Did Greenspan deserve support for another term?

• Author: Salerno, Joseph T.
• Position: Reflections

On April 22, 2003, President George W. Bush declared in response to a reporter's question, "I think Alan Greenspan should get another term" (Maer and Associated Press 2003; see also Hill 2003). Bush's expression of support for Greenspan's reappointment for another four-year term as chairman of the Federal Reserve System (the Fed) came more than a year in advance of the expiration of the chairman's term in June 2004. Regardless of his decision to accept or decline reappointment, the question of whether Greenspan deserved support for another term merits consideration for the light it sheds on the performance of the U.S. economy in the dawning years of the twenty-first century.

To begin with, my answer to the question posed is a resounding "No!" I have two reasons for this negative response. First, the Fed's performance has been astoundingly bad throughout Greenspan's tenure as chairman. Second, and perhaps worse, Greenspan has been a relentless purveyor of economic fallacies designed to obscure and justify this egregious performance. Unfortunately, his exalted position, combined with his unrivaled facility for circumlocution and obfuscation, has led the media, the markets, and even many professional economists to treat his fallacious dicta as profound insights into the economic process. Astonishingly, the media-fueled cult of Chairman Greenspan continued throughout the 1990s even though some of the most celebrated pseudoprofundities that he uttered represented blatant reversals of views he had expressed just months earlier. For example, Greenspan's famous "discovery" that the productivity growth of the New Economy was causing the stock-market boom of the late 1990s came hard on the heels of his contradictory and equally famous declaration that "irrational exuberance" was driving the stock-market run-up (Woodward 2000, 172-74, 179-82, 195-96, 223).

An Austrian Perspective on the Recession

In an address a few years ago, I gave a detailed analysis and critique of Greenspan's public utterances on money and the economy. I concluded that they added up to little more than empty rhetoric that served as a cover for the Fed's cheap-money policy of the Clinton years, which had caused massive and unsustainable malinvestments in the real economy and an inflationary bubble in financial markets (Salerno 2001). I need not repeat this analysis here. However, I quote the concluding paragraphs of my address because they bear on Greenspan's more recent words and deeds at issue in this article. In February 2001, I wrote:

This monetary tightening [of 2000] devastated the New Economy and the NASDAQ tanked, falling by over 50 percent from its high in March 2000. But, even more importantly, it also brought the investment boom in the real sector of the economy to a screeching halt. This momentous news was duly noted in the Wall Street Journal.... "And new numbers out yesterday [January 31, 2001] show that investment did drop in last year's fourth quarter.... [B]usiness investment on equipment and software actually fell at a 5% rate--a dramatic reversal from 21% growth in the first quarter of 2000. A big drop reported last week in orders for capital goods, excluding aircraft and defense, suggest that capital retrenchment isn't over." This news should give Greenspan a great pain in the pit of his stomach.(1) Unfortunately, it is unlikely to do the economy any good, because Greenspan and the legion of economists, journalists and business leaders that he has misled with his empty talk believe that the slowdown is a simple matter of sagging spirits and lost faith and that this malaise can be cured by the psychological hocus pocus of reducing short-term interest rates--i.e., turning on the monetary spigot full blast again. This does not appear to be working however. Although Greenspan's first interest-rate cut on January 3 appeared to give the NASDAQ a boost, despite a second cut in interest rates on January 31, the index has fallen back into the doldrums where it began the year. So I hold out great hope that before the end of this year, with the arrival of a full-blown recession, all will finally see that the Maestro has no clothes--and absolutely no real knowledge of how the economy works. I wonder what the probability would be of his resigning in that case? Permit me to boast of my prowess as a contrarian economic forecaster for a moment. One month after I wrote those words, the U.S. economy plunged into recession, according to the official definition of the National Bureau of Economic Research (NBER). Actually, my forecast that the economy stood on the precipice of recession, when almost everyone else was misled by Greenspan's talk of a "soft landing," was based squarely on the Austrian theory of the business cycle. This theory informs us that a fall in real investment resulting from a reversal of inflationary monetary policy, which occurred in 2000, presages the inevitable onset of economic recession. Moreover, the theory focuses our attention on the pattern of real investments in the economy, which is distorted by the Fed's persistent manipulation of interest rates. Once such distortions have built up over time and have been embodied in the economy's structure of physical capital goods, a long period of readjustment, which non-Austrians call a "recession," is required for their correction. Most economists and market pundits unfortunately ignored this insight and focused exclusively on financial markets rather than on the underlying entrepreneurial combinations of concrete capital goods to which stocks and bonds are mere property titles. Thus, they were taken in by Greenspan's assertion that the Fed could pilot the economy safely in for a "soft landing" by slowly letting the air out of the stockmarket bubble.

The prevailing consensus overlooked that a cessation or even a slowing in the growth of the money supply precipitates a rise in interest rates back toward levels that reflect voluntary saving and risk preferences in the economy and, in the process, reveals to entrepreneurs the unsustainability of many capital investments. This revelation induces a time-consuming process of liquidation and destruction of various capital-labor combinations and the reallocation of the more versatile of these resources, especially labor, to...