Approached with an open mind, there is plenty of thoughtful analysis of the future in Alan Greenspan's surprisingly readable memoirs. 

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There was something reassuringly comforting about the market’s positive response to the Federal Reserve’s 0.5% interest rate cut last week. It must be open to doubt how relevant (other than as a symbol) the cut is to resolving the immediate crisis in the interbank lending market, and how wise it will prove to be in terms of the future behaviour of banks and investors.  Moral hazard is still very much alive and well. 
 
While it will buy time for the credit markets to return to a more orderly state, and for stocks to avoid a nasty fall, it means that Mr Bernanke will inevitably get a lot of flak from high-minded observers. But the Fed’s move, bolder than some expected, will at least serve the purpose of providing an important measure of emotional comfort to market participants.
 
In times of financial crisis, it is surprising how even the most seasoned bankers feel the need to shelter behind the comforting illusion that somebody somewhere is in charge of events, a role that politicians, with their low levels of trust, are typically ill-suited to provide.
 
In his memoirs, Alan Greenspan relates how during the October 1987 stock market crash, his “most harrowing” conversations were with financiers and bankers that he’d known for years, “major players from very large companies whose voices were tightened by fear. These were men who had built up wealth and social status over long careers and now found themselves looking into the abyss. Your judgment is less than perfect when you’re scared”.
 
Greenspan’s message on those occasions, he tells us, was: “Calm down. It’s containable”. Even Goldman Sachs, he relates, was on the point of reneging on an overnight commitment to transfer $700m to Continental Illinois in the aftermath of Black Monday, something whose consequences in an already fragile lending market might well have been catastrophic, both for the markets and for Goldmans itself.
 
On such occasions, even hardened men of the world have nerves that need to be steadied. While queues of bank depositors looking to take out their money dominate the TV news, the real damage in any financial crisis comes not when borrowers panic, but when lenders lose their confidence and bottle. No central banker can claim to have earned his spurs unless he has exerted his authority to forestall a market panic in this way.
 
What is interesting about Mr Greenspan however, and makes his memoirs (The Age of Turbulence) of more than passing interest, is that his time in charge of the Federal Reserve has, by his own admission, seen an unprecedented diminution of the chairman’s powers to shape events in the financial markets. The chairman of the Fed remains the pivotal figure in the global financial system, with unrivalled power to move markets in the short term.
 
But those who laud him as the saviour of the markets during earlier crises, such as the Watergate sleuth Bob Woodward is his ludicrously favourable biography Maestro a few years ago, overlook the fact that a combination of globalisation and financial innovation are steadily undermining the scope and reach of the Fed chairman’s powers. To the casual outside observer the head of the Fed may appear to be Superman: but to the man in post, from the inside looking out, there is more than a hint of the Wizard of Oz.
 
The main charges against Mr Greenspan are that he failed to stop the Internet bubble in time; and that by keeping the cost of money too low for too long, and introducing the Greenspan put, he has helped to inflate a series of ever bigger bubbles in asset prices, whose consequences, when they finally emerge, will be both nastier and more enduring than if he had acted in a more decisive manner earlier.
 
There is truth in that, but the case for the defence is not without its merits either. Greenspan’s argument is essentially that pre-emptive measures would have been both futile and costly, given the overwhelming power of the disinflationary forces that were being unleashed by a potent combination of technology-related productivity gains, continued globalisation and the introduction for the first time into the capitalist world of two billion new workers in the Former Soviet Union, India and China.
 
For most of his time in charge, in other words, all the Fed’s policy decisions were taken with a huge and favourable tailwind. The yield on the 10-year Treasury note, he notes, peaked at 10.6% immediately after Black Monday and proceeded to fall for the next 16 years, “seemingly irrespective of the Fed’s policy stance”. While every tiny interest rate move immediately seemed to reduce short term inflationary expectations, nothing that the Fed could do with the tools at its disposal seemed capable of raising long term bond yields (the “conundrum” he referred to on more than one occasion).
 
In the circumstances, keeping the economy moving, which is one half of the Fed’s mandate, and letting asset prices find their own level, was not such a foolish policy for a pragmatic Fed chairman to pursue, as long as conventional inflation targets were being met. While such a laissez-faire attitude towards asset prices seems instinctively offensive, no counter-factual academic has yet, it seems to me, convincingly demonstrated that the argument is wrong.
 
In his final chapter, Mr Greenspan outlines the way that global forces in his view are likely to shape the world economy over the next 25 years. As the fortuitous trends that so favoured his tenure unwind, the world he sees ahead is for the first time in a generation one of headwinds: slower economic growth, higher inflation (4.5% per annum) and 10-year bond yields at 8% or more. If he is right, investors would be wise to stop agonising over what might have been and concentrate instead on the challenges that this new order poses.  
  
  
  
  
  
  
  
 

Jonathan Davis
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