QUERETARO, Mexico, July 15 (UPI) -- Tuesday in his semi-annual monetary policy report to the Congress, Greenspan defended the Fed's monetary policy and lauded the progress the U.S. economy has made in recent months. All the progress, it turns out, can be put down to what might be called a new new paradigm.
The Fed has been "accommodative," Greenspan argued, undeniably. "Yields across maturities and risk classes have posted marked declines," he said. There were signs, he argued, too, that the medicine was working, with industrial production "stabilized," consumer spending holding up and housing markets "strong."
What stands in the way of better performance, a stronger recovery? Greenspan pointed elsewhere, to a "pervasive sense of caution reflecting, in part, the aftermath of corporate governance scandals."
Greenspan's line was that corporate America is on the defensive following the scandals, not confident enough to "ramp up significantly their hiring and spending." Come on, boys, overcome your inhibitions and all will be well: that seemed to be the message. Another problem was the boys overseas, "economic weakness abroad," which reduces the demand for U.S. goods and services. Not everyone is as accommodative in policy-making as Alan.
But what about the post-bubble lack of demand in the world economy?
If the Greenspan view of the obstacles to a stronger recovery was less than convincing, his analysis of what, in his view, is going right, was simply troubling. He made much of "balance sheet adjustment," in companies and in households. For households the key thing was "a solid advance in the value of the owner-occupied housing stock." This was how the world's leading central banker referred to inflation in U.S. house prices.
There was more good news. Households increased their net worth in the first half of 2003 by 4.5 percent, Greenspan told us, largely because of these higher house prices, so that "only 15 percent of that increase in wealth represented the accumulated personal saving of households." In other words, most of the adjustment that has taken place in households' balance sheets is not a reflection of any change in household behavior but inflation in house prices and a recovery in the stock market.
But, after the consumer spending binge of the late 1990s, might it not be the case that U.S. households need to rely less on assets such as stocks and houses for their savings? Might they not need to change their behavior and save more? A traditional central banker might have thought so. Not, it appears, the modern version.
What Greenspan wants is asset price appreciation -- a bit of irrational exuberance in house prices -- and the spending of part of the gains from that exuberance, just as happened before with another bout of exuberance in a different asset. And for the moment his loose money policy is provoking just what he wants.
"The huge wave of refinancing this year and last has been impressive," he said. This takes us to the most alarming phrase of all in his testimony: "changes in technology and mortgage markets that have dramatically transformed accumulated home equity from a very illiquid asset into one that is now an integral part of households' ongoing balance-sheet management and spending decisions." What this means is that the ready availability of cheap mortgages -- it's that wonderful internet -- is enabling households to turn house price inflation into consumption.
Yes, it is a new paradigm again. Once it was stock price inflation that could be converted into money, via stock options or simple gains on stocks, and spent. Now it is house price inflation which, thanks to super new "technology," can be turned into spending.
Is this not marvelous? Americans have no need ever to save. They can just do what they like doing: spend. Under the modern central banker there is always some asset whose price can be sent soaring to generate spending money.
Thus is Greenspan working towards a recovery of the U.S. economy. Yet there were sober words, too, in his testimony, about the "especially pernicious, albeit remote, scenario in which inflation turns negative against a backdrop of weak aggregate demand."
"Remote," he might call it, but if it is remote, it is odd that Greenspan has oriented policy entirely towards averting this pernicious scenario: of a deflating U.S. economy. For this is the threat that has driven him ever since 2000 and explains why he has cut interest rates so fast and so far and promises, even today, that he can do more.
But is a Japan-style meltdown really the threat that menaces the United States? Or would a less accommodative monetary policy and a deeper recession in 2001, extending into 2002, by now have begun to prepare the U.S. economy for a sustainable recovery? That, of course, would have obliged a painful change in the behavior of U.S. households. They would have had to have cut spending more, saved more; and more of them would be out of work, and the stock market and housing market would be lower.
Yes, the policy questions are difficult for this is territory that has not often been traveled. Few countries have had an asset bubble as big as the one in the United States in the 1990s. But now that bubble has burst Greenspan is consciously fomenting a second one. Is that the best remedy? Or might not a bit of pain be unavoidable and necessary?
The danger, to our mind, is that Greenspan's "solid advance" is not solid at all. It is all based on flooding the markets with liquidity, forcing down mortgage rates to indecently low levels, cutting rates on savings deposits to almost nothing, encouraging the creation of more and more debt -- while friend George racks up the government debt -- and encouraging spending based on extracting equity from an asset, housing, whose price is inflating recklessly and which, subsequently, like the equity market, is likely to fall.
Then how will those household balance sheets and the U.S. economy look?
The new new Greenspan paradigm looks just as dangerous as the new paradigm that created the current mess.
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