The Greenspan Recession

Posted: Aug 15, 2001 12:00 AM
"HELP WANTED": Fed Chairman who understands stable money. Thanks to deflationary monetary policy, the economy here and around the world is slipping into a deep freeze, and there is no prospect of a thaw any time soon. As George Gilder observed in the Wall Street Journal, the prices of gold and industrial staples such as steel are down more than 40 percent in four years. He wrote, "A high-tech depression is under way, driven by a long siege of deflationary monetary policy ... which has shriveled hundreds of debt-laden telecom companies and brought Internet expansion to a halt." As Larry Kudlow recently reminded me, "Alan Greenspan told Congress in 1994 that commodity market signals provide more useful and timely information than the official government data on prices, unemployment, national income and so forth." Today, Greenspan is totally ruling out market signals, and he told me recently that he believes our current economic problems are simply "the working of the business cycle." That is preposterous. We are in the deflationary stages of a "go-stop" money cycle created by the Fed's discretionary monetary policy. For more than three years, the Fed has ignored all its supply-side friends who insisted that the chairman's fear of "irrational exuberance" was misplaced. We warned that it was misguided to raise interest rates with the express purpose of slowing down the economy, throwing people out of work and tanking the stock market. Once the Fed decided to try to reverse the economic slowdown it had intentionally engineered, Greenspan also ignored our warnings that targeting interest rates was starving the economy of liquidity even while interest rates were coming back down. We were right on all counts. In spite of having reduced the Fed funds rate 225 basis points in only seven months, monetary policy remains too tight. The bottom of the yield curve is inverted with the interest rate on two-year federal notes lower than the overnight rate, the price of gold is no higher today than when the Fed began to lower interest rates and the dollar continues to appreciate against other major currencies. Since June, producer prices have plunged at an average annualized rate of 8.1 percent. When economist Art Laffer wrote to Nobel Prize-winning economist Bob Mundell recently seeking his opinion on my contention that monetary policy has been deflationary and that the only way to restore monetary stability is to anchor the dollar to the price of gold, Bob responded: "When the dollar price of gold is falling at the same time that the dollar is appreciating against other major currencies that do not have inflation problems, U.S. monetary policy is too tight." Unless the Fed abandons interest-rate targeting and adopts a commodity-price rule using gold as a reference point, the Fed will continue to put the U.S. economy and the world through a deflationary wringer until prices fully adjust downward. While the U.S. economy can survive this tortuous process, it will inflict needless torment and misery on a lot of Americans, and countries not as resilient as ours, such as Argentina, may well be crushed by the dollar deflation. Unfortunately, the confusion caused by the Fed's interest-rate targeting is distorting the way people think about the world economy, and it is leading to a false debate between a "strong dollar vs. a weak dollar." Manufacturers feel squeezed by the deflation and attribute it to a "strong dollar." A media frenzy forces our Treasury secretary into a corner where he feels he has to defend the strong dollar lest he provoke another market debacle like 1987. But the ever-strengthening dollar is the result of deflationary monetary policy, and our policy objective should be neither a strong nor a weak dollar but rather a stable dollar. At the end of August, second- quarter GDP growth will almost certainly be revised downward from 0.7 percent on an annual basis to close to zero or even into negative territory, and when that revision occurs, people will begin to talk about the Greenspan Recession and also to hold him responsible for the inevitable political fallout a year later if Republicans lose control of the House of Representatives, a distinct possibility if this economy does not recover soon. I once again urge Chairman Greenspan to abandon interest-rate targeting and begin buying bonds until the signs of deflation stop flashing red. The price of gold must rise back above $300 and commodity prices must rise off their bottoms, the yield curve must reassume a normal upward slope with a reasonable spread between the Fed funds rate and the two-year bond, and the dollar must stop appreciating ever higher against foreign currencies. This wouldn't require elaborate international negotiations if the chairman would seize the opportunity today to lead the Fed toward the adoption of a commodity price rule with gold as a reference point, which would eliminate Fed discretion and introduce automaticity to the conduct of monetary policy. If Greenspan would lead with a price rule at the Fed, the economy would quickly revive; Europe, Japan and the rest of the world would follow our lead; and history would smile upon the "Maestro" for his efforts.