Why Greenspan Trashes the Markets

by | Mar 1, 2000

When Federal Reserve chairman Alan Greenspan speaks, markets listen. But Mr. Greenspan doesn’t create wealth, as E.F. Hutton did when he spoke. Mr. Greenspan’s speeches tend to destroy wealth. Last week, for example, Greenspan told Congress that he’ll keep raising interest rates. In response, the stock market plunged nearly 3%-meaning that about $400 billion of […]

When Federal Reserve chairman Alan Greenspan speaks, markets listen. But Mr. Greenspan doesn’t create wealth, as E.F. Hutton did when he spoke. Mr. Greenspan’s speeches tend to destroy wealth.

Last week, for example, Greenspan told Congress that he’ll keep raising interest rates. In response, the stock market plunged nearly 3%-meaning that about $400 billion of wealth was destroyed. We have only Greenspan to blame for the drop, because there’s nothing wrong with the American economy. Growth is strong, corporate earnings are up, inflation is down, job creation is robust. Rising stock prices reflect this good news-and the chance it’ll persist. The market is an efficient mechanism for valuing companies.

But the Fed presumes otherwise. It believes the market is a “bubble” and that rate hikes are needed to burst it. In fact, these rate hikes will only boost inflation, depress earnings, and lower the value of companies. Invariably, that’s what has happened before.

This isn’t the first time Greenspan has destroyed investors’ wealth. The stock market usually plunges when he speaks. He made similar remarks and raised rates dramatically in the months before the October 1987 crash of 30%, when nearly $3 trillion of wealth was destroyed. In December 1996 he said the market’s rise was due to “irrational exuberance.” Stocks fell 10% in the following weeks-a destruction of $1.3 trillion in wealth. Since June of 1999 he has raised interest rates by one percentage point. The market is lower today than it was then, resulting in billions in foregone wealth creation.

The real problem in these cases was not inherent to the private economy. The problem was Greenspan’s view that prosperity is inherently “unsustainable.” Greenspan believes prosperity sows the seeds of its demise. He insists that economic growth breeds inflation. But this view defies both logic and history.

Historically, this country’s fastest growth rates occurred precisely when inflation was lowest. For example, America in the 19th century saw the stupendous rise in output known as the Industrial Revolution. Yet the inflation rate for most of the century was virtually zero. In recent decades, that performance has been repeated, on a smaller scale, by a computer-based technological revolution that has been characterized by relatively low inflation. In contrast, the 1970s saw frequent dollar devaluations and skyrocketing inflation-with the result of rising interest rates, economic stagnation, deep recessions, and double-digit unemployment. The historical evidence is clear: growth and inflation do not go together. In fact, they are irreconcilable opposites.

Logically, this should be expected. When money has stable purchasing power, businesses can plan more effectively and thus grow more quickly. Prosperity is a result of low inflation, not a danger to it. And the higher wages made possible by growing productivity do not undermine the purchasing power of money. Inflation only occurs when the government prints paper money that is not backed by increased production.

By raising interest rates and encouraging economic contraction, Greenspan proceeds to punish the businessmen for the sins of the bureaucrats.

But Greenspan’s theory shifts the blame for inflation from the government to the private sector. He blames inflation on “too much” production rather than too much paper money. Then, by raising interest rates and encouraging economic contraction, Greenspan proceeds to punish the businessmen for the sins of the bureaucrats.

Greenspan has a reputation as pro-free-market economist, and many pundits credit him for the economic and financial gains of the 1990s. But this reputation is undeserved. The Federal Reserve is a form of socialist central planning applied to money and banking, and socialism has been a wealth destroyer wherever and whenever it’s been practiced. Not surprisingly, the Fed has never delivered on its supposed job of providing sound money-not even under Greenspan. The dollar has lost 95% of its purchasing power since the Fed was formed in 1913-and 47% of its value since Greenspan became Chairman in 1987. By contrast, in the 19th Century-a gold-standard era with no Federal Reserve-a dollar bought as much at the finish of the century as at the start. Both inflation and interest rates today are far higher than under gold-based money: the last time the US had a gold-based dollar, a 30-year mortgage cost 4% — today it costs 8.5%. Is this the “achievement” for which Greenspan deserves credit?

To the extent we’re prosperous today, it’s despite Greenspan’s speeches and policies-as the market turmoil that follows his pronouncements reflects. Were Mr. Greenspan still a private sector economist, his false musings would fall harmlessly on deaf ears. But when he speaks as the Fed’s head, markets are forced to listen-and react accordingly.

Made available through The Center for the Moral Defense of Capitalism.

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Dr. Salsman is president of InterMarket Forecasting, Inc., an assistant professor of political economy at Duke University and a senior fellow at the American Institute for Economic Research. Previously he was an economist at Wainwright Economics, Inc. and a banker at the Bank of New York and Citibank. Dr. Salsman has authored three books: Breaking the Banks: Central Banking Problems and Free Banking Solutions (AIER, 1990), Gold and Liberty (AIER, 1995), and The Political Economy of Public Debt: Three Centuries of Theory and Evidence (Edward Elgar Publishing, 2017). In 2021 his fourth book – Where Have all the Capitalist Gone? – will be published by the American Institute for Economic Research. He is also author of a dozen chapters and scores of articles. His work has appeared in the Georgetown Journal of Law and Public Policy, Reason Papers, the Wall Street Journal, the New York Times, Forbes, the Economist, the Financial Post, the Intellectual Activist, and The Objective Standard. Dr. Salsman earned his B.A. in economics from Bowdoin College (1981), his M.A. in economics from New York University (1988), and his Ph.D. in political economy from Duke University (2012). His personal website is richardsalsman.com.

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