Hear Alan Greenspan explain in plain English exactly why the Fed needed to raise interest rates in May 17, 2000. Click on the link below. Why raise rates?
(Al and Paul ran into each other at a convenience store in DC not long after today's May 16, 2000 rate hike. An agent for iTulip.com, hiding behind a rack of Hostess cup cakes, caught the following conversation.)
Paul: Hey, Al. How goes the bubble?
Al: Oh. Hello, Paul.
Paul: Nice hike today. Almost a "real" one. Ha ha. You know, like I used to do. A whole percent at a time. Wow. Those were the days.
Paul: Remember the last time you raised interest rates a full 50 points when the stock market was up in the clouds? I don't mean back in 1995 before the market was showing, how'd you put it in 1996, "irrational exuberance"?
Paul: Yes, waaaay back in August 8, 1987. I recall what happened next. Didn't happen right away, though. Market hit a new high a few weeks later... August 26, 1987. Then it turned down the next day, I remember that. Then I guess it flopped around for almost two months, like a fish on a pier, until October 19...
Paul: Then it just CRASHED.
Al: True, true. Remember when you raised rates in the 70s and inflation just got worse and worse? Speculation in real estate got totally out of control.
Paul: Yeh. And you got the same problem, Al. That's what happens when you move rates up in wimpy little baby steps and tell all those reporters you're gonna do it a week in advance. You do rate hikes that way and consumers get ready for ya. They build in expectations of rising rates right into their purchase decisions. They accelerate purchases of cars and houses and other stuff they buy on credit before loans get more expensive. They know that's gonna happen... 'cause you tell them! Demand increases short term.
Al: Well, Paul, as you well know, I can't surprise the markets...
Paul: On top of that, businesses start passing on higher money costs to consumers. That behavior carries over into cash purchases as well.
Al: So you're saying... what.
Paul: That you've kicked off an inflationary cycle with your rate hikes. Nice going, Al! First a stock market bubble with that insane money growth policy of yours and now inflation with your rate-hike-of-the-month program. What a dope!
Al: Hey. I can see when something's not working. I don't wait until inflation's reached, oh, 14% like some central bankers have in the past here in the US of A. I abandoned the 25 point rate hike policy this time and gave it 50 points.
Paul: But it wasn't a surprise, Al. I know you don't want to sneak up on your bubble stock market -- boo! -- 'cause you know it's going to pop if you do. But you warn consumers in the bargain so they keep accelerating purchases to beat you to the next rate hike. Look at real estate prices. Crappy little ranch houses in northern CA for a million bucks, up from $500,000 since you started hiking rates. Oh, they're scared, Al. They're terrified. Ha! Look at that demand curve at work... in the wrong direction. Bwaaaaahahahahaha!
Al: Fine. Ok. So what would you do, Paul.
Paul: Well, there's no way around it. Ya gotta surprise 'em. Sneak up and hit 'em with a base ball bat. You did that on the down side with those emergency rate drops you did in 1998. The markets love that kinda surprise. Well, do it in reverse. Look at my rate hikes from September 26, 1980 to May 5, 1981. A full 1 percent each time, from 10% all the way to 14%. Whack, whack, whack! No tears. God, that was fun!
Al: I can't do that, Paul. The dollar is already too strong. We're killing the euro. The Europeans will start a trade war. Look at the US current account deficit. Besides, your hikes from 10% to 14% were an increase of 30% over two years. I've brought rates up from 4.5% to 6.5%... that's a 30% increase but in only a year and a half.
Paul: Yah, but you did it in those little predictable steps. What a waste! You got to keep consumers guessing. Forget the stock market. It's gonna crash sooner or later anyway. What's the big deal? You crashed it in 1987 and everyone was ok. You do want to hit the demand curve, don't you? You can't have it both ways.
Al: Remember what you said last September about 50 stocks?
Paul: Yes! That was great! "The fate of the world economy is now totally dependent on the US stock market, whose growth is dependent on about 50 stocks, half of which have never reported any earnings." I got a ton of press outa that one.
Al: You know, I had a hard time not taking that personally.
Paul: Really? Ha ha.
Al: Anyway, you know why I can't let the stock market tank, not now. Demand may collapse with it. The world depends on the US. Asia in general and Japan in particular are still fragile...
Paul: ...not to mention the need to keep the dollar strong enough to help Asia export their way out of their crisis but not too strong to piss off the euros. But ya can't save the world, Al. You can't make everyone happy. You were very critical of the Fed's decision in 1927 to try to bail out the Bank of England as I recall... disaster.
Al: I'm in a tough spot, Paul. I wish the US was a creditor as when you were running the Fed. I wish the rest of the world was in better shape.
Paul: You're whining, Al. Lemme give you some advice. To make a long story short, you're screwed. You launched inflation with that burst in the money supply you created end of last year for the Y2K crisis that never materialized. Inflation was carried forward by rising oil prices. Then you got the economy creating new kinds of money faster than you can make categories for 'em How about M22? Ha! I didn't have that problem. Mine were OPEC and the pols and generals. They make inflation Al, we gotta deal with it.
Paul: Look, the economy's gonna do a face plant Q4 this year. You know that. The important thing is to keep the dollar up or you're toast, recession or not. I taught you that, at least, didn't I? Now, a recession's a tough thing in an election year. Lot's of heat. Heck, I did it to Carter. No sweat. The trouble is inflation's gonna keep coming at ya like a cat at catnip.
Paul: Yup 'cause the dollar's gonna tank when that recession happens, even if you crank rates up to 10%. The Japs and Chinese and Brits... they're all gonna sell their US stocks and bonds when they see the economy turn. Dollars all over the place. It'll make my 70s inflationary recession look like a cocktail party! Ha!
Al: You know, Paul. You're a jerk.
Paul: Yah. That's why I made such a good Fed chairman. And you're a swell guy, Al, giving Wall Street, the bond traders, the banks, and the pols everything they want. You created a budget surplus with your bubble market. Rich guys love ya. The middle class loves ya. The working Joe's got a stick in the eye. But who cares? You please just about everyone, Al, which is why you suck as a Fed chairman. You care too much that people like you. It's your Achilles heal. Listen -- they love ya on the way up, but they ain't gonna love you when this thing goes back down.
Paul: I gotta go. Parting words to the wise. When's your next meeting?
Paul: Hike 25 points between now and then, say, in two weeks. A little surprise. A message. Get it?
Al: See ya, Al. Good luck! Ha ha.
Paul: Yah, good running into you.
"I meant to say the Internet improves reproductivity."
Occasionally Greenspan is pressed to explain how new technologies improve the efficiency of corporations enough to keep inflation tame so late into the current economic expansion. He waves his hands and mumbles about the Internet and fiber optics in the same sentence, implying that these technologies are improving productivity. That's motherhood and apple pie for economists, but where's the evidence? Over and over, Greenspan demonstrates that he really doesn't have any idea how or have any evidence to support the claim that the Internet is significantly improving productivity. Many skeptics point out that an unaccounted for increase in work hours likely contributes more to improving productivity statistics than technological advances do. Cell phones, home internet access, faxes, pages... all these tools entice workers to extend their work hours, yet these hours are not in the statistics. Of ten hours per worker per day of productivity, only eight hours per worker per day is counted, exaggerating productivity per worker statistics.
We agree it sure "feels" like technology is making us all more efficient, but we patiently await solid evidence before drawing conclusions. Greenspan, on the other hand, is sufficiently convinced without such evidence that he continues to pursue loose monetary policy so as not to constrain the economy's growth, all the while fueling massive asset inflation.