When A. H. Greenspan Talks Markets (Don’t) Listen

Martin Harris

Martin Harris is an architect and former farmer.

      It was a great little TV ad in its day. At a country club’s open-air lunch tables, pools and tennis court in background, one silver-haired retiree/investor confides to another: “E. F. Hutton says that XYZ stock…” He never finishes the sentence: other country-clubbers set aside their gin-and-tonic glasses to cup their ears and eavesdrop. The message: Hutton can move markets and thus make money for clients. You, viewer, should become one. The problem: brokerage houses are supposed to be investing in markets, not moving them.

      The Federal Reserve is supposed to be moving them: as needed, to stabilize the currency, because the U.S. Congress didn’t want the task as set forth in the U.S. Constitution (Article1, Section 8: to coin money and regulate the value thereof) any more after failing at the job with the First and Second Banks of the United States. By the late 19th century Wall Street bankers were, for all practical purposes, controlling and stabilizing what had been a patchwork of currencies, and so in 1913 Congress simply formalized the arrangement by setting up a Federal Reserve System to do what Congress couldn’t or wouldn’t.

      And how well has the Fed done its job? I’ll report, you decide. Here are the numbers. In the 124 years from 1789 to1913, when the dollar was being managed by the Congress, Nicholas Biddle, Andrew Jackson, Abe Lincoln, and Wall Street bankers, it depreciated 12 percent. You would have needed $1.12 in 1913 to buy what $1 bought at the Nation’s founding. In the 90 years of Fed management, 1913 to 2003, it has depreciated 94.5 percent. You need $18.08 now to buy what $1 bought the year after the Titanic sank. $1 is 5.5 percent of $18.08.

      And why has the Fed not done any better? After all, nations around the globe stabilize their money against a market basket of commodities and services, using the mathematical functions of a currency board to make sure a British pound, or whatever, has the same purchasing power this year as last. The answer, of course, is that it doesn’t want to do better. As our own domestic inflation rate approached zero in recent years, the Fed has stepped in—to prevent deflation, they say—with a series of interest rates cuts to increase borrowing and thus the quantity of money in circulation: more money chasing the same goods, or inflation. The Fed’s goal, it says, is “modest” inflation, not currency stabilization.

      And why inflation? Unlike the above facts, this is opinion: because, in a nation of voter-debtors, politicians (and Fed Governors) who like their well-paid jobs will always make sure that debt service will be easy (with depreciated dollars) rather than hard, with full-value or even appreciated dollars.

      And where did they learn this lesson? From American agriculture, more precisely the mid-Western farmers of the post-Civil War decades of continuous monetary deflation, getting deeper in debt as crops declined in value against an ever-stronger dollar. The Populist near-rebellion, with the slogan of “free-silver” simply a respectable way of demanding cheaper money through inflation, shook the establishment of the day: at a time in history when neither the Nation nor most individuals had any debt, they were caught unawares when a swing-vote bloc, homesteaders, suddenly changed the rules and demanded an ever-cheapening dollar. Now everyone’s in debt, and, not surprisingly, the Fed accommodates: we promise you controlled inflation, Alan Greenspan, Fed Chairman, now says. 

      Back then, of course, agriculture mattered: the farm population was still well over half the total, and it’s less than two percent today. But today, urbanites and governments as well are in debt, which is why deflation is now unthinkable, stabilization not good enough, and inflation a desired goal for those supposedly charged with, as Fed Governor Ben Bernanke says, “achieving and maintaining price stability.” To make sure the dollar stays mildly inflationary, Alan Greenspan’s Fed has cut overnight deposit interest rates to one percent (only two years ago the Federal funds target rate was at six percent) But guess what—Mr. Greenspan apparently lacks Mr. Hutton’s charisma, and, for the first time in Fed history, the bond market itself isn’t listening. Bond buyers aren’t buying bonds; indeed, they’re selling, bond prices are dropping, and therefore interest rates are climbing. If you’ve priced mortgages recently you know.

      And if you have no mortgage, you don’t much care. If you own bonds, they’ll fall in value as rates climb. If you want to buy land, equipment, or both on credit, now’s the time to act because, historically, interest rates are still quite low. Here’s my point: since 1789, Americans have been promised a government which would “regulate” the value of money. Since 1913, Americans have been promised a Fed which would “stabilize” the dollar. Since 1978, Americans have believed that the Fed could do the job: under Paul Volcker in the early ‘80s, it ended double-digit inflation and since then has apparently been able to fine-tune our financial structure through interest-rate manipulations, supposedly in pursuit of currency stabilization. Now we know different.

      Now we know that the Fed’s goal isn’t stabilization at all, but rather inflation in the 2-3 percent range. For anyone in debt, that’s good news: it means that, say, a 6 percent note costs him only 3 percent. And we also know that what the Fed wants, it won’t always get. Not only have recent rate cuts failed to move the markets, but more importantly, the Fed is running out of maneuver room: it has only a single percentage point of influence left. When rates are at or near zero, as they have been in Japan recently, how then can government stimulate the economy? Short answer: it can’t, at least not with the usual monetary-policy tools. It’s not being said in polite circles (country-club lunch tables, for example) but I’d suggest that the Fed is suffering an enormous credibility decline. Will Congress take back the job? I doubt it. Is deflation of the 1865-1895 type possible? I’d say yes, with all it’s nasty implications for debtors; but then farmers have already been experiencing crop-value-deflation, just like their great-grandparents, all through recent decades, and the Fed hasn’t cared a whit. It was only when deflation began to cast urban shadows that Greenspan and company became concerned.

      If Greenspan and the Fed aren’t effectively guiding national monetary policy, who and what is? I’d say the market is: that multitude of individual decisions on savings, investment, purchases, loans which, in sum, make up Adam Smith’s “invisible hand.” As in J. P. Morgan’s time, we’re back in a situation where the marketplace, not would-be economic commanders, controls the value of the dollar. (As it did, pretty much, up to 1913.) In short, whether we have deflation, stability, or inflation, now depends on the decisions of all of us, not of Mr. Greenspan and his Open Market Committee. Is this a good thing?

      Here’s the comment of Daniel McFadden, vineyard operator, UCAL-Berkeley economics professor, and Nobel laureate:

The history of government regulation of markets is littered with examples of restrictions, ostensibly adopted on behalf of consumers, that instead protect concentrated economic interests.

I agree.   Ω