The Man Who Knew

Does Alan Greenspan still matter? Reassessing his legacy feels like the Cadaver Synod: we’ll dig up a bunch of FOMC transcripts from the early 2000s and complain that the Fed was completely unaware of what is obvious only in hindsight. Rehabilitating Greenspan is equally pointless, though: he was the most important economic policy maker in the country for about two decades, and right after his tenure ended we had the worst crisis in a generation.

Understanding Greenspan, as both a person and a policy wonk, is fruitful. His career casts a helpful light on issues we still face: Greenspan has to deal with the consequences of an increasingly financialized and globalized economy. Today, we have to navigate an equally financialized economy that’s more globalized, but where free trade is in retreat.

This is not an optimistic time. The economy is great on paper, with unemployment at multi-decade lows and US equities at all-time highs. But it still feels like a post-crisis economy (an inter-crisis economy), not a boom. Greenspan’s career, from the 1950s through 2006, spans most of the best years America’s ever had. His tenure as Fed chair, from 1987 through 2006, includes the great bull markets in equities and real estate.

Good or bad, Greenspan means something. I recently read The Man Who Knew to figure out what.

Greenspan the Man

Alan Greenspan was going to be a jazz musician. After high school, he spent a few years playing clarinet and saxophone for a living, before he went back to school to get a B.A. and M.A. in economics. He spent some time as an analyst at The Conference Board, and a few decades running Greenspan-Townsend, an economics consulting firm.

So, Greenspan is an inspiration to anyone whose first career didn’t work out. But it’s easy to take that lesson too far: by the time he was 30, Greenspan had a graduate degree in his chosen field. He’s about 5% late-bloomer and 95% “guy who briefly got paid for his music hobby.”

During his years at Greenspan-Townsend, Alan Greenspan was paid to make incremental economic forecasts based on voluminous data — freight car loadings, factory orders, materials pricing. This I found extremely relatable; my day job is the modern version of this. (We have more data, and we get it faster than Greenspan did in the 1950s, but we also have much more competition.)

His career started to get really interesting in the 60s, when he dabbled in politics: Greenspan worked on the Nixon campaign, and later in the Ford and Reagan administrations. It’s at this point in his career that we start to see the Greenspan paradox: at one level, he was a bland, data-driven technocrat; at the same time, he was an absolutely ruthless bureaucratic knife-fighter. At one point, Nixon tried to manipulate the Fed by spreading a rumor that Fed chair Arthur Burns, while complaining about inflation, was demanding a raise. Greenspan was the hatchet-man who explained to Burns as gently as possible that he ought to say something nice about Nixon’s economic management to get those headlines to go away.

Later on, he slow-walks Henry Kissinger into dropping a convoluted plan to buy cheap oil from the Shah of Iran. Greenspan, like everyone in macro, reserves his deepest contempt for macro tourists.

Incidents like those are the ones where there’s a paper trail. Are they exceptions, or were they the rule? I generally assume that if I catch someone misbehavingtwice, and they’re both competent and acting like they have something to hide, it’s a pattern. I suspect that, as more of the people whose careers overlapped with Greenspan retire, we’ll get more stories like this: times that Greenspan, the bland technocrat, wielded a bureaucratic stiletto to maneuver himself into an advantageous position.Greenspan more or less admits this. He told a friend who was considering a D.C. job “This is a town full of evil people. If you can’t deal with every day having people trying to destroy you, you shouldn’t even think of coming down here.”

This is not, strictly speaking, a bad trait. I would hate to live in a world where competent people are too principled to get into a position of power. But there’s a sort of Laffer Curve for ruthlessness: totally decent people are ineffectual in large bureaucracies like the U.S. Government, but completely ruthless people, however competent they are, are destructive. (Depending on your political biases, feel free to cite Dick Cheney or Rahm Emmanuel as the classic example of this.)[1]

Greenspan the Fed Chair

Right after the end of Greenspan’s tenure, the work of Hyman Minsky came into long-overdue vogue. Minsky describes a cycle:

1. A growing economy gets more stable over time. The big beginning- and end-of-cycle swings start to moderate, and industry-level variances in economic growth shrink.

2. This leads to a drop in risk premia; investors demand lower returns for a given stream of uncertain cash flows, since they’re less certain.

3. Risk-seeking investors lever up.

4. If everyone has enough leverage to get the absolute returns they’re used to, the system is brittle, prone to panics, pseudo bank runs, etc. At some point, some minor instability causes a crisis.

5. There’s a mass liquidation, recession, and unemployment. Companies go bankrupt, unemployment skyrockets, central banks cut rates. Eventually, after the shakeout, we return to step one.

You can describe the Greenspan Fed in similar Minsky terms. Early in his tenure, Greenspan faced the Crash of 1987, and responded by cutting rates and injecting liquidity into the system. In the late 90s, Long-Term Capital Management collapsed, and, again, Greenspan cut rates aggressively to prevent a recession. After the tech bubble popped in 2000, Greenspan once again repeatedly cut rates.

Every time it looked like speculators would get punished for using too much leverage or tilting their portfolios too far towards risk assets, there was Alan, Catcher in the Rye, ready to save the day.

Two forces gave Greenspan the air cover necessary to respond aggressively to market disruptions. First, inflation dropped massively early in his tenure. The CPI had been printed double-digit numbers in the late 70s and early 80s, and was still running at above 4% when he started, but inflation quickly dropped to the 2–3% range for most of the 90s. Some of this was due to demographic changes — the inflation of the 70s was partially due to household formation by Boomers — and some of it was due to globalization moving low value-added manufacturing to parts of the world with cheap labor. Either way, inflation declined steeply during Greenspan’s time as Fed chair, so he could cut rates without worrying too much about runaway effects on consumer prices.

Another factor was Greenspan’s insight (claim? Fabrication?) that productivity growth had accelerated due to information technology, in a development that was not fully reflected in the economic data. This is debatable: at one level, sure, accountants who switch from physical ledgers to Excel are more productive, but it’s hard to measure how much more productive. At another level, there are serious questions about the value of marginal output from these jobs. White-collar knowledge work seems to exhibit both wage- and work time-stickiness; mysteriously, even as we’ve switched from pencil and paper to HP-12Cs to Excel to Python, our weekly work hours have been fairly static. If there’s a steeply diminishing marginal impact, we might get 10x the output per hour but a minimal incremental benefit — perhaps the average asset was mispriced by 5% in the pencil-and-paper era and now we’ve worked that number down to 4%. A good thing, especially multiplied by the value of all financial assets, but not life-changing.

The problem with Greenspan’s approach to markets was that it worked, so it didn’t: rescuing investors from market panics incentivizes them to ignore the risk of panics. More importantly, it encourages them to focus on micro mispricings rather than macro-scale imbalances. If one stock whiffs this quarter, it’s not a systemic issue; if every single investment bank is undercapitalized, Fed to the rescue! This is rational behavior on the part of investors, since relative-value calculations reflect the real world while macro bets are a bet on what’s going on inside the Fed chair’s head on that particular day. But it may not be ideal, from a societal perspective, to specifically disincentivize people from thinking about the biggest issues.

The Chatty Fed

One tool Geenspan’s Fed made increasing use of was communications. Fed communications are a force-multiplier: cut rates, and the market responds; cut rates and say you’ll cut them as low as necessary to achieve some goal, and the market responds a lot more.

This gives the Fed power, at the cost of constraining its behavior: now, to deviate from their previously-communicated plan is to reduce the influence of their public statements. There were a few times in Greenspan’s tenure during which the Fed seemed to operate on autopilot, consistently making the same incremental choice over and over again (the mid-2000s tightening cycle, in which the FOMC raised rates 25 basis points every meeting for years, qualifies).

Greenspan famously presided over a huge equity bubble in the 90s, and gave famously elliptical answers when people asked him if it was a bubble. His “irrational exuberance” speech is a great example: we remember the phrase, but not the context. Here’s what the speech was like:

What is the price of a unit of software or a legal opinion?

…

Where do we draw the line on what prices matter?

…

How do we know when irrational exuberance has unduly escalated asset values?

…

How can we compare the effect of cross-bred, high-potency strains like the one I just overindulged in to the ditch weed and oregano we used to get in college?

I may have embellished slightly, but that speech was not Greenspan talking down markets; he’s just riffing on the question of how to measure inflation for non-physical goods, and in the full context of the speech he sounds baked out of his mind.

It is an important question. At the peak of Greenspan’s prestige, in the late 90s, it looked like he’d made the right call: inflation was overstated due to hard-to-measure improvements in services. This let the Fed keep rates low, letting the market rip. When the journalistic fabulist Stephen Glass claimed that bond traders had a literal shrine to Greenspan in the early 90s, he wasn’t wrong, just early.

Today, we’d make a more nuanced call: economic fundamentals were deteriorating in an important way, but the combination of an export boom and a savings glut masked this. Essentially we geared the economy towards leveraging up or selling down assets in order to pay for cheap imports — from countries who kept a lid on currency appreciation by buying the same USD-denominated assets we were selling.

This activity creates jobs, sure. But wealth it just transfers.

The Verdict

Greenspan was massively overrated during his tenure, then somewhat underrated, and now mostly irrelevant. How you rate him depends on whether or not there are things above a Fed chair’s pay grade. If globalization works the way Ricardo said, it’s a dividend, and the job of the Fed is to keep unemployment and inflation balanced at a lower point than they otherwise would be. If globalization acts as a substitute for productivity growth, then globalization plus a Fed that minimizes unemployment conditional on low inflation will lead to unsustainable asset price inflation.

The paradox of Greenspan is that his skill as a political operator complemented his skill as an economist. If he’d been less Machiavellian, someone less competent would have been in charge. But once. that opportunism paid off, it meant that he wasn’t willing to make hard decisions.

Ambitious Washington types can read this book as an instruction manual for achieving power or a cautionary tale about what happens when you get it. Unfortunately, we all know which reading will win.