Watching the Greenspan Show Jude Wanniski February 13, 2004

After spending a good part of Wednesday and Thursday watching Fed Chairman Alan Greenspan’s testimony before the House and Senate banking committees, I came away with many of the same impressions summarized in the press accounts. However, my assessment of what to make of them is different enough to warrant this report.  

For me, the most interesting exchange came Wednesday when Rep. Ron Paul [R-TX], the only advocate of a gold standard on House Banking, asked Greenspan if he doesn’t worry about all the power that he and the other Fed governors have amassed. Paul noted that when the FOMC changed two words in the statement it released at its last meeting in January, within minutes Wall Street shed 150 points on the Dow and $200 billion in equity values! Greenspan responded that the congressman knows we are no longer on a commodity standard but are on a fiat standard, and that Congress essentially put this power into the hands of the Fed for better or worse. This is why he spends so much time before committees of Congress trying to explain why the Fed is doing what it is doing. Greenspan well knows that under a “commodity standard,” the broad market automatically matches the supply of dollars to the demand for dollars, which means the Federal Reserve has not much to do. 

Greenspan was clearly pleased on Thursday in his appearance before Senate Banking, pleased to take credit for the big rally in stocks and bonds that greeted his Wednesday testimony, which added back the wealth the FOMC had subtracted earlier. What power! On the other hand, none of the Senators seemed to notice that while the dollar strengthened against the euro and yen last week while gold dropped sharply below $400, the dollar now is slumping again and gold has climbed back to $410. The fairly general consensus was that by indicating inflation now is not a problem, Greenspan signaled the markets should not worry too much about the Fed pushing up the 1% fed funds rate anytime soon. One Bloomberg commentator even suggested Greenspan inferred there would be no need to raise the rate at all until the unemployment rate gets down to 4%, which is certainly not the impression I got. The “Maestro” was almost playful in his appearances, explaining how everything seems to be going just fine with the economy – in the short term at least – but there are mysteries about why productivity increases are so high and job creation lagging. The Republicans would have liked Greenspan to say the government’s household survey of jobs is better now than the payroll survey, as the former shows more job creation than the latter. But Greenspan prefers the latter; it gives him more room to manage expectations about what he will do on interest rates. He said that we would have to wait and see, and that by doing so gives himself the widest possible leeway in the highly-charged political months ahead.

Greenspan now knows much better than he did a few weeks ago how a word or two from him can be leveraged to manage expectations now that the market knows the next move in rates will be up. This means we still could see a hike in the funds rate as soon as the June FOMC meeting, but we also could see a burp or head fake from him two weeks from now when he comes back to Capitol Hill. If the dollar and gold behave themselves, he can be just as playful, aiming to win the applause of Wall Street as long as it is not too exuberant. If he sees too much weakness in the dollar and gold, he knows just about what to say to get them back into line. He holds the reins in his hands and has the spurs on his boots.

Another observation in this line of reasoning is that Greenspan amassed even more power into his hands by minimizing the influence that last year’s tax cuts on capital have had on the stock market and the economy. He would much prefer to have the world around him attribute the bull market of the last 11 months to his shrewdness in managing monetary policy. Certainly the willingness to push the funds rate as low as it is has had the effect of ending the monetary deflation that created the economic problems at the end of the Clinton Administration and the first three Bush years. But the lower tax rates on capital clearly are responsible for much of the bull market and for the “mysteries” of why productivity has been red hot, unprecedented in his memory, as Greenspan told Senate Finance. He could have noted that last year’s tax cuts on capital gains and dividends engineered by House Ways and Means Chairman Bill Thomas also were unprecedented in their firepower, but he had only given the most tepid okay to the bill at the time. 

When it came to the tax issues on everyone’s mind in connection with the $500 billion federal deficits as far as the eye can see, Greenspan also was playful, giving Republicans and Democrats enough of what they wanted to hear. Should the Bush tax cuts be eliminated in order to get the deficit under control? No, said the Maestro, employing Laffer Curve arguments in a way he rarely has. You can’t be sure the higher taxes will not erode the tax base, reducing revenue and failing to achieve balance, he said. If you cut spending, though, you can get the desired results. The Republicans, led by Sen. Bob Bennett of Utah who fed Greenspan some softballs, smiled broadly at the answer. But what about making the tax cuts permanent, as Mr. Bush proposes? For this query, Greenspan put aside the Laffer Curve, which the administration has in mind, saying they will cause economic decline and revenue loss if they all allowed to expire. Instead, the Fed chairman dragged out the old “pay-go” rules that expired a few years ago, which required Congress to pay for any static revenue loss attributed to a spending increase or a tax cut. While he again indicated he thought the tax cuts should be made permanent, Greenspan said they should not if they were not paid for with spending cuts. Here, the Democrats on the committee smiled broadly. 

As for the trade deficit, I’m afraid Greenspan said so many different things in the two days that I really can’t come to any conclusions other than that he says they are nothing to worry about. In his prepared remarks, undoubtedly written for him, he seems to say a cheaper dollar will cure the current account deficit, which does not sound like the Greenspan I’ve known for more than 30 years. Under questioning, he made the case that the rest of the world is eager to sell the U.S. more goods than it is buying from us, accepting claims against future income in the form of stocks and bonds. It is doing so because we are the envy of the world in the way our standard of living keeps rising because of our superior system. I have to admit it is a pleasure to hear Greenspan when he engages in these kinds of tutorials about capitalism and free markets. Sen. Charles Schumer [D-NY], who would like to pass legislation prohibiting “outsourcing” to India or textile imports from China, seemed mesmerized by Greenspan’s tutorials, or at least deciding to not combat the Maestro in close quarters, for fear of being humiliated with a word or two. 

After several hours over two days watching this extraordinary performance from Greenspan, I told a client who called that I had probably overdosed. But I confess that I would not mind watching the replays on C-SPAN, which will probably show up this weekend. This guy really has the power. 

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