The debate as to whether the Greenspan Fed’s easy money policies are to blame for the 2008 financial crisis tends to focus on the Fed’s actions after the bursting of the dot-com bubble in 2001. Some (like Stanley Druckenmiller) argue that the Fed should have allowed a recession and a “cleanup” while others such as Paul Krugman argue that it is ludicrous to tighten monetary policy in the face of high unemployment and low inflation.
The simplistic criticism of Greenspan-era monetary policy is that we should have simply allowed recessions such as the 2001 recession to play themselves out. In other words “let it burn”. But the more nuanced criticism of the ‘Greenspan Put’ school of monetary policy is not that it supports the economy, but that it does so via a monomaniacal obsession with supporting asset prices and hoping that the resulting wealth effect trickles down to the masses. I have made this point many times in the past as have many others (e.g. Cullen Roche).
There are many ways to support the economy and only our current system focuses entirely on bailing out banks and shoring up asset prices in exclusion to all other policy options. Why can’t we allow the banks and the market to fail and send helicopter money to individuals instead? Why can’t we start money-financed deficits and increase interest rates at the same time? By narrowing our options to a choice between ‘save everybody!’ or ‘let it burn!’, we choose an economic system that favours the 1% at all times. The Fed Kremlinologist extracts rents from the Greenspan Put during the times of stability and the sharks come out during the collapse1.
Krugman is correct in arguing that a recession is no time to stop the firefighting so that an asset market bubble may be prevented. But the original sin of the Greenspan era was not in triggering bubbles during a recession. It was in using monetary policy to support asset markets and the financial sector even when the real economy was in no need of monetary stimulus. The most egregious example of such an intervention were the rate cuts during the LTCM collapse which were implemented with the sole purpose of “saving” financial markets at a time when the real economy showed no signs of stress. Between September and November 1998, the Fed cut rates by 75 basis points solely for the purpose of supporting asset prices and avoiding even a small failure within the financial sector. Even a cursory glance at market events would have told you that the wider economy was in no need of monetary stimulus. Predictably, the rate cuts also provided the fuel for the final exponential ascent of the dot-com bubble2. This “success” also put Greenspan, Robert Rubin and Larry Summers on the cover of TIME magazine, which goes to show just how biased political incentives are in favour of stabilisation and against resilience.
The problem with the ‘Greenspan Put’ doctrine is not that it fails to prevent bubbles when a recession is on. The problem is that it creates conditions such that eventually there are only two states possible for the economic system – a bubble or a collapse. Market participants could assume that any fall in asset prices would be countered with monetary stimulus and took on more macroeconomic asset-price risk. They then substituted for the market risk they had been relieved of by the Fed with increased leverage. Rates of return across asset classes settle down to permanently low “bubble-like” levels except during times of collapse which are increasingly catastrophic due to the increased system-wide leverage. The stark choice faced by Greenspan in 2001, either an asset bubble or a recession, was a result of his many misguided interventions from 1987 till 2001. Of all these interventions, the LTCM affair was his biggest mistake.
- As Constantino Bresciani-Turroni notes in his book on the Weimar hyperinflation ‘The Economics of Inflation: A Study of Currency Depreciation in Post-War Germany’, “even in the past times of economic regressions, of social dissolution, and of profound political disturbances have often been characterised by a concentration of property. In those periods the strong recovered their primitive habits as beasts of prey.” ↩
- For example, the last rate cut by the Fed came three days after TheGlobe.com set a record for the largest first-day gain of any IPO on Nov 13, 1998. ↩