ORACLE Looks Back

Greenspan was the US Fed chairman for most of the last 20 years, rapidly being acknowledged as the golden age of economic performance. World per capita growth at record levels; world growth the highest since the mid-’60s. Inflation at historically low levels. There is a temptation to corelate management of the US economy with the creation of the Goldilocks world of great growth and even greater price stability. Several academic papers have purported to show that greater central bank independence around the Western world has played a strong contributory role in the superlative economic performance. Who was at the head making all the correct decisions? Greenspan.

While tempting, a fairer conclusion is that Greenspan was extraordinarily lucky. The events leading to Goldilocks rules were mostly outside the domain of influence of the US (or any other) Fed. His predecessor, Paul Volcker, did preside over, and heavily influenced, a structural change. At the time of the Greenspan takeover in 1987, inflation and inflationary expectations had changed in the developed world; and the developing world was witnessing the beginning of a tsunamic change in the attitudes of the erstwhile socialist planning twins, China and India. A few years into his job, and the last remaining bastion of controls and inefficiency, the Soviet Union and its satellites, fell by the wayside. A brave new world was ushering in the age of benign economic turbulence. Growth, productivity and declining inflation worldwide; bureaucrats and policymakers in retreat as movers and shakers. This was the package Greenspan was asked to manage. This was luck.

Paradoxically, despite being one of the first to recognise that the world had changed, Greenspan made some surprisingly bad “calls”. It is in the DNA of a forecaster to tempt fate by being the first to make an accurate prediction; and Greenspan was a successful forecaster before his Fed tenure.

The chapter titled “Irrational exuberance” is instructive about the limits of even first-rate policy makers. He coined the term to describe the “overheated” nature of the US stock market in 1996. Around 1995, Greenspan started to believe productivity in the US was rising rapidly, but not being acknowledged by either the data or the experts. With his dogged persistence and insights, he turned the conventional wisdom around. A genius forecaster well ahead of his time. But the same genius feared asset price inflation: “ever rising productivity could not explain the looniness of stock prices.” So despite Rubin’s gentle advice of not being bigger than the market he persisted with the notion that the stock market was way, overextended — exuberant and irrational.

It is instructive to assess what actually happened. The day before this pronouncement (December 4, 1996), the Dow had closed at 6423. On the 19th, 11 trading days later, the Dow closed at 6474, having never traded more than 3 per cent below the Greenspan irrational level in the intervening period. He was “right” for less than two weeks. To be sure, the Dow did briefly dip below 6423 on April 11, 1997. The Dow has not seen that irrational exuberant level since, not after the bust of 2000, not after 9/11. Today it is more than double the Greenspan exuberant level.

Greenspan grudgingly acknowledges that “the investors were teaching the Fed a lesson”. Unfortunately, central bank governors targeting asset price inflation has become a habit; fortunately, with ever increasing doses of egg in the face of those who think they know better. To his credit, he admits to being quite wrong on the markets and perhaps even wrong on the policy of targeting asset price inflation. If only other central bankers were so humble, and in Greenspanic style, forthright about admitting mistakes.

Greenspan does get China and India broadly right. On China, like most if not all commentators, he is guarded and circumspect. One has to read between the lines about the possibility that China’s economic policy has been much more mercantilist than acknowledged in polite company. On India it is a no holds barred assessment of India’s failure in the past leading on into the present — Nehru’s “idea” of Fabian socialism. This is heresy for most Indians — indeed laudatory books have been written on the notion that the idea of India is the idea of Nehru. It is good that Greenspan is moved more by a reading of history, and a logical understanding of evidence, than by the purveyors of romantic ideology, the “ideocrats”.