Fedwatch: The Shifting Greenspan Standard Jude Wanniski May 10, 1999

There is one sentence in Fed Chairman Alan Greenspan's Thursday speech to the Chicago Fed with which we more or less agree: "Over the longer run, of course, the actions of the central bank determine the degree of overall liquidity and, hence, the rate of inflation." That is, the actions by the Fed also determine the degree of overall liquidity in the short run and, hence, the rate of inflation. When it supplies more liquidity than the market demands, it puts in motion a monetary inflation that begins with a rise in the price of gold. The reverse puts in motion a monetary deflation. At one time, not too long ago, Greenspan believed that himself. As his Chicago speech indicates, and as it only could have been read by the bond market, Greenspan believes that in the "shorter run," where he lives, there is an inflation trying to get under way due to the tightness in the labor market. It has been held back thus far by productivity increases due to technological advances that he did not anticipate, he said, but these increases can't go on forever, so inflation remains a threat: "It is, thus, up to us at the Federal Reserve to secure the favorable inflation developments of recent years and remain alert to the emergence of forces that could dissipate them." In other words, in the short run, we may have to raise interest rates.

Thus the Greenspan Standard gets further and further from gold, closer to a mish-mash involving targets that have nothing to do with inflation or deflation. It is little wonder to us that the bond market must discount government securities that it should be bidding up, given the total absence of inflationary impulses.

Technological change, even as mind-boggling as the promise of the Internet, has zero effect on inflation or deflation, which are purely monetary phenomena. Otherwise, how could the producer price index be the same in England in 1930 as it was in 1717? How could it be the same in the United States in 1930 as it was in 1800? These were the centuries characterized by the industrial revolution and rapid technological advance. Prices of new capital goods will decline as they come on stream. But prices of consumer goods remain constant. As the capital/labor ratio rises, the carpenter from one century to the next takes less and less time to earn a loaf of bread or a suit of clothes or a home in Middletown, USA. The young Greenspan knew that. The 73-year-old Fed chairman who went back to college for a Ph.D. when he was in his 50's, now thinks inflation is the result of too many people working, not enough inventions, or persistent trade deficits. Trade deficits? Here is Greenspan in Chicago: "A more distant concern, but one which cannot be readily dismissed, is the very condition that has enabled the surge in American household and business demands to help sustain global stability: our rising trade and current account deficits. There is a limit to how long and how far deficits can be sustained, since current account deficits add to net foreign claims on the United States." This is incredible nonsense, as if we now have to worry about running a trade surplus, and THAT would be inflationary.

The $10 decline in the gold price to below $280/oz., associated with the UK's decision to sell 415 metric tons of its reserves, may perversely comfort Greenspan, thinking that gold really does not have the monetary properties it once did. The amount of the sale, 0.04% of world gold stocks, is insignificant, especially relative to the Fed's vigilance in fighting a phantom inflation. In assaying the new Greenspan Standard, the bond market now has to assume the Fed at some future point also will be willing to fight a phantom deflation. With no intellectual anchor at the Fed, the value of government debt will be determined by whim in a world of constant surprises.