Greenspan’s missing principles

If you had the chance to spend an hour questioning the most powerful central banker of all time, what would you ask them?

That’s the position Dan Denning and I found ourselves in this week. We’ve been in Baltimore, joined by analysts from all over the world, to meet Alan Greenspan. The “maestro” himself. The man many people believe spawned the “bubble economy” we live in today.

Today I want to show you what we learnt. Pay close attention. Greenspan outlined a problem that could trigger the next financial crisis. He also spoke at length about a flaw in the financial and political system that could ruin your retirement (and create a sharp correction in the stockmarket in early 2017).

He also inadvertently proved – at least to me – why no matter how powerful a central banker may seem to be… the system always wins. I’ll explain what I mean by that in a second.

Leave your principles at the door, Alan Greenspan

You may already be familiar with who Alan Greenspan is and what he represents in the financial system. If so please bear with me. I’ll give you the short version for anyone who’s new to this.

Greenspan was the head of the Federal Reserve from 1987 to 2006. During that period, global debt grew from 11% of GDP to 115%. He experienced two major crashes (1987 and 2000/2001) in which he helped write the playbook today’s central bankers use: keep calm and keep printing. He left his position at the Fed just as the biggest bubble of the lot – the subprime housing bubble – was reaching its peak in 2006.

But what makes him such a fascinating character isn’t just that. It’s the fact that prior to becoming the hero of central bankers and centrally-controlled economy enthusiasts the world over… Greenspan actually claimed to be a gold bug and free market man!

He was also a libertarian. He believed in the same ideas we cherish and defend at Capital & Conflict: free markets, sound money, personal liberty and small government.

Yes he “believed” in hard currency. And he “believed” that a central bank should attempt to replicate a gold standard as closely as possible.

So how do you square that circle? How did he become the man who helped facilitate one of the greatest bubbles in financial history?

How did he slash rates, bail out financial institutions (starting in 1998 with Long-Term Capital Management) and expand the Fed’s balance sheet while simultaneously believing in free markets?

Is he a hypocrite?

A sell-out? A schizophrenic?

That’s why Bill Bonner asked Greenspan to come and talk to us. At least, it’s one of the reasons. But did he answer the question?

Not quite. You don’t run the Fed for 19 years without picking up a few tricks of the trade when it comes to the art of misdirection. The closest we got was that he had a choice of “being on the outside shouting in, or on the inside biting his tongue occasionally”. He also claimed he felt duty bound to “follow the law of the land” once in office.

I’ll give him a 9.8 for the mental gymnastics.

But moral contortions aside, did Greenspan acknowledge any mistakes in policy? Show contrition? To me, the most important question was does he really believe it is right for a central banker to have the power to distort the markets, reshape the economy and distribute wealth according to what they think is “right”?

In short, has economics become completely divorced from ethics?

Here’s how that exchange panned out:

Question: I want to ask you about institutionalised theft. Do central bankers think about the consequences of their actions for households and consumers who have saved all their life, who have expected a compounding effect in their savings, but they’re now expected to assume no compound interest, no increase in savings?

They get to the end of their working days and what they’re faced with is nothing to compensate them for not locking in.

You’ve mentioned Brexit and you’ve mentioned Donald Trump to a certain extent, Scottish independence. I would also argue [those votes] wouldn’t have happened if interest rates had been above zero as well.

The reason for saying that is that when I look at the results of Brexit and Trump, it inevitably brings up immigration in the UK. And yet most of the people who voted for Brexit don’t work. They don’t have a problem with immigrants taking their jobs, but they have a problem with having to save more and more every year in order to eke out an existence.

What was the thinking of central bankers about keeping interest rates so low that it’s tumbling people into a very different political movement now?

Answer from Alan Greenspan: Let me tell you. [Pause] There’s one thing that bothers me considerably, which nobody makes any mention of. There is in the European Central Bank a mechanism as it exists of necessity where the European Central Bank is made up of the central banks of the European, euro area and there’s a thing called TARGET2, do you know what TARGET2 is?

That pause, between “let me tell you” and his completely unrelated answer about Europe, was perhaps the most illuminating part of the entire conversation.

It was the point the most famous central banker of all time could have acknowledged, or attempted to defend, the moral bankruptcy at the heart of central banking. No one ever gave central bankers the right to decide who wins and loses in the economy. Through their policies they redistribute wealth and create massive inequalities. The anger caused by those policies is now being felt as part of “populist” movements.

But he didn’t. He paused… and moved on.

And so must we. Because what Greenspan used as his conversational escape route was Europe – and what he clearly believes could be the next major financial crisis.

Watch Europe for the next financial crisis

I didn’t expect Greenspan to make any major predictions about the US monetary system. He’s biased: the dollar is part of his legacy.

Like a parent incapable of seeing the flaws in their children, I doubt he’ll ever truly acknowledge the financial problems he helped create in the US.

That’s not true of the euro, though.

When it came to the eurozone he was surprisingly direct. From where I was sitting, it sounded like he believes the next major financial crisis will be triggered by either Greece or Italy and will result in the total destruction of the euro as a major currency.

Greenspan pointed out that Mario Draghi’s promise to “do whatever it takes” – otherwise known as his promise to flood the market with freshly printed euros until everyone just leaves him alone – has a flaw. It only works if people are willing to accept euros.

Someone in Greenspan’s position at the Fed doesn’t quite have this problem. The dollar is still the world’s reserve currency. For as long as that lasts, people are going to need dollars. You can print with abandon because there’s no real alternative.

That’s not true in Europe

There are two reasons why.

Firstly, internal demand. By that I mean demand for euros within eurozone nations. There’s a high level of demand there because people need euros to pay their taxes.

But equally those nations didn’t always use the euro. People have long memories. They remember when the euro didn’t exist and each nation had its own currency. Perhaps they even yearn for the good old days.

It sounds like Marion Le Pen does, anyway.

Earlier in the week she proposed the creation of a new basket of currencies to be used in Europe – a kind of shadow euro. France could then reinstate the franc and peg its currency to that basket.

That’s one way in which internal demand for euros could drop – a move back towards national currencies. Once you pay your taxes in francs… there’s not much incentive to hold euros.

The other mechanism would be external demand falling. That means the rest of the world looking at Europe, seeing its huge structural problems will never be resolved, and ditching the euro.

Again that would lead to a situation where “nobody wants euros” any longer. Draghi may as well be printing monopoly money at that point. He’d be out of ammo.

Of course, either one of those scenarios would likely trigger the other. External demand drying up would push more nations towards reinstating national currencies. Or vice versa. It doesn’t really matter. Europe is doomed either way.

The end of the welfare state

An equally pressing threat to investors and savers in the Western world, according to Greenspan, is entitlement spending. No one even mentioned it in the US election. Why?

Because mention it and you’ll lose! The US entitlement system is unsustainable. It was a topic Greenspan brought up unprompted. Perhaps that’s what keeps powerful former central bankers up at night: how do we pay the people all the money we’ve promised them in retirement?

It’s the same problem across the Western world. You need the right demographics to keep a large scale entitlement/retirement system well funded. Very few countries have those demographics. That clearly worried Greenspan.

We’ll come back to that another time. But the short-term prediction he made was that budgetary restraints will prevent Trump from doing much of what he’s promised. If that’s the case and large-scale fiscal stimulus doesn’t happen, the Trump trade will have to be unwound and markets that have priced it in will correct.

Trump will be inaugurated just hours from now. Perhaps we’ll start getting some answers soon!

Have a great weekend.

Nick O'Connor's Signature

Nick O’Connor
Associate Publisher, Capital & Conflict

Category: Geopolitics

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