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Sayonara, Dr Greenspan!

Oct 25, 2005

Goodbye Dr. Greenspan! Welcome Mr. Bernanke! Well, Alan Greenspan's 19 years of reign as the 'first banker' of the world in his role as the thirteenth US Federal Reserve Chairman will come to an end in January 2006. And this is what he had to say of the incoming Chairman, Ben Bernanke - "The President has made a distinguished appointment in Ben Bernanke. Ben comes with superb academic credentials and important insights into the ways our economy functions. I have no doubt that he will be a credit to the nation as Chairman of the Federal Reserve Board." Who he was?
As reported in the Federal Reserve's website, "Alan Greenspan took office on June 19, 2004, for a fifth term as Chairman of the Board of Governors of the Federal Reserve System. He originally took office as Chairman and to fill an unexpired term as a member of the Board on August 11, 1987. Dr. Greenspan was reappointed to the Board to a full 14-year term, which began on February 1, 1992, and ends on January 31, 2006. He has been designated Chairman by Presidents Reagan, Bush, Clinton, and Bush (Jr.)."

What has he done?
Notably, under the stewardship of Dr. Greenspan, the US (and the world) has survived many crashes. The crash of 1987, the Asian crisis of 1998, the bursting of the stock market bubble in 2000-2001 were all shocks that might have had far worse consequences for the global financial sector and the world economy, were it not for appropriate intervention by monetary authorities (especially, the Fed).

The term 'irrational exuberance' became Greenspan's most famous quote, out of all the millions of words he has uttered publicly. This term is often used to describe a heightened state of speculative fervor in global financial markets (as was witnessed in the 2000-01 dot com boom). Greenspan had used this term in a speech before the American Enterprise Institute in December 1996, where he posed a question to the world central bankers - "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?" He added that "We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability."

Well, well, well! Immediately after he had uttered these words, the stock market in Tokyo fell sharply and closed down 3%. Hong Kong fell 3%. Frankfurt and London fell 4%. And the US fell 2% at the open of trade. The strong reaction of the markets to Greenspan's seemingly harmless question was widely noted, and made the term irrational exuberance famous.

However, the subsequent tightening (interest rate hikes) that followed Greenspan's speech was aimed not only at the asset bubble itself, but at the impacts such excessive appreciation in equity markets were having on the real economy. As the noted economist, Stephen Roach from Morgan Stanley quipped, "It was a classic example of the Fed playing the role of the tough guy - the central bank that takes away the punchbowl just when the party is getting good." Unfortunately, the tough guys weren't so tough after all.

As the Fed took aim on the US markets by tightening its monetary policy, there was opposition from Washington's political circles. And ironically, and depressingly for the world economy, the Fed ran for cover in the face of political criticism instead of standing by its stance in its role as an independent central bank. And as Stephen Roach adds, "Not only were its initial bubble-containment efforts put aside, but Alan Greenspan went on to champion the notion of a sea-change in the macro climate - a once-in-a-century productivity miracle that would justify the stock market's exuberance as rational. That was the Original Sin that has since been compounded in the years that have followed."

The asset-based spending model has, since then, given rise to a number of imbalances that the world is witnessing now. The US has piled up a huge current account deficit (to the tune of around 6% of their GDP). Now, despite such a strong consuming demand for credit, interest rates in the US have been lying low and the real interest rates (adjusted for inflation) have remained negative. There are two key reasons for the continued strong consumption demand from US consumers. One, they are buying at negative interest rates and investing in emerging market equities that provide them with higher return than the much safer US treasury bills and bonds. Two, to counter risks of currency appreciation due to high dollar inflows, the forex reserves that these emerging nations have built up are re-invested in US debt thus adding to the liquidity in the US money markets, which consequently results in interest rates remaining low. This has turned out to be vicious circle and has caused the current imbalance in global money and currency markets.

Greenspan had, recently, confessed that some of these imbalances have been a consequence of the extensive liberal policies of the Fed with respect to interest rates in the past few years. in the recently held 'Advancing Enterprise 2005 Conference' in London, Greenspan had owned up that the fall in US interest rates since the early 1990s has supported both home price increases (the asset bubble as it is termed) and, in recent years, an unprecedented rate of existing 'home turnover'.

These decisions aside, we believe that Dr. Greenspan has done a remarkable job for the US economy over these long years of his stay at the top. While his rate cuts of early part of this decade have led to the current imbalances (developing countries with their export based dependency model are also to be blamed), he has been an excellent crisis manager. His legend was largely built, in fact, on guiding the Fed's quick and reassuring action in the wake of the 1987 stock-market crash, the 1998 crises in Asia and Russia, the 9/11 terrorist attacks on the US and more. He has indeed done a good job! And with his going, an era has come to an end.

About Ben Bernanke
Ben Shalom Bernanke is the Chairman of the US President's Council of Economic Advisers. He graduated from Harvard University in 1975 and then earned his Ph.D. at the Massachusetts Institute of Technology in 1979. He taught at Stanford University from 1979 until 1985, and has since then been a professor in the Department of Economics at Princeton University. He is known for his work on the transmission channels of monetary policy, particularly a 1992 paper with Alan Blinder arguing that expansion of credit was more important than the money supply. His work on the transmission of monetary policy also gave rise to an interest in the causes of the Great Depression, a period in U.S. history accompanied by substantial monetary deflation. He has been nominated as the fourteenth Chairman of the Fed since the position was created in 1914. (Source: Wikipedia)

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