Beyond The Collective
At the same time, Greenspan was becoming a considerable business success. When he first met Rand he was working at the National Industrial Conference Board. Bond trader William Townsend invited Greenspan to join him in forming an independent economics consulting firm. According to Branden, Greenspan hesitated to take the plunge. Branden urged him on, saying, “Take the leap. You can do it. . . . You just don’t appreciate how good you are.” Townsend Greenspan & Company hit the big time quickly, signing up a glittering constellation of Fortune 500 companies as clients. Several years on, Townsend died, leaving Greenspan in control of the company, and a wealthy man. Again according to Branden, Greenspan later thanked him, saying, “You believed in me.”18 For all that, Greenspan mentions Branden only once in his autobiography, and then only in passing.19
Greenspan’s involvement in politics began as a spectator in the 1950s, as he watched Arthur Burns, his faculty adviser in the PhD program at Columbia University, become chair of the Council of Economic Advisers (CEA) under President Eisenhower. Rand was suspicious of Greenspan’s relationship with Burns. She loathed Eisenhower, seeing him as what we would now call a RINO—a Republican in Name Only.20
The path of Burns’s career in many ways eerily presages Greenspan’s, starting with the CEA and ending with the chairmanship of the Fed. It was also a cautionary tale for Greenspan. In his academic career Burns was a fierce defender of free markets, but when he joined government he seemed to become a Keynesian—following the doctrine of John Maynard Keynes, the British economist—advocating government stimulus and government control. Perhaps it was a pragmatic compromise, accepting the world as it is and sticking up for free markets to the extent possible. But as Fed chief, Burns is widely regarded as having caved in to political pressures from President Nixon, overly loosening monetary policy, and unleashing the catastrophic inflation of the mid-1970s and early 1980s.
Accounts differ as to exactly how Greenspan’s personal participation in politics began. Some biographers attribute his joining Richard M. Nixon’s campaign for the presidency in 1967 to a chance meeting with Leonard Garment, an old chum of Greenspan’s from his youthful days as a jazz musician, who would several years later become infamous as Nixon’s lawyer during the Watergate scandal.21 Greenspan himself says it started through his friendship with Martin Anderson, a Columbia economics professor whom he had met at an NBI lecture, who at the time was the Nixon campaign’s chief domestic policy adviser.22 Anderson had become a friend of Ayn Rand—he even contributed a book review to an edition of The Objectivist Newsletter—but he was never a member of The Collective’s inner sanctum.
Greenspan was impressed by Nixon’s mind, writing that “he and Bill Clinton were by far the smartest presidents I’ve worked with.”23 But he saw Nixon’s darker side, too: the bigotry, the paranoia, the stream of expletives that “would have made Tony Soprano blush.”24 So Greenspan chose not to accept an offer of a full-time position in the Nixon administration after the election. Smart choice. Not only did he mostly avoid having his reputation damaged by the Watergate scandal, but he also avoided association with a sequence of Nixon’s economic policy decisions that utterly flew in the face of free markets—most notorious, Nixon’s imposition of wage and price controls and the suspension of gold convertibility in 1971.
Then, in 1974, in the depths of a horrible inflationary recession, during an Arab oil embargo, and at the peak of the Watergate scandal, it all changed.
Ayn Rand’s Man in Washington
Greenspan got a call from Treasury Secretary William Simon asking him to become chairman of the Council of Economic Advisers. He said no. He got another call from White House Chief of Staff Alexander Haig. Again, no. The next call came from Greenspan’s old friend Arthur Burns, by then Fed chairman. Greenspan remembers, “My old mentor puffed on his pipe and played to my guilt.”25 This time it was yes. “But I told myself I’d take an apartment on a month-to-month lease, and figuratively, at least, keep my suitcase packed by the door.”26 The same day as Greenspan’s Senate confirmation hearing, Nixon announced his resignation.
So Greenspan became CEA chair under new president Gerald Ford, and was sworn in at the White House with his mother, Ayn Rand, and Rand’s husband, Frank O’Connor, in attendance (again, see Figure 8.1). Three weeks later, at Greenspan’s first CEA meeting, an economist present said that the cure for inflation “applies alike for Bolsheviks and devoted supporters of Ayn Rand, if there are any present.” Greenspan chimed in, “There’s at least one.”27
Rand didn’t damn Greenspan for going to Washington as John Galt damned Dr. Robert Stadler. She loved it. It was a difficult time in her life—she was beginning a long struggle with lung cancer—and as Barbara Branden put it, “Alan Greenspan’s success was one of Ayn’s rare sources of pleasure. . . . Ayn was delighted with his accomplishments, and delighted that he spoke openly and proudly of his admiration for her, for her work, for her philosophy.”28
Sometimes Ayn was outright thrilled with what Greenspan could do in government. While Nixon was still president, Greenspan participated in a commission that led to the abolition of the military draft, a goal near and dear to Rand’s libertarian heart. In this effort Greenspan worked closely with Milton Friedman, whom we’ll meet in Chapter 9, “The Economist of Liberty.”
Rand was over the moon, as it were, when Greenspan arranged for her to attend the blast-off of Apollo 11.29 But she bickered with him about heading a commission under President Reagan that ended up bolstering Social Security, a program Rand loathed. At a dinner in a New York club, she dressed him down so violently about it that people stopped and stared.30 But in the end, she said, “I am a philosopher, not an economist. . . . Alan doesn’t consult with me on these matters.”31
The Making of a Maestro
Greenspan got to be both philosopher and economist when he was appointed chairman of the Federal Reserve by President Ronald Reagan in August 1987.
Rand, who died in 1982, didn’t live to see it. But it was a moment of supreme irony, and not only because the libertarian Rand-ite Greenspan was assuming the role of the nation’s most powerful regulator. More, it was because the Fed is charged with providing the nation with arbitrary amounts of paper money, completely free from the strictures of the gold standard, or any other standard. Yet in a 1963 article for The Objectivist Newsletter, Greenspan had written that “gold and economic freedom are inseparable, that the gold standard is an instrument of laissez faire, and that each implies and requires the other.”32
In the same article, he wrote, “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation.”33 Yet that’s just what Greenspan set out to do as Fed chair: to protect savings from inflation in the absence of a gold standard.
Or did he? If you look at the data the right way, it almost seems that Greenspan implemented a covert gold standard for the Fed during the first half of his long tenure as chair.
Consider Figure 8.2. It shows the federal funds rate—the short-term interest rate that is set by the Fed, its major instrument of policy—compared to the price of gold (dashed line). Do you notice anything strange? In the first half of the chart, up through most of 1996, every time the gold price rose, Greenspan raised the interest rate (light gray line). Every time the gold price fell, Greenspan lowered the interest rate. He didn’t respond to every little wiggle in the volatile gold price; that’s why we show the two-year moving-average price, a way to smooth out the short-term volatility and look at the durable price trend. But when gold made major moves, so did the interest rate.
Figure 8.2 Greenspan’s Stealth Gold Standard versus His Irrational Years. (Left axis) Gold Price, Two-Year Moving Average; (right axis) Federal Funds Rate
Source: Federal Reserve, Reuters, author’s calculations
Why would this be? The reason is simple. When the gold price measured in dollars rises, it’s telling the central bank that the value of the dollar is
falling; that is, there is a risk of inflation. So raise interest rates to stop inflation. When the gold price measured in dollars falls, it’s telling the central bank that the value of the dollar is rising; that is, there is a risk of deflation. So lower interest rates to stop deflation. There’s no gold being physically bought, sold, stored, or moved in this setup. Yet gold is determining monetary policy. It is truly a gold standard, albeit not an overt one.
Why did it have to be only a stealth gold standard? Why not tell the world? Because while for the ordinary man on the street gold is still a superlative symbol of lasting value, in the rarefied air of academic economics it has become a symbol of outmoded and unsophisticated thinking. That epitome of economic snobbery John Maynard Keynes dubbed it “the barbarous relic,” and urged the world’s nations to abandon the gold standard in the Great Depression. The nickname stuck. While in reality every central bank in the world still hoards gold in its vaults, it’s not something respectable economists talk about as a part of modern monetary policy.
Dr. Robert Stadler put it simply enough in Atlas Shrugged: “If we want to accomplish anything, we have to deceive them into letting us accomplish it. Or force them.”
Greenspan’s stealth gold standard worked brilliantly for all the years in which it was applied. They were years of admirable economic stability. Yes, there was a recession in the middle of those years. But it was short and mild, and the stealth gold standard kept the Fed from overreacting to it. Certainly there were none of the bubbles during those years that would come to plague the U.S. economy afterward.
What of the stock market crash in October 1987? You can’t blame that on Greenspan or his stealth gold standard—it occurred just two months after he showed up at the Fed. On the contrary, here was another case in which Greenspan admirably didn’t overreact, perhaps thanks to the stealth gold standard. The conventional wisdom about the crash is that Greenspan miraculously rescued the world economy from its aftereffects. Some applaud Greenspan as a savior; others criticize him for putting in place after the crash the so-called Greenspan put—the implicit guarantee, the moral hazard, that supposedly led to the bubbles of the late 1990s and the first decade of the 2000s. But the reality is that Greenspan did essentially nothing after the crash. He issued a statement saying, “The Federal Reserve, consistent with its responsibilities as the nation’s central bank, affirmed its readiness to serve as a source of liquidity to support the economic and financial system.”34 Just 29 little words. No bailouts. No nationalizations. No bazookas. No helicopter drops of money.
A central banker who does nothing—except watch the gold price. Maybe Greenspan was a Randian hero after all, a double agent for libertarianism in the very bastion of regulatory power.
Maybe it was true what Greenspan told U.S. Representative Ron Paul, the only libertarian member of Congress, when Paul asked him whether as Fed chair he would now add a disclaimer to his Objectivist Newsletter article on gold and economic freedom. Greenspan told Paul, “I reread this article recently—and I wouldn’t change a single word.”35
The Maestro Untethered
But then something changed in late 1996. For no known reason, Greenspan went off his stealth gold standard. As the price of gold fell, for the first time he didn’t lower interest rates. Instead, he raised them.
The stealth gold standard ended at exactly the same moment as Greenspan gave his famous speech warning of “irrational exuberance”—December 5, 1996. Speaking after two excellent years for the stock market, in which the Standard & Poor’s 500 had risen 37.6 percent in 1995 and then another 23.5 percent so far in 1996, Greenspan said,
[H]ow do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions . . . ? And how do we factor that assessment into monetary policy? . . . the sharp stock market break of 1987 had few negative consequences for the economy. But we should not underestimate or become complacent about the complexity of the interactions of asset markets and the economy.36
After that, Greenspan kept rates where he raised them in early 1997. Gold continued to fall, which under the stealth gold standard should have signaled to Greenspan that deflationary pressures were building, and that rates should be lowered to relieve them.
By 1998, those deflationary pressures started to weigh on the world’s most fragile debtors: the fast-growing Asian nations that had borrowed vast sums of dollars to build out their commodity-based economies. In the deflation Greenspan had triggered, the prices of commodities fell along with the price of gold, and at the same time debt service in dollars became intolerable. It was much like what happened to debtors around the world in the deflation of the Great Depression of the 1930s. The result was the so-called Asian flu, a contagion of currency devaluations and debt defaults that swept Asia from Thailand to Russia.
In the United States, the highly leveraged hedge fund Long-Term Capital Management (LTCM) got caught in the undertow of Asian and Russian defaults and devaluations. With all the top Wall Street firms exposed to LTCM, it was a systemic crisis. In response, Greenspan finally lowered interest rates—which his stealth gold standard would have had him do years before—and the pressure was relieved.
At the same time, the Fed organized a rescue of Long-Term Capital Management. We say “organized,” because that’s all the Fed did; it didn’t spend a dime of its own money bailing out LTCM. All it did was get all of LTCM’s shareholders in one room at the New York branch of the Federal Reserve, and convince them that the only way to save Wall Street was to have all of them kick in extra money to LTCM. It was the opposite of a bailout—it was a bail-in.
When the smoke cleared, Greenspan got credit for expertly averting a global crisis—yes, the same one he himself caused by going off his own stealth gold standard. Greenspan was featured on the cover of Time as the chairman of the Committee to Save the World, and people started calling him the maestro.
And the legend of the Greenspan put grew. Ask anyone on Wall Street how the LTCM crisis was resolved, and chances are good you’ll be told—wrongly—that the Greenspan Fed bailed it out.
With his laurels polished to the point of gleaming, Greenspan didn’t learn from his mistake. As irrational exuberance kicked into high gear and the dot-com stock market went hyperbolic at the end of the decade, Greenspan started raising rates again, taking them to new highs—even as gold kept falling.
He spoke of the “new economy,” yet he kept raising rates. It was as though he was now on a stealth Nasdaq standard instead of a stealth gold standard. But try as he might, he couldn’t burst the bubble. He says now, in frustration, that he had “raised the spectre of ‘irrational exuberance’ in 1996—only to watch the dot-com boom, after a one-day stumble, continue to inflate for four more years, unrestrained by a cumulative increase of 350 basis points in the federal funds rate from 1994 to 2000.”37
From Bust to Bubble
After the dot-com bubble burst in early 2000 (probably more from its own unsustainable silliness than anything Greenspan had done to burst it), the deflationary consequences of abandoning the stealth gold standard took on deadly new dimensions.
Coming out of the brief recession of 2001, inflation fell to the lowest levels in 40 years. It had dipped in mid-1998, and Greenspan had seen the consequences in Asia, Russia, and Wall Street. Now it was lower still. It was not negative—not actual outright deflation. But for Greenspan, knowing in his heart of hearts that he’d been erring versus his own stealth gold standard on the side of deflation, it was scary.
So Greenspan panicked. He went from keeping rates too high for too long to keeping rates too low for too long. He lowered interest rates to a mere 1 percent in mid-2003, a level not seen since the Depression. And he kept them there for an entire year, what the Fed kept announcing to the market, all the while, would be a “considerable period.” Then when the Fed finally started raising rates, it announced that its rate-hiking regime would be “measured.” Starting in mid-2004, the
Fed began a series of regular, timid, 0.25 percent rate hikes at every Federal Open Market Committee (FOMC) meeting. Rates didn’t even get back up to a mere 3 percent until mid-2005.
Greenspan denies this,38 but many scholars now believe that keeping rates so low for so long was what triggered the boom in excessive mortgage lending in the United States and around the world—the boom that became a bubble, the bubble that became a bust, and the bust that became a global banking crisis and the Great Recession.
Among Greenspan’s sharpest critics on this is John Taylor, the Stanford University economics professor famed in monetary policy circles for positing the Taylor rule for setting interest rates. Taylor delivered his critique in the summer of 2007, just when the first tremors of the mortgage bust were beginning to be felt—when no one had any idea it would lead to a global crisis. At the Fed’s prestigious annual Jackson Hole research symposium, Taylor argued:
During the period from 2003 to 2006 the federal funds rate was well below what experience during the previous two decades of good economic macroeconomic performance . . . would have predicted. Policy rule guidelines showed this clearly. There have been other periods . . . where the federal funds rate veered off the typical policy rule responses . . . but this was the biggest deviation. . . .
With low money market rates, housing finance was very cheap and attractive—especially variable rate mortgages with the teasers that many lenders offered. Housing starts jumped to a 25 year high by the end of 2003 and remained high until the sharp decline began in early 2006. . . .
As the short term interest rate returned to normal levels, housing demand rapidly fell bringing down both construction and housing price inflation. Delinquency and foreclosure rates then rose sharply, ultimately leading to the meltdown in the subprime market. . . .39
Donald Luskin Page 27
