Jewish World Review Nov. 18, 2005 / 16 Mar-Cheshvan 5766

The Greenspan Effect

By Mort Zuckerman

http://www.JewishWorldReview.com | A decade ago, I wrote a number of editorials criticizing the Federal Reserve for putting the brakes on the economy too soon and hard. Shortly afterward, I ran into the Fed chairman, Alan Greenspan, who asked, "What do you know about monetary policy that I don't?" It was a riposte I am happy to recall, coming from someone who earned the respect of the world by seeing so many submerged icebergs long before we hit them.

In the latter half of the 1990s, Greenspan differed from much of the conventional economic wisdom. The economy and employment were growing so fast it looked as if inflationary overheating were imminent. Greenspan believed, instead, that information technologies were improving productivity more rapidly than official statistics showed. To our great benefit, he let the productivity—for that is what it was—continue, and we didn't suffer the inflation that had been so widely predicted.

During Greenspan's long stewardship at the Fed, we avoided countless icebergs—the stock market crash of 1987, financial crises from Mexico to Asia, two recessions, corporate scandals. But measured inflation rates have fallen, the business cycle has been smoothed out, the jobless rate is down, so is the cost of borrowing, and the dollar has stayed at the top of the world's currencies, with only two mild recessions and an average inflation rate showing dramatic improvement.

Numbers don't tell the entire story, however. Greenspan emerged as a kind of Rock of Gibraltar, inspiring confidence in financial markets here and abroad. His success lay in a unique ability to understand the psychology and mechanics of markets and business, to sift what mattered from a mountain of data, and to avoid being locked in by experts or inflation targets.

No chairman of the Fed has so excelled in the necessary art of ambiguity. "If I made myself clear," he said once, "I have misspoken." His wife says he had to propose three times before she understood him.

Of course, no one could do so well without incurring some criticism. Some attacked Greenspan for the stock market bubble of the 1990s and the current housing boom. Greenspan has been unfazed, however, believing that the Fed should not be piercing bubbles but rather maintaining an economy flexible enough to survive the turbulence if bubbles burst. I think a more valid criticism might be lack of resistance to the Bush tax cuts, which contributed to the monstrous deficits we're now enduring.

Nonetheless, Greenspan leaves a clean desk and a freer, less regulated economy more able to correct itself than when he took over. The question as we change pilots is whether the new Fed chairman, Ben Bernanke, can see the icebergs the way Greenspan could. Bernanke is an outstanding economist, but he lacks Greenspan's experience with financial markets. How will he read the mixed signals, with inflation accelerating for the first time in years, yet core inflation still at around only 1.3 percent—well within the 1 to 2 percent comfort zone?

Proceed with caution. If Bernanke feels he has to establish his anti-inflation chops, he will have little room. Greenspan has already caused the Fed to raise the federal funds rate from 1 percent to 4 percent. Bernanke has always been willing to take a fresh look at data and use it to address many complex issues, such as how U.S. interest rates have managed to stay low despite the twin budget and trade deficits. Putting aside Greenspan's riposte to me, I'd say this is a time for Bernanke to calibrate interest rates carefully and postpone further tightening (always subject to new data). Many believe the current inflation concerns will turn out to be a false alarm, given levels of productivity and the pressure of global competition on prices. One clear risk is the current-account deficit. It now requires the United States to attract $3 billion every single business day. Here might well be the seeds of a dollar crisis forcing higher interest rates—the last thing America's economy, housing market, and overindebted consumers need.

We enjoy a special home-court advantage in having our currency as the world's financial standard. It enables us to borrow in the same currency we print. Foreign producers send their merchandise here; we send dollars there; they, or their central bankers, invest in dollars, chiefly U.S. securities—as if the money never left home. But how many will willingly hold the dollars they have and accept current low interest rates without trust in the chairman's judgment?

Since we will have to fund our deficits by drawing freely on surplus savings elsewhere in the world, we must find a way to do this without a sharp drop in the dollar or a related backup in interest rates, at a time when the budget deficit appears out of control.

Of all President Bush's recent nominees, Bernanke is arguably the most important, since his leadership will powerfully affect the future of the American economy—and that of the world.