I Asked Alan Greenspan A Question Of Historic Importance Last Week

 

Thanks to Bill Bonner and my other friends at Agora Economics, I had the opportunity to meet former Fed Chairman Alan Greenspan on January 18th at the Agora Economics Roundtable 2017 in Baltimore.   Below is the transcript of the questions I asked him and his replys. Please keep in mind that this was a discussion. We only had an hour with Dr. Greenspan.   Roughly 15 to 20 questions were put to him. Time was short. I had only a very limited time to ask my question and to get a meaningful response.   I believe the question I asked is of historic importance. I was determined to get an answer. I did.

You will find the transcript below. But, first, let me point out that, today, I have added a few comments in RED (below) to help clarify points that my not be obvious to those who have not followed this subject closely.

Here’s the transcript:

Richard Duncan:   Dr. Greenspan, we know almost everything about the crisis of 2008 by this point, but there’s one very important thing that we don’t know, in my opinion, and that is what was your thinking about the fiat money creation that was being carried out by the central banks of the trade surplus countries? They created trillions of dollars between 2000 and 2007 and they invested 70% of those into US dollar denominated assets, mostly treasury bonds.
 

For instance, during the “Conundrum years”, mid-2004 to mid-2006, foreign exchange reserves went up by one and a quarter trillion dollars; and 900 billion of those reserves were held in US dollars.   Those dollars were invested in US Dollar-denomiated assets, mostly treasury bonds. That was enough to finance the entire US government budget deficit for those two years, with 200 billion dollars left over. Doesn’t that explain “the Conundrum”?   And how did you think of that at the time?

The Conundrum: Between mid-2004 and mid-2006, the Fed increased the Federal Funds Rate by 425 basis points, but longer-term interest rates (such as the yield on 10-year US government bonds) did not go up as they normally do when the Fed hikes short-term interest rates. In the middle of this interest rate tightening cycle, a Senator asked Chairman Greenspan why long-term interest rates were not going up even though the Fed was hiking. Chairman Greenspan replied, “I don’t know. It’s a Conundrum.”

Alan Greenspan: I don’t think it does. If you look at double-entry bookkeeping in the national accounts, the type of transactions you’re talking about don’t directly affect that. That is, if you get a central bank, let’s say the case in which is the most general way, in 2008 the federal reserve, because everyone wanted to hold dollars, which I found very fascinating as it was as late as … Remember, we were a fiat currency, we were a weak fiat currency, but stronger than everybody else so through that crisis reserves were US dollars and the federal reserve made a large number of swaps, which were temporary exchange of dollars for Lira, for Euros, any foreign currencies of other central banks.
 

They were unwound shortly thereafter so it’s not … The basic problems are, you get bubbles because human nature is what it is. People get euphoric. We know by experience that fear is a far more formidable force in human activity than euphoria and as a result, for example, recessions go down far more sharply than recoveries and the stock market behaves exactly the same way so that you’ve got these very odd patterns. Without getting into too much detail, most economic models that work try to integrate human nature into the asymmetries that we’re seeing. What I’ve seen at the moment that you would not have gotten a crisis in 2008 if we took, say, eliminated Dodd-Frank completely and merely substituted a significant increase in equity capital requirements in the commercial banking industry for everything else.

 

The reason I say that is we have data going back in the United States to 1869 since the beginning of the control of the currency and that shows that income, net income of commercial banks to equity assets has been a remarkably stable five …

 

Richard Duncan: I’m sorry, could I interrupt. This wasn’t a swap, this was a central bank, the PBOC, printing money, buying dollars and buying treasury bonds, pushing up their price and pushing down their yield.

 

Alan Greenspan: Everybody does that but you can’t push the yield down if the market’s running against you.

 

Richard Duncan: You were trying to push them up by hiking the Federal Funds Rate by 425 basis points …

 

Alan Greenspan: I wasn’t there.

 

Richard Duncan: This was when you were hiking rates in 2004, 2005 and 2006, but the ten-year bond yield didn’t go up ..

 

Chairman Greenspan retired from the Fed in January 2006.

 

Alan Greenspan: No, what happened then is what I call “The Conundrum”.

 

Richard Duncan: Yes.

 

Alan Greenspan: We thought, what we thought was that we had to tighten the markets and as we did the only tool that we had was the federal funds rate and historically we did not trade in the long end of the market.

 

Richard Duncan: My question is, the long end didn’t go up because the PBOC was printing RMB, buying dollars and buying treasury bonds.

 

Alan Greenspan: No, that’s not the reason. The reason was that the cold war came to an end and the Berlin wall came down and you have a huge increase in the number, it was something like a billion people came out from behind the iron curtain and tried to integrate with the remainder of the world’s economy and obviously the economic ruin behind the iron curtain that was exposed when that wall came down was a great shock to everybody. You had all of these semi-skilled people moving into the west and there was enough of a downward pressure on wages because big new supply occurred that you’ve got interest rates going down.

 

For example, I remember extraordinarily well that Mexico was able to issue a 20-year peso-backed bond at a reasonable interest rate, not terribly much above the United States. This is within a relatively few years. Remember in 19 … I’m trying to think, it was when Mexico was about to go bankrupt, which was 1984 and it had Tesobonos, which were basically not backed by anything and we bailed them out, the United States bailed out Mexico at that particular point. They were able to come back very few years later with a 20-year issue in pesos and they couldn’t … For decades, I don’t think they ever were able to issue a 20-year peso-denominated anything.

 

Richard Duncan: The creation of the equivalent of 10 trillion dollars by the foreign central banks between 2000 and 2014 had no impact on the global savings glut?

The event organizers were signalling (and had alaready signaled a few times) that my time was up….

 Global Savings Glut: Both Ben Bernanke and Alan Greenspan explained that the Fed was unable to prevent the property bubble in the United States (and, consequently, the global economic crisis, because there was a “global savings glut”).   By that they mean that people in the developing economies had a very high savings rate and they chose to invest their savings in US Dollar-denominated assets, instead of investing at home. Their investments caused US bond prices to rise and US bond yields (i.e. interest rates) to fall. And there was nothing the Fed could do about it.

We don’t know because you can’t tell. There were so many forces at play at that time it was difficult to separate them. We were confronted with the fact that with this huge increase in savings, because remember, the income of the previously behind the iron curtain countries was not spent, they saved a good part of it because there were no institutions for savings. That drove down the long-term rates in the market of both the US dollar and all other rates. In that type of condition you’ve got a very difficult problem on the part of the federal reserve who was trying to raise rates but the flood, the savings glut, was coming from the movement of funds from behind the iron curtain, basically.
 

These were people who were literally blocked off until you got a huge increase and the rates kept going down for a number of years. I don’t know whether, to what extent you can attribute anything to anything, but that was critically the major factor in retrospect.

 

End

I find his final remark especially fascinating: “I don’t know whether, to what extent you can attribute anything to anything….”

Also, I’m not sure how much money the people behind the iron curtain had saved up, but I’m sure it was no where near $10 trillion dollars. I would be surprised if as much as $100 billion of savings moved from Eastern Europe to the US. The iron curtain fell in 1989. The Conundrum occurred between mid-2004 and mid-2006.

I believe this Q&A with Alan Greenspan is of historic importance. Subscribers to Macro Watch can log in now and watch the new Macro Watch video to find out why.

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9 comments

  1. Interesting comment as to the deflationary effect of the increase in labor supply consequent to the dismantling of the berlin wall; but, as you say, in 1989. A billion people? That’s in the range of 14-20% of global population, depending upon the time selected in the 20 year period following. I share your doubt as to the magnitude of a “second-world” savings glut dumping into Europe and the United States – certainly it could be nowhere near the $10T figure you cite as produced by foreign central banks.

  2. Hi Richard,
    Can you expand on your reference to the Q&A being of historic importance. I’m slightly [understatement] perplexed at AG’s responses. For such a great mind, the historic importance that I get from this is that a Fed chairman has a large blind spot in understanding the causes of the crisis and more broadly how the economic machine works… Kind regards, RF.

    1. I have just read the accompanying slides and I now get why you believe [the Q&A] its of historic importance.

      Fully agree that “I don’t know whether, to what extent you can attribute anything to anything…” was weak.

  3. Richard,

    First, thanks for this post. I learned a lot the last time you brought this question up (when you thought AG knew the answer in his Congressional testimony but was dodging).

    But I think I understand and agree with AG view here, and would have probably answered it in the same way. Because he’s going a layer deeper to what’s actually the root of the issue.

    What I mean: When other counties print fiat and buy dollars (e.g., China) their currency doesn’t just collapse to nothing. Why? Because they are WORKING for peanuts and exporting real goods and services to us at a discount. So it’s not their “printing” that causes problems. It’s the fact they use their WORK is being used to fund investment (this is the “savings glut” that AG is taking about) and not consumption.

    Here’s how to best understand AG answer IMO: imagine Cuba or Zimbabwe decided to print to devalue their currency. Well, it wouldn’t do anything but collapse their currency. But China (and others) using their printed money tactic to produce real goods and services to sell to us. America merely goes into debt without having to print ourselves.

    So AG answer makes sense to me. It’s all about the savings glut. Printing money is merely an effect, not the cause. AG is thinking deeper that the mere mechanism or tactic. He’s looking at strategy and root cause.

    But I agree with you America could have stopped the crisis by creating trade barriers pr trade balance. But that’s not AG job, he just handles currency. It’s political policy that decides how we deal cheap labor. Hello, Trump!

  4. Hmm very interesting, but rightly or wrongly it confirms a suspicion I have had for some time. His statement “No, that’s not the reason. The reason was that the cold war came to an end and the Berlin wall came down…” suggests to me that whatever the cost, during the 90s the West had to appear as if it had won the cold war. It had to be a good place to live for the **highly skilled** workers migrating to the West (not semi skilled at all as AG states). If the Soviet Union and the West had both gone into political/economical collapse at the same time it would have been a geopolitical stalemate.

    I completely agree with your analysis that the whole setup was triggered post-Nixon shock by exporter states having to reinvest their paper money and perpetuate the cycle of export-print money-buy dollar-invest-dollar-US consumer consumes-export more. My suspicion is that the whole thing was perpetuated into a gargantuan bubble because at the time it was in everyone’s interests to do so.

  5. Richard

    Please could you elaborate on Mr Greenspan’s statement here : ” I don’t think it does. If you look at double-entry bookkeeping in the national accounts, the type of transactions you’re talking about don’t directly affect that.”

    Why would he think that to be the case? He seems to think that there is no mechanism between that connects that printing with the effects you were describing. What would be your description of the mechanism and why would AG differ in opinion?

  6. If Dr Greenspan, and his successors, did genuinely not understand at the time (2008) that money creation at such an unprecedented scale was the cause of the crisis, what still prevents them, in 2017, to understand and acknowledge this fact, seeing the further harm it has done to the economy?

    Are they really so blind as not to understand, eight years layer, what the policies promoted by central bankers had led to? This is very surprising, because they would only need to read the very comprehensive and critical opinions now openly expressed by eminent economists:
    http://www.telegraph.co.uk/business/2017/01/23/damaging-low-interest-rates-qe-must-end-now-think-thank-warns/
    http://www.cps.org.uk/files/reports/original/170119134902-StopDependingontheKindnessofStrangers1.pdf

  7. It seems to me AG is playing dumb. I don’t believe Central bankers will ever admit or acknowledge the effects of fiat money creation on asset prices and other economic distortions. It appears the only thing of importance is keeping the debt based economic system intact and preventing its collapse as has been the case with all credit bubbles in history. Admitting anything else would undermine the faith and confidence of the masses in their political leaders and expose the illusion of the current system. Welcome to Oz! The emperor has no clothes. Place you bets and decide how long you want to stay on the dance floor as Jamie Dimon once stated.

  8. Great video. I think Greenspan was in deliberate denial . A smart man like him surely know what the cause behind the global savings glut. Remember that politics are inherently very savaging ( power hunger) and also by nature very short term oriented. ( they more focus on if they can be re-elected or the immediate outlook of the domestic economy). Of course, if they knew that the GFC is coming , they probably would have stopped.
    I think the US dollar as a world denominated currency had made these possible, of course with a huge price tag. US is willing to go under huge current account deficit ( aka export demand) not because they want to help out the third world country( despite that has been a good outcome out of this exercise) . But because that it takes less effort to see immediately result ( the growth on GDP and peoples wealth effect without having to pump up productivity.) This is a very good short cut for political trump with little to no side effect ( or at lease while they are in power ) . The future disaster can be handled by the successor. I think Alan almost got away with it.. but not quite.
    ‘there is no truth, just perspective’ Please dont be offended by my sheer honesty.

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