June 22, 2010
Alan Greenspan himself, calling for fiscal restraint and a “tectonic shift” in fiscal policy. The man who pumped the economy with all that cheap money now seems to be saying, “Uh oh. I screwed up big time. Guys, it’s time to rethink economics.”
Read the Bloomberg article here:
Former Federal Reserve Chairman Alan Greenspan said the U.S. may soon face higher borrowing costs on its swelling debt and called for a “tectonic shift” in fiscal policy to contain borrowing.
“Perceptions of a large U.S. borrowing capacity are misleading,” and current long-term bond yields are masking America’s debt challenge, Greenspan wrote in an opinion piece posted on the Wall Street Journal’s website. “Long-term rate increases can emerge with unexpected suddenness,” such as the 4 percentage point surge over four months in 1979-80, he said.
Greenspan rebutted “misplaced” concern that reducing the deficit would put the economic recovery in danger, entering a debate among global policy makers about how quickly to exit from stimulus measures adopted during the financial crisis.
“The United States, and most of the rest of the developed world, is in need of a tectonic shift in fiscal policy,” said Greenspan, 84, who served at the Fed’s helm from 1987 to 2006. “Incremental change will not be adequate.”
“The federal government is currently saddled with commitments for the next three decades that it will be unable to meet in real terms,” Greenspan said. The “very severity of the pending crisis and growing analogies to Greece set the stage for a serious response.”
“Our economy cannot afford a major mistake in underestimating the corrosive momentum of this fiscal crisis,” Greenspan said. “Our policy focus must therefore err significantly on the side of restraint.”
None of this is news to you if you’re fluent in Austrian economics. Greenspan sees the writing on the wall. The United States’ position is just like that of Greece and we’re currently on a trajectory to dive right off the cliff, just like they did.
It’s not a time for huge deficits, and no, the economy has not recovered, as all the propaganda is telling us. It’s time for major spending cuts, to stop borrowing money from foreigners, quit printing money and set out on the road to paying off our credit cards and debts. No monetary juggling is going to pull us out of these problems. Deficit spending’s not going to help either. We need a total change in state and federal government budgets. We need major spending cuts. In fact, we’ve already hit our peak debt limits. Most Austrian economists say we’ve passed the point of no return already.
Greenspan’s nervous. He’s calling for major fiscal restraint and cuts in spending. I’m with him. That’s exactly what we need.
Paul Volcker’s been telling us this same sort of thing for quite a while too:
Former Federal Reserve Chairman Paul Volcker thinks the U.S. central bank is to blame for allowing bubbles to inflate asset markets, and says that current Fed chief Ben Bernanke is in a tough spot.
“Too many bubbles have been going on for too long … The Fed is not really in control of the situation,” the Times quoted Volcker as saying, seemingly clear criticism of both Bernanke and his predecessor Alan Greenspan.
A slumping U.S. housing market following years of rampant price rises has sparked a global credit crunch and could tip the economy into a recession.
Critics blame the ultra-low interest rate policies of the final Greenspan years — when the U.S. central bank steered overnight federal funds rates to 1% and held them there for a prolonged period of time — for fueling the housing bubble.
Bernanke, who was also a Fed board governor between 2002 and 2005, inherited the problem to an extent.
Greenspan has long been criticized for being very aggressive in cutting interest rates when growth was threatened, but slower to raise them when it picked up and the risks flipped toward higher inflation.
Volcker, a towering man known widely as ‘Tall Paul’, is credited with breaking the back of rampant 1970s inflation by aggressively tightening monetary policy, for which he was greatly criticized in some quarters at the time.
“It’s no fun raising interest rates,” Volcker said.
I hate to prophesy doom and gloom, but I think there’s a very rough road up ahead. Here’s an excerpt from an Austrian economist:
Austrian Business Cycle Theory
According to Ludwig von Mises and his followers, the boom-bust cycle is not inherent in the free market, but is rather caused by the government’s interference in the credit markets, specifically its manipulation of interest rates. The government causes the boom period when it injects new credit into the system (pushing down rates), and then the unsustainable, non-economic investment projects put into motion necessitate a bust at some future date. (Here is a reading plan for this topic.)
The following chart illustrates the Misesian explanation. Note the chart does not include the recent September cut.
Generally speaking, the chart indicates an inverse relationship between the two series. This accords with the commonsense view that cutting interest rates provides a stimulus while hiking them is contractionary. However, what the Austrian approach provides is the understanding of the real forces behind the boom-bust cycle. In other words, most financial commentators think that today’s interest rates affect today’s economic growth, end of story. But if a previous boom period has led to massive malinvestments, there must be a bust period to liquidate the various projects (for which there is an inadequate capital structure to complete).
To put it another way, many commentators seem to believe that if the Fed held interest rates low indefinitely, then we’d never have high unemployment, just rampant price inflation. And yet, the recent experience shows that this is dead wrong. The Fed didn’t cause the recent problems by “responsibly” hiking interest rates. No, rates had been steady at 5.25% for some time, and then the housing bubble burst and the mortgage market faltered, thus “forcing” the Fed to take action.
Looking back at the chart above, we can see why the worst may be yet to come. In (price) inflation-adjusted terms, the early-2000s levels of the actual fed funds rate is the lowest since the Carter years. And many readers may recall the severe recessions of 1980 and 1982 that followed that period.
In the Austrian view, the boom-bust cycle is caused by the Fed’s maintenance of artificially low interest rates, which causes businesses to expand, hire workers, buy other resources, and so forth, even though these projects are not justified by the true supply of savings in the economy. The greater the “stimulus” the worse the malinvestments.
From 2001–2004, the Fed kept (real) rates at the lowest they’ve been since the late 1970s. One of the consequences that has already manifested itself is the housing bubble. But a more severe liquidation seems unavoidable. The recent Fed cut may postpone the day of reckoning, but it will only make the adjustment that much harsher.
Charts like the one provided in that article give a nice look at how interest rates influence economic growth. You can see that when the economy starts to constrict the Fed is dumping interest rates and the economy spikes back up. But cheap money, like cheap pleasures in life, has nasty side effects.
Many economists don’t even believe in bubbles. It’s all in your imagination. Take the praised Eugene Fama of the Chicago School.
JOHN CASSIDY: Many people would argue that, in this case, the inefficiency was primarily in the credit markets, not the stock market — that there was a credit bubble that inflated and ultimately burst.
EUGENE FAMA: I don’t even know what that means. People who get credit have to get it from somewhere. Does a credit bubble mean that people save too much during that period? I don’t know what a credit bubble means. I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.
CASSIDY: I guess most people would define a bubble as an extended period during which asset prices depart quite significantly from economic fundamentals.
FAMA: That’s what I would think it is, but that means that somebody must have made a lot of money betting on that, if you could identify it. It’s easy to say prices went down, it must have been a bubble, after the fact. I think most bubbles are twenty-twenty hindsight. Now after the fact you always find people who said before the fact that prices are too high. People are always saying that prices are too high. When they turn out to be right, we anoint them. When they turn out to be wrong, we ignore them. They are typically right and wrong about half the time.
CASSIDY: Are you saying that bubbles can’t exist?
FAMA: They have to be predictable phenomena. I don’t think any of this was particularly predictable.…
Well, (it’s easy) to say after the fact that things were wrong. But at the time those buying them [subprime-mortgage-backed securities] didn’t think they were wrong. It isn’t as if they were naïve investors, or anything.
And while you’re out struggling to buy your first home, the academics are sitting in their ivory towers claiming bubbles don’t exist. Nobody saw it in advance after all. Well, Austrian economists did!
He’s an efficient market hypothesis (EMH) advocate. He thinks that prices instantly adjust to news so that at any given time prices reflect all there is to know. Bubbles can’t form. What is a bubble?
If you want to hear an Austrian economist’s perspective on Fama, you can read this article here:
Economics is a strange subject. So many people have a different take on everything. I don’t have a lot of respect for the subject. I think most of what’s out there is bullshit. If people really understood the economy we wouldn’t be having this worldwide recession.
Someday on here I’m going to write a post on what I think about economics in general. I have a whole shelf of economics books I’ve read. I’ll just write up what I think of them. Unfortunately I get tired of studying it because most all of it doesn’t work. You labor for years mastering various economic school perspectives and think you understand things, then you don’t. It was all wrong. *pulls hair out* How many other posts have I promised to write on here? Instead I just typically rant… Oh well.
Economics isn’t like Physics which actually does work. If it was, the world would be a much better place.