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The Greenspan years.

There are at least three reasons the year 1987 was big for the international financial system. That year, global stock markets crashed by a magnitude that today would be equivalent to a 2,500-point plummet of the Dow Jones Industrial Average. Alan Greenspan became Chairman of the Federal Reserve and, of course most importantly, The International Economy magazine came into existence.

Looking back on that period, the more things have changed the more they have stayed the same. Our inaugural magazine issue featured articles by then-New York Federal Reserve President E. Gerald Corrigan, trade expert Susan Schwab, and economist Larry Summers--all of whom appear again in the current issue. And one other thing remains the same: Alan Greenspan continues to dominate the news.

In his new book, The Age of Turbulence (Penguin, 2007), the former Fed chief, often referred to as "the Maestro," offers his take on his more than three decades of public service. The result is a curious mixture of economic analysis and political gamesmanship, producing many positive reviews but comments from other analysts on both the right and the left that have been spectacularly critical. For some, the book creates more questions than it answers. Was the Chairman a closet liberal Democrat all along? Yet did he cravenly betray Democrats by garnering favor with the George W. Bush White House in support of tax cuts? Is the book's preoccupation with crisis management ironically an effort to obscure a weakness in that regard, despite a wealth of intuitive talent in other areas? Does the book lavish praise on subordinates who were patsies and ignore those who stood up to him, particularly on monetary policy issues? Is Greenspan ultimately responsible for the pain and heartache produced by the bursting of today's U.S. housing bubble? And should he have seen the coming subprime disaster? These are the uncomfortable questions being thrown at the author.

My take is that Chairman Greenspan enjoyed more than impressive success guiding the U.S. economy and financial system through a new, turbulent period of financial market globalization. He should not back down in defending a remarkable record. As for his book's political analysis, however, a lot of it seems strangely out of touch with the facts and too much blinded by sympathetic feelings for old Ford Administration friends. Reading the Greenspan book, it is almost as if the Reagan Administration never existed. Here was a president, a former actor, who presided over the creation of twenty million new jobs in an economy that went from stagflation (where the existing consensus was that America was finished as a great economic power), to unprecedented non-inflationary economic growth. At the time, middle class Americans through bracket creep faced the tax rates reserved for the super rich, a suffocating situation Reagan's fiscal policy corrected but is virtually a non-event in the Greenspan text, as is largely Reagan himself. In recent years, even commentators on the left have acknowledged the positive economic paradigm shift that occurred under Reagan's watch.

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In this book, Gerald Ford is presented as the remarkable policymaker of the era, a laughable assertion given that the former president presided over a period of economic stagflation culminating in the ultimate policy breakthrough of breathtaking proportions--the WIN button. It is not that President Ford's Administration takes complete blame for this economic disappointment (an oil shock and a reckless Federal Reserve policy under the Nixon-accommodating Arthur Bums deserved a lot of the blame). It was simply the lack of policy creativity and imagination by the Ford economic team, on which Greenspan served, that gave the world four years of Jimmy Carter and continued economic malaise. Yet in The Age of Turbulence, these years of political and economic failure were somehow shining moments of character, honesty, and integrity. Strangely, the Reagan years of remarkable economic success, with admittedly some disappointment, barely happened.

That's the less convincing part of the book (if you assume the Chairman's daring inflation forecast for, believe it or not, the year 2030 was merely an example of his wry sense of humor). The convincing part relates to Greenspan's extraordinarily successful career as Fed Chairman, the success of which has actually been unfairly underplayed by many reviewers, perhaps as a result of being overshadowed by the political gamesmanship. Let me offer three examples of those achievements: First, it is easy to forget that during the 1987 stock market crash, only weeks after the Chairman took office, a significant body of conservative economic opinion suggested the Fed needed an immediate hike in short-term interest rates. That's right. Even the Wall Street Journal editorialized that a hike was needed to bolster the dollar as a means of reassuring global financial markets. Greenspan wisely rejected such advice and flooded the market with liquidity.

Second, many reviewers give Greenspan little credit for an amazingly prescient observation in the late 1990s. In today's business of central banking, there are no fixed rules, no black boxes full of formulas to achieve certainty. Instead, policymakers increasingly are forced to operate by instinct. In the late 1990s, Greenspan perceived a sustained rise in U.S. productivity growth underway. He adjusted monetary policy to take into account the counter-inflationary effect of such productivity enhancement and the American economy today is several trillion dollars larger as a result.

Lastly, the frequent criticism of Greenspan's dramatic reduction of short-term interest rates down to one percent in the 2003-04 period oversimplifies the situation confronting the FOMC at the time. If you "Google" that period, the vast majority of economic commentary fixated on the very real potential that the U.S. economy was slipping into a deflationary spiral. Fed officials were well aware that a dozen years before, their counterparts at the Bank of Japan found themselves in a similar situation. The difference is that the Bank of Japan waited too long to dramatically ease, and then prematurely raised rates only to find themselves having to reverse course. The result was a lost decade of economic activity, stemming from a policy blunder of massive proportions. Thankfully, Greenspan was intent on not repeating the BoJ mistake of raising rates prematurely.

As with most things in life, there are tradeoffs. Greenspan's actions contributed to the forming of a U.S. housing bubble and the related credit contraction associated with the subprime mortgage market collapse. Yet as painful as the current credit crisis has been, it pales in comparison to the downside of the United States falling into a decade of economic paralysis a la Japan in the 1990s. To a certain extent, the Japanese are still suffering from their deflationary period. It was Greenspan's (and Bernanke's) determination that America not become Japan, and their policy prescription worked, but not without downsides.

In the end, the Chairman's book should have presented a more powerful message that financial globalization offers a mixed bag. The good news is that the internationalization of financial markets has contributed to an era of tremendous wealth creation and poverty reduction. The bad news is that it has led to financial panics and periods of steep volatility. According to the World Bank, bank panics today are twice as prevalent than during the period before financial globalization. But do we want to return to that period of disappointing economic performance, stagnant markets, and less robust job creation? During the past quarter-century of financial globalization, the economy was in recession roughly 5 percent of the time compared to more than 20 percent during the quarter-century before globalization.

Over the past two decades, Greenspan has been the Maestro at smoothing out these periods of financial volatility. But the message of his book should have been that when it comes to economic policy, tradeoffs are inevitable. In this brave new world, the central bank's expertise at smoothing out these volatile periods is growing, but so are advances in communications technology and financial engineering which contribute to instability. At the end of the day, Greenspan's message should have been that, despite the promises by politicians, we can't have it both ways--prosperity without risk. The American people would have benefited from such a distinguished economic leader, an extraordinarily successful policymaker, explaining what's in store for all of us as we try to come to terms with this bruising monster we call a global financial system. The bottom line: The book is a solid A- effort, with or without the dating 2030 forecast. But it could have been an A+ had the fundamental assessment of the last quarter-century been more comprehensive.

--DAVID M. SMICK Founder and editor of The International Economy, Mr. Smick is writing a book on the new global economy.
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Title Annotation:FROM THE FOUNDER
Author:Smick, David M.
Publication:The International Economy
Date:Sep 22, 2007
Words:1437
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