“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else.” John Maynard Keynes.
Bob Woodward set for himself a rather difficult task. In his book, Maestro, he attempts to paint a heroic portrait of a purposefully ambiguous Federal Reserve Board Chairman Alan Greenspan. Although Woodward does a competent job of explaining some of the more Byzantine aspects of the operations of the Federal Reserve, his effort falls too often into hagiography. Even if one accepts the portrayal of Greenspan as a maestro beautifully and skillfully conducting the orchestra of the economy, one has to be concerned about any system so critically dependent upon having a rare expert.
The primary obligation of the Federal Reserve Board seems straight forward enough: Increase the money supply at the same rate that wealth is created in the economy. Create too much money and too many dollars will chase too few goods and inflation results. Inflation adds noise to economic transactions and calculations making the economy less efficient. In the long run, inflation suppresses real economic growth. Miscalculate on the other side and the country experiences deflation and possible recession.
Unfortunately, measuring the money supply is problematic. With various monetary instruments from currency, to bank deposits, to deposits in mutual funds, defining and quantifying the monetary supply has become more and more difficult.
The Federal Reserve Board also relies on indirect measures to divine the present and future states of the economy. If prices start to increase, or growth appears to be unsustainably fast, or unemployment becomes low enough to increase rapidly wage rates, then the Board may indirectly infer that the money supply has grown too large and raise interest rates. The entire effort is complicated by the fact that the actions to increase or decrease the money supply can take months to affect the economy. Therefore, the Federal Reserve Board must attempt to anticipate the future and act proactively.
Greenspan has been the Federal Reserve Chairman since 1987. He was appointed by President Ronald Reagan to replace Paul Volcker. Volcker was not a very popular character. He had the unenviable task of driving interest rates to 19% in a painful but successful effort to wring double-digit inflation and inflationary expectations from the economy.
Perhaps Greenspan’s initial luck was not that much better than Volcker’s. His tenure began just before the stock market experienced a precipitous 20% drop in 1987. Greenspan wanted to comfort the markets without loosing monetary discipline. Greenspan responded with the vague but reassuring statement, that the Federal Reserve was prepared to insure that there was no liquidity shortage in the economy. The country survived this 1987 stock market drop and in a few short years, the market exploded upward much further than in it had been in October 1987.
The only recession during Greenspan’s tenure, thus far, occurred after the energy price increases during the Gulf War. The Bush Administration, pled, begged, and even tried to berate the Federal Reserve into loosening the money supply. To this day, George Bush (41) believes that Greenspan cost him the 1992 election.
As Woodward points out, the first Bush Administration made two important strategic errors. The first was to publicly pressure the Federal Reserve to ease interest rates. Always sensitive to maintaining not only the independence but also the appearance of independence of the Board, Greenspan was less inclined to reduce rates when he might appear to be doing so in response to political pressure.
Bush’s second mistake was to not take the political initiative in explaining the economic recovery. The economy had been actually recovering from 1991 on. The unemployment rate was still high, but unemployment is a lagging indicator of the economy. Bush appeared detached and was not successful in conveying his concern for those the economy had not yet helped. It was Bush’s political failings more than Greenspan’s monetary policy that caused his defeat to Clinton in 1992.
According to Woodward, Bill Clinton avoided both mistakes. Clinton’s most important political asset was his ability, sincere or not, to invoke the sense that he empathized with those who were suffering. He “felt their pain.” Perhaps most importantly Treasury Secretary Robert Rubin knew Greenspan well and was savvy enough not to lobby publicly Greenspan for specific actions. Greenspan’s policies managed to insure robust economic growth in 1996, the presidential election year, and helped ease Bill Clinton into a second term.
Nonetheless, in the mid-1990s, budget projections clearly showed Federal budget deficits of $200 billion indefinitely in the future. The unemployment rate was a little under 6%, about as far down as it could go, so the conventional wisdom had it, without triggering inflation. The Federal Reserve was prepared to keep the economy from overheating. Such actions would have likely killed the growth of the late 1990s that obliterated the budget deficit and plunged unemployment rates to 4%.
Woodward explains that Greenspan was intrigued with apparent contradictions in the economic numbers. On the one hand, conventional measurements suggested that productivity, output per worker, was growing only slowly. On the other hand, profits were going up, wages were not increasing rapidly and there were no signs of inflation. Greenspan’s conclusion was that computers and communications advances were increasing worker productivity in ways that were not being measured.
Others favored this same hypothesis. It was not novel, but it was controversial. Important economists did not subscribe to the argument that productivity was really increasing. The prominent Liberal economist Paul Krugman of Stanford University ridiculed other economists who suggested that higher growth rates could be sustained by increases in productivity. Krugman believed that, “…the so-called revolutions in management, information technology and globalization are vastly overrated by their acolytes.”
It is an interesting irony that Greenspan, former member of Ayn Rand’s inner circle, was leaning toward looser monetary policy, while Liberal economists were not so sanguine about the rapid growth in the economy.
In any case, Greenspan’s skill and fortune may be running up against an inevitable recession. At present, the economy is struggling at near zero growth rates. This last week, the Federal Reserve decreased interest rates by 0.5%. If the reaction of the stock market is a measure, the reduction is too small and too late to avoid a recession. We shall see in the next year, whether the Maestro will be able to cajole one more virtuoso performance from the economy.
The Lexus Runs Over the Olive Tree
Sunday, April 15th, 2001A few years ago, Thomas L. Friedman penned a book about globalization entitled The Lexus and the Olive Tree. The title embodies a metaphor. The Lexus represents the wealth and prosperity brought on by the relentless forces of markets, capitalism, and free trade associated with globalization. The olive tree represents “everything that roots us, identifies us, and locates us in the world … a family, a community, a tribe, a nation, a religion or, most of all a place called home.” The olive tree can represent the values and institutions we wish to nurture with the wealth represented by the Lexus.
While wealth and connectedness symbolized by the Lexus and the olive tree can both be part of a healthy society, the forces of global markets often bring these values into conflict. The economic and regulatory walls erected by societies to protect communities and cultures make it difficult to partake in the growth and wealth production made possible by global markets. Modern markets depend on rapid communications and travel and the free flow of trade and capital. To reap the benefits of globalization requires that societies open themselves up to the world. Openness and market transparency are important values, but they can also overwhelm local cultures as McDonald’s restaurants, Disney World, and the cell phones replace local cultural symbols and practices. What pleases global markets is not always what is culturally, morally, or religiously uplifting.
Nonetheless, globalization is a moderating influence between nations. Economically interdependent nations entwined in trade are less likely to begin wars with each other. Even the forces of nationalism and cultural exclusivity, values associated with the olive tree that sometimes lead to war, are often modulated by economic imperatives. War is bad for business.
Those who support free trade with a brutal authoritarian regime like the People’s Republic of China (PRC) do so with the faith, borne out by some empirical evidence, that the requirements of global trade, the rule of law, financial accountability, and open communications, serve to undermine the Communist regime there. Even though authoritarian structures may appear solid on the surface, economic freedom eats away at the foundation of authoritarian regimes.
Others are less sanguine about the salutary benefits of trade. They recall Lenin’s prediction that the capitalist will sell you the rope with which you will hang him. However, the regime that Lenin begat is as dead as he is. It turns out that people are not particularly anxious to hang people with whom they can conduct profitable business.
In an important way, last week’s release of the 24 American crewmen from the reconnaissance plane, which was forced to land after a collision with a Chinese fighter jet, is evidence of the effect of trade. If the United States and the PRC were not engaged in extensive trade, the 24 crewmen would probably still be in China. When the North Korean government seized the reconnaissance ship the USS Pueblo in 1968, they held the crew for eleven months. Of course, the North Koreans to this day have an impoverished and insular economy. There was little economic incentive for the North Koreans to be accommodating.
In this case, the Chinese government realized that a prolonged incident would decrease the likelihood they would be admitted to the World Trade Organization. The US represents a large fraction of the export trade of China. If this trade were reduced it could cause economic turmoil in the PRC, which in turn could lead to political instability. It is probably not entirely coincidental that the day before the crewman were released Kmart informed the Chinese that American consumers were intent on boycotting goods from China.
By the same token, the US reaction was also modulated. Part of the restraint on Americans was the fact that the PRC held Americans in custody; part was an unwillingness to see the matter escalate to the point of affecting trade. Many of us Americans love commerce more than we hate communism.
Although we did not explicitly apologize, we said “very sorry” in such a way that the Chinese could deliberately misinterpret it as an apology. The US got the crewmen back through the use of what diplomats call “constructive ambiguity.” The imperatives of globalization overwhelmed other considerations. The Lexus mowed down the Olive Tree.
However, it is in the American parochial interest and in the interest of international trade and global economic prosperity if this incident is not simply forgotten in the service of economic amicability. Lawlessness and mendacity are not appropriate character traits of those who wish to be part of the world economic community. As Jim Hoagland of the Washington Post pointed out the lie that the American’s caused the plane collision “is a reflexive act of pride and pride is driving force for [the Chinese President] Jiang as he draws an even clearer line in the sand for Bush.” Trade may have restrained China’s hand, but the PRC is still intent on politically dominating the Pacific region.
Now that the American crewmen rest comfortably on American soil, the PRC government, particularly the Chinese military whose incompetence and intransigence was the cause of the aircraft collision and protracted detention of 24 Americans, needs to learn there are importance consequences to unlawful behavior. A price needs to be extracted so that similar actions by the Chinese in the future are discouraged. However, using trade as a weapon may be counterproductive, harming the Chinese people as opposed to the Chinese government. We want to drive a wedge between the Chinese people and their government, not push them together in common cause.
First, Americans should resume reconnaissance flights along the same flight paths they previously used. At least in the near future, we should devote the resources necessary to accompany to the aircraft with fighter escorts. The Chinese should be warned they within a mile of these reconnaissance it will be considered an attack on the plane and defensive action will be taken. The right to fly in international airspace needs to be asserted if it is to be maintained. International bullies should not be accommodated.
Secondly, the US needs to sell Aegis cruisers to the Taiwanese. The anti-missile defenses of the ships will partially offset the buildup in southern China of missiles capable of reaching Taiwan. Moreover, it must be privately made clear to the Chinese that the decision to make the sale was cemented by their illegal actions.
Globalization has made the world safer. However, the world is not yet given over entirely to commercialization. Sometimes more traditional responses remain necessary.
Posted in Economics, Politics, Social Commentary | No Comments »