The Greenspan years

The Greenspan years

December 19, 2007
The Greenspan years
The autobiography of America's central banker - logical positivism and political extortion
Robert B. Reich


How did a self-described “lifelong libertarian Republican”, son of Jewish immigrants and follower of the controversial 1950s philosopher and author Ayn Rand, become the most powerful force in the American economy for most of the past two decades – including the entire duration of the Clinton administration? As Alan Greenspan reveals in his memoirs, his success was due, first, to being in the right place at the right time. He was appointed chairman of the Federal Reserve Bank, America’s central bank, at a time when Keynesianism – the belief that government could wisely stabilize the economy through spending and taxing – was becoming discredited, and when America began relying as never before on its central bank to do that job. Greenspan was also fortunate to enter government just as Republicans were in the ascendant. He joined Richard Nixon’s Presidential campaign in 1968 and Nixon appointed him to chair the President’s Council of Economic Advisors. In 1987, Ronald Reagan appointed him chairman of the Federal Reserve. Above all, as his memoir reveals, Greenspan’s power lay in his deep understanding of the way the American economy actually works, as opposed to how it works in theory. As America’s central banker, Greenspan eschewed standard economic models in favour of hard data. His empiricism had deep roots – as a young man he had been deeply influenced by Ludwig Wittgenstein and logical positivism. “The world would become a better place”, Greenspan learned, “if people focused exclusively on what was knowable and important, which was precisely logical positivism's aim.”

Greenspan’s greatest legacy stemmed from his commitment to what was knowable and important when the standard economic models suggested otherwise. Based on how the economy had performed in the 1970s and 80s, those models assumed that if it grew faster than 2.5 per cent a year and the rate of unemployment dropped below 6.5 per cent, inflation would result. Prices would rise as workers demanded higher wages and suppliers’ inventories grew depleted. By the spring of 1996 the US economy was growing at an annual rate of 6 per cent and unemployment had dropped to well below 5.5 per cent, suggesting that Greenspan and his colleagues should slow things down. But Greenspan the empiricist saw an economy very different from that of the 1970s and 80s. “Innovations like the Internet and e-mail went from exotic to ubiquitous. Something extraordinary was happening . . .”, he writes:

"The textbook strategy would be to tighten rates, thereby slowing economic growth and nipping inflation in the bud. But what if this wasn’t a normal business cycle? What if the technological revolution had, temporarily at least, increased the economy’s ability to expand? . . . I zeroed in on what I believed to be the primary riddle of the technology boom: the question of productivity . . . . Year in and year out, business had been pouring vast amounts of money into desktop computers, servers, networks, software, and other high-tech gear . . . . This became evident as early as 1993 when new orders for high-tech capital began to accelerate after a protracted period of sluggish growth . . . . Most companies were reporting rising operating profit margins. Yet few had raised prices. That meant that their costs per unit of output were contained or even falling . . . . Productivity was truly accelerating. And if so, then rising inflation would be unlikely."

Greenspan convinced his colleagues at the Federal Reserve Board not to raise interest rates, and the rest is history. “By not being too quick to raise rates, we helped clear the way for the postwar period’s longest economic boom.” Unemployment eventually dropped to around 4 per cent, and, as demand picked up for unskilled workers, inequality temporarily narrowed. Bill Clinton is usually credited with the 1990s boom, but it was really a product of Greenspan’s willingness to take a fresh look at the high-tech economy that was emerging in America and reject the economic models created in a different era.

Greenspan’s most disturbing legacy sprang from a different source. As a young man he found in Ayn Rand the moral guidance he felt he needed for the rest of his life. Rand, founder of a libertarian philosophy she later termed “objectivism”, had made virtues out of individualism and enlightened self-interest, and was deeply suspicious of all collective effort. Greenspan grew to share Rand’s views. In particular, he was sceptical about efforts to help the less fortunate. “What attracted me to Reagan”, he explains, “was the clarity of his conservatism which was to say that tough love is good for the individual and good for society.” This “implies much less government support for the downtrodden”.

Bill Clinton was elected in 1992, in part to reverse what Reagan had wrought. Clinton promised to provide all Americans with the health care, education, job training and other supports they needed in order to adapt to a fast-changing economy, as well as repair the nation’s roads, bridges and ports, which had been neglected for many years. Yet by the time Clinton came to office, the federal budget deficit had grown so large he had to trim his ambitions. Ironically, that deficit had ballooned largely because Ronald Reagan had cut taxes and increased spending, mostly on the military. Although he was chairman of the Federal Reserve Board during Reagan’s final years in the White House, Greenspan’s memoirs don’t suggest he warned Reagan against the widening deficit. It seems more likely that Greenspan agreed with Reagan and others in his administration that deficit spending as Reagan undertook it would serve to “starve the beast”, forcing any subsequent Democratic President – such as Bill Clinton – to offer less support to the downtrodden.

The question we faced at the start of the Clinton administration (I was a member of Bill Clinton’s Cabinet) was how much deficit reduction was necessary, and how much of Bill Clinton’s original agenda would have to be jettisoned as a result. Greenspan urged Clinton in no uncertain terms to make deficit reduction the priority and sacrifice everything else. “The path to a beneficient future, I told the president-elect, was lowering the long-term trajectory of federal budget deficits.” What Greenspan did not tell Clinton, but admits in his memoirs, was that Clinton had been saddled with Reagan’s profligacy – almost exactly as Republicans had planned it. “Reagan had borrowed from Clinton, and Clinton was having to pay it back.” Greenspan’s advice to Clinton came with an implied promise and threat. If Clinton cut the deficit, Greenspan would reduce interest rates and allow the economy to expand briskly. This would make the “latter part of the 1990s . . . look awfully good”, thereby improving the odds of Clinton’s re-election. But if Clinton failed to cut the deficit adequately, Greenspan would not reduce interest rates, and the economy would continue to limp along, perhaps threatening Clinton’s re-election. Greenspan admits he was “not oblivious to the fact that 1996 would be a presidential election year”. He was, in short, engaging in political extortion. The choice was Clinton’s, but Greenspan held a gun at his head. “Either he could opt for a package of spending programs that would fulfill some of his campaign promises, or he could opt for a deficit-cutting plan . . . there was no in-between – we couldn’t afford both.” Several of Clinton’s advisers, of whom I was one, did not believe the budget needed to be cut as much as Greenspan wanted, or that so much of Clinton’s campaign had to be abandoned. As Greenspan puts it, “the conflict extended to within the White House, where key people were still pushing for an agenda less compatible with Wall Street”. But only Greenspan had a gun. So he and Wall Street won.

The ensuing boom seemed to validate the choice Clinton made, but in reality it only validated Greenspan’s power. Lower interest rates had the desired effect, at least in the short term. The economy surged forward, and Clinton won re-election. In the ensuing years, tax revenues exploded, the budget deficit disappeared, and by the start of the Bush administration the federal government had a significant budget surplus. For the first time in decades, America had the resources it needed to provide health care, education and job training, and repair the nation’s infrastructure. But Greenspan did not trust the government to do any of this. He threw his support behind a tax cut, instead:

"Chronic surpluses could be almost as destabilizing as chronic deficits . . . . Spending would have to be raised or taxes cut, and to me the preferable course seemed clear. I have always worried that once spending is notched up, it is difficult to rein in. The same is less true about tax cuts."

Greenspan’s testimony before Congress in 2001, calling for a tax cut, was critical to George W. Bush’s successful mustering of the political support he needed for his mammoth tax cut, the benefits of which have gone mostly to wealthy Americans. The Bush tax cut drained the federal treasury, eliminating the entire budget surplus within months. Greenspan writes that he didn’t intend to endorse the Bush tax proposal specifically, but this seems disingenuous. Bush’s proposal was the only one under consideration at the time, the new President had made it the centrepiece of his economic policy, and Congressional and media attention was riveted on it when Greenspan testified. Greenspan must have known his testimony would be interpreted as support for Bush’s tax cut. He had spent decades in Washington and well understood the ways of the capital city. “I resigned myself to the idea that my testimony would be politically framed.” He later told his wife, in the mocking tone Claude Rains once used with Humphrey Bogart, “I am shocked, shocked, that there is politics on Capitol Hill”. Indeed, Greenspan admits he was “willing to be optimistic about the legislation’s effects. It would work down the surpluses before they became dangerous”.

What Greenspan still views as “dangerous” was a tragically missed opportunity to redress the nation’s long-term problems. They transcend the ups and downs of the business cycle, and must still be dealt with if middle- and lower-income Americans are to have any chance of improving their standard of living. In the new global economy, private investment will go anywhere around the world it can get the highest rate of return. The only aspect of a nation’s economy that remains unique is its people – especially their education, health and the transport and communications systems linking them together. These generate lasting productivity gains. But partly owing to Greenspan the libertarian, even if a Democrat were to retake the White House in 2008, the government wouldn’t have nearly enough money to do what is needed. America’s primary and secondary schools will lack the necessary resources to provide young people from lower-income families with the education they need. Tens of millions of Americans will continue to lack health insurance and tens of millions more will barely be able to afford the insurance they do have. America’s infrastructure will continue to deteriorate. Last July, a steam conduit dating from 1914 exploded in New York City; last August, a forty-year-old bridge collapsed in Minneapolis, killing several motorists. Finally, and for all these reasons, inequality will continue to widen.

Although the second half of his memoir dips into several important areas of public policy, Greenspan barely mentions the crisis in America’s health care system or the desperate state of the nation’s infrastructure, and he gives cursory attention to education. He urges that educators put greater reliance on “market forces” such as vouchers (“I suspect Rose and Milton Friedman . . . were right on track”), and briefly acknowledges that “the cost of education egalitarianism is doubtless high and may be difficult to justify in terms of economy efficiency and short-term productivity”. Greenspan writes that he is concerned about widening inequality, lamenting that the first decade of the twenty-first century has been “marred by a disturbing shift in the concentration of income” and that “two-tier economies are common in developing countries, but not since the 1920s have Americans experienced such inequality of income”. But given his support for Bush’s lopsided tax cuts for the wealthy and his deep aversion to Clinton’s original agenda for poorer Americans, his words seem strangely disembodied, if not hypocritical. Alan Greenspan the empiricist contributed a great deal to America, instigating the longest economic expansion in recent history and rewriting the rules of monetary policy. But Alan Greenspan the Ayn Rand libertarian has caused the nation grave injury.

Robert B. Reich is Professor of Public Policy at the University of California at Berkeley, a former US Secretary of Labor, and the author of Supercapitalism, 2008.