economic management. It is expressed in the German word verschlimmbessern, which translates generally to making something worse by attempting to improve it.

These conundrums suffused Greenspan’s convictions from the very beginning of his time at the Fed. They are revealed in several iterations. Greenspan’s Confucianism: that the self-interest of bankers, investors, and money managers was co-determined by and could not be defined apart from the entire economy. Greenspan’s Libertarianism: bankers, investors, and money managers could be “trusted” (incentivised) by self-interest to behave in the interests of the long term; suffering consequences where they failed to do so. Greenspan’s Keynesianism: that the role of the Fed was to use its tools to influence behavior (which flies in the face of the power of self-interest), and to administer correctives where there was catastrophic failure (which means varieties of bailouts, so socialising losses).

Several cryptic conclusions beg to be arrived at from Mallaby’s elegant treatment of Greenspan’s Fed tenure:

  • Inflation is conceptualised poorly: at minimum, it is a “Parmenidian phenomenon” that never comes into or goes out of existence.
  • Former Fed governer Alan Blinder has likened inflation to a bad cold. That seems a wrong concept: Inflation—because it always exists—seems more akin to temperature; rising and falling between the body and its extremities. As such there is never “low” or “no” inflation; it is always with us.
  • The integrated nature of finance and global interdependent leverages means that “too big to fail” for any large or even midsized financial institution is now a near-iron law since their failure increasingly risks global meltdowns. This means there is less of a creature called the “American economy” and rather something emergent called the global economic system; as the Yellen “data-driven” Fed and President Trump’s recent attempts at tariffs have shown.

Greenspan’s own early insight into the role of finance and financial institutions in the economy expanded the area of an economy’s footprint, the range of productive activity, and its sources of potential troubles. But he missed rising temperatures of inflation in house pricing from 2000–2008—much as we ignore it now in securities and the costs of “alternative credit,” running at a low ebb in the economic system.

Quibble if you must concerning the generality of Greenspan’s decisions since—as Maestro—he dominated the Fed and its FOMC meetings. But every man is to himself an orthodoxy. In that 1959 paper Greenspan warned about the pernicious effects of finance in the economy, yet he seemed blindsided by it in 2004–2005 as the housing bubble inflated. His career is perhaps the apotheosis of applied market theory by its most able practitioner. He acted within the constraints of his knowledge and beliefs, though not without political considerations.

Others argue specifics: had he dampened the first eddies of the housing bubble in 2000 and dealt more effectively with derivatives from 2000–2005, the 2008 catastrophe would have been averted. I doubt it, because of the indeterminacy of markets and the redundancy of actions to manage them. There were economists, however—Lindsey Lawrence, Alan Blinder, Ned Gramlich, and Janet Yellen among others—who challenged Greenspan to consider corrective measures. None stand out as much as a non-economist, the intrepid Brooksley Born—Chair of the Commodity Futures Trading Commission—who in 1998 warned Greenspan assiduously concerning the scale and risk-profiles of the emerging derivatives market.

The Maestro’s conundrums dramatized both his contradictions and those in the market models known best to us. Mallaby succeeds in presenting them to us altogether, as storyteller, colleague economist, and exegete.  

Gilbert NMO Morris—a philosopher, legal scholar, economist, and former diplomat—was professor at George Mason University, where he taught in four faculties. He was also Senior Economic Advisor to the Minister of Finance and Chairman of the National Investment Agency and National Bank of Turks and Caicos Islands. He is one of the world’s leading experts on financial centers. He was educated at the London School of Economics.

Posted: May 13, 2018

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Robert Aickman
Volume 20, Number 2 (Winter 1980)

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