Friday, May 2, 2008

6 Ways Greenspan Caused the Current Economic Crisis

Fiona King of CurrencyTrading.Net just forwarded an excellent blog that she posted concering Alan Greenspan's role in the current economic crisis. I disagree with her policy prescription, but most of her analysis is accurate. Her policy prescription (which is to increase financial regulation) will lead to more of the same problem. But King's blog is excellent.

The problem with more regulation is that, as Enron demonstrated, regulation is an infinite regress. Unscrupulous actors (be they government officials or corporate executives) find ways around the regulation, and the regulator (if not corrupt, which they usually are) has to increase control. But increasing control terminates economic actors' freedom and flexibility. Freedom and flexibility are necessary to growth. Without the ability to respond to market change and to innovate, the economy stagnates. The end result is a controlled system that is like North Korea's or Cuba's at worst and Europe's at best. Stagnant growth is associated with innovation's being forestalled by regulators, corruption, exclusion of people of low socio-economic status from economic opportunity and declining living standards. Regulation solves nothing. It creates poverty.

Moreover, King accepts the explicit purpose or ideological rationale for the Fed and misconstrues its underlying purpose. The Federal Reserve is a wealth transferral device that serves financial interests at the expense of workers (see Howard S. Katz's book Paper Aristocracy for a detailed discussion of this point). The idea that a small amount of inflation will help workers but a large amount of inflation will hurt them is fallacious. A small amount of inflation will transfer a small amount of wealth from producers to investors and bankers, and a large amount of inflation will transfer a large amount of wealth from producers to investors and bankers. Greenspan inflated alot, and alot of wealth has been transferred. Warren Buffett, George Soros and the folks who have bought up Greenwich, Connecticut and the Dakotas have grown wealthy while the average worker has seen flat wages. That is what the Fed will do so long as it is permitted unrestrained freedom to inflate the money supply.

It is the Fed that needs to be regulated through a metallic standard. Any other system leads to abuse and wealth transferral from poor to rich. How many decades of this do progressive-liberals need before they accept that their idea has failed?

The Greenspan Fed has done what the Fed does in a big way. In the 1920s, the Hoover Fed reacted stupidly to the banking crisis of that era, and the depression resulted. In the post World War II period, the Fed has generated inflation, and the result has been flat real earnings since the mid 1970s and reduced innovation. As the federal government responds by transferring even more wealth from producers to Wall Street and commercial banks, such as respecting the Bear Stearns bailout, the public becomes poorer and the assets of multi-millionaires and billionaires are protected.

There is no other purpose of the Fed. The idea that the few percent reduction in unemployment that results from short term stimulus really is the Fed's purpose is naive.

King points out that in response to the technology stock bubble (which, I add, also resulted from the Greenspan Fed):

"The Fed, under the leadership of Dr. Greenspan, moved quickly to slash its bechmark Federal Funds Rate to 1%, the lowest level in nearly 50 years. At the time, Dr. Greenspan was acclaimed by economists for mitigating business cycle volatility and returning the economy back into a period of rapid growth. In hindsight, however, this period of easy money may have enabled the run-up in housing prices that caused the current housing crisis...This in turn resulted in a weak dollar..."

King adds that Greenspan failed to stop incompetent lending strategies by the financial community that had been authorized by the Home Ownership and Equity Protection Act of 1994. As well:

"the inability of the financial system to absorb the shock from the unexpectedly high default rate on subprime loans. This failure to anticipate can be traced back to 1998, if not earlier, when the Federal Reserve spearheaded a bailout of Long Term Capital Management (LTCM), a large hedge fund which lost nearly $5 Billion trading complex securities. Some would say that this created a moral hazard situation, whereby banks became comfortable taking larger risks because of the foreknowledge that they would be bailed out if their bets went sour."

King adds that Greenspan was indifferent to asset bubbles. All of this is accurate. Although this analysis is accurate, I am concerned that the prescription that results is more of the same policy pattern that caused this problem. Regulation created the Fed. The Fed caused the asset bubble because of inflation. American workers have seen decreased opportunities and flattening real incomes because of the Fed's inflation and because of regulation.

King's prescription is even more regulation. I disagree.

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