Greenspan's Self Congratulation

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

Greenspan may be patting himself on the back a bit prematurely and
undeservedly. At a meeting of the American Economic Asssociation in San
Diago on Jaunuary 3 of the new year, over a long holiday weekend,
Chairman Greenspan spoke on Risk and Uncertainty in Monetary Policy.  He
gave his personal view as a veteran from "the policy trenches."  It is a
very peculier topic, one that would be expected from the risk manager of
commercial bank, not a central banker whose job presumably is ensuring
systemic stability rather than managing, therefore accepting, sytemic risk.

Greenspan paid tribune to the tightening of monetary policy by the
Federal Reserve in 1979 under Paul Volcker for "ultimately breaking the
back of price acceleration in the United States, ushering in a
two-decade long decline in inflation that eventually brought us to the
current state of price stability."  Price acceleration in economics
means the worst kind of vicious circle in which price push up wages
which in turn pushes up prices with the process accelerating through
anticiaption eventually into hyperinflation, the killer of economies and
political systems. True to a central banker, Greenspan did not bother to
mention the cost, or pain, of such a monetary policy, only the
benefits.  Volcker ended inflation in the early 1980s by administering
wholesale financial blood letting on the US economy.  A case can be
easily made that the cure was worse than the disease. Nor did Greenspan
mention his role in causing the 1987 crash.   There are those with less
selective memories who will recall that Greenspan precipitated the 1987
crash by raising the discount rate 50 basis points to 6% at a time of
extreme interest rate sensitivity and pushed the economy over the edge.
Portfolio insurance has been identified as having exacerbating the
crash. The technique involves selling stock futures when stock prices
fall to limit or insure a portfolio against large losses. This gives
index arbitrageurs the opportunity to benefit from lower future prices
by buying futures in Chicago and selling the stock market in New York,
adding horrendous selling pressure in the market. But the fundamental
cause of the 1987 crash was the trend of corporations moving to debt
from equity financing. Corporate new debt tripled in a decade, with debt
service taking up 22% of internal cash flow. Total nonfinancial debt was
200% GDP in 1987, compared to about 120% in 1977, the year of high
inflation. Corporate credit ratings deteriorated but the lending did not
cease because funds were being raised in the non-bank credit markets
through securitization, causing the credit market to run away complete
from Fed control.

In the 1987 crash when the Dow Jones Industrial Average (DJIA) dropped
22.6 percent in one day (October 19) on volume of 608 million shares,
six times the normal volume then (current normal daily volume is about
1.6 billion shares), the US Federal Reserve under its newly installed
chairman, Alan Greenspan, merely nine weeks in the powerful post,
flooded the banking system with new reserves by having the FOMC (Fed
Open Market Committee) buy massive quantities of government securities
from the market, and announced the next day that the Fed would "serve as
liquidity to support the economic and financial system."  He created
US$12 billion of new bank reserves by buying up government securities.
The $12 billion injection of high-power money in one day caused the Fed
Funds rate to fall by three-quarters of a point and halted the financial
panic. If the government had been running a balanced budget in previous
times and there were no government notes outstanding to be bought, the
economy would have seized up. This shows that government deficits and
sovereign debt are part and parcel of the modern financial architecture.

Alan Greenspan, as newly appointed chairman of the US Federal Reserve
Board, built his reputation by releasing a single sentence that said he
would supply all the liquidity the banking system needed to stay afloat
after the 1987 crash. He pumped billions of US dollars, a fiat currency
that he could print at will, into US financial institutions by pushing
down the overnight lending rate aggressively. Greenspan's move flooded
financial markets with money, which helped preserve liquidity and
restore confidence in the US financial system, but it started the bubble
economy of the 1990s, which ended in Asia on July 2, 1997. Greenspan did
in essence the same thing in 1998 and again after September 11, 2001.
Greenspan will go down in history as the central banker who revived
moral hazard.

There is nothing wrong with deficit financing to keep the economy
humming.  But providing liquidity to keep a banking system alcking in
discipline afloat is another matter.  It is an indulgence that the Fed
itself has been criticizing the Bank of Japan for doing.  The trouble is
that the Fed under Greenspan thinks the banking system is the economy,
that the banking system can be helped by risking the fundamentals of the
economy. Reagan attacked the wrong target when he said that government
does not make money, only the private sector does.  Government makes
money by issuing credit to grease the economy.  Banks, despite popular
misconception, do not make money; they merely keep a percentage for
their intermediary role on the flow of money, as a reward for keeping
money productive.  When banks failed to keep money productive, they
deserve to be punished.  In fact, the health of the system depends on
the proper punishment of wayward banks.  It is a rule that the Fed under
Greenspan seems to have forgotten.

One of the main causes of the 1987 crash as explained by tax economists
was a threat by the House Ways & Means Committee to eliminate the tax
deduction for interest expenses incurred in corporate takeovers. That
explains the down side if one buys the theory but it does not explain
the volatility.  Greenspan made the famous "irrational exuberance"
speech at the Annual Dinner and Francis Boyer Lecture of The American
Enterprise Institute for Public Policy Research, Washington, D.C. on
December 5,  1996, when the Dow Jones Industrial Average was at 6,437,
against January  14, 2000 when the DJIA peaked at 11,723.  On March 16,
2000, the DJIA experienced its largest one-day point gain in history -
499.19 points - to close at 10,630.60.  On April 14, 2000, the DJIA
plummetted 617.78 points, closing at 10,305.77 - its steepest point
decline in a single day historically so far.  The Dow Jones Industrial
Average experienced its largest one-day  percentage drop in history, 508
points or 22.61 percent on October 19, 1987. This drop on  October 19,
1987 caused volume to surge to an unprecedented 604 million shares. The
next day, volume reached 608 million shares.

Experts note that each financial crisis is unique, which probably is
true in detail. These experts also seek comfort in the observation that
the identified excesses of past crashes have been dealt with through new
regulatory measures, which is also undeniable. Yet financial crisis have
persistent common threads in that they seem to defy precise anticipation
and that their occurrence leave serious structural damage. Thus the
requirement of a conservative debt to equity ratio is needed to protect
market participants from market misjudgment and the system from policy
misjudgement by the Fed. Yet the American system prospers on living on
the edge through maximization and socialization of risk, thus building
in failure or collapse that hurts not just the willing risk takers, but
the general public who has been put into risky situations they cannot
afford by the sales talks of sophisticated risk management. Part of that
sales talk has been coming from Greenspan at the Fed.

Greenspan went on to list Volcker's accomplishments: "The fall in
inflation over this period has been global in scope, and arguably beyond
the expectations of even the most optimistic inflation fighters. I have
little doubt that an unrelenting focus of monetary policy on achieving
price stability has been the principal contributor to disinflation.
Indeed, the notion, advanced by Milton Friedman more than thirty years
ago, that inflation is everywhere and always a monetary phenomenon is no
longer a controversial proposition in the profession."

This is like saying if you close the window, fresh air will not come
into the room without explaining why the window needs to be closed or
acknowledging that fresh air is desirable.  The controversy with
Friedman's notion is not with the link between inflation and monetary
policy, but on his definitions of inflation and monetary policy,
outdated by fundamental changes in a globalized financial system.  With
flexible exchange rates of fiat currencies and with domestic inflation
directly affected by the price of imports, monetary policy managed by
interest rate policy translates into exchange rate conditions that
affects inflation through the international exchange value of the dollar
which sets its purchasing power which in turn defines domestic inflation
rate.  Domestic inflation in the US then is masked by an inflated
exchange value of the dollar in a globalized market, thus allowing the
Fed to lower interest rates, which will in time lower the exchange rate
of the dollar which will unmask domestic inflation.  There is no
escaping that truism. If the dollar dcontinues to fall, US interest
rates will rise, or there will be a run on the dollar. In fact, longer
rates, which the Fed does not directly control, despite Governor Ben S.
Bernanke's remainder of the Fed owning a printing press, have begun to
rise from market forces, regardless of the Fed's vow to keep short-term
rate low for a long as possible..

The alleged "recovery" of the stock market in 2003, with the DJIA rising
by 25% from its low in March, and the NASDAQ rising a phenomenal 50%,
and the S&P 500 rising 26% and the Russel 2000 rising 45%, is tempered
by the dollar falling 20% against the euro, 10% against the yen despite
BOJ intervention, and a whopping 34% against the Australian dollar on
rising demand on gold, iron ore and other commodities produced there. In
the first trading session in 2004, the yen fell to a three-year low of
106.07 yen despite repeated intervention by Japanese authorities. It was
down from 106.95 yen late on the last Friday of 2003. The Bank of Japan,
acting on behalf of the Ministry of Finance, was estimated by traders to
have bought $3 billion to $5 billion to stem the dollar's slide versus
Japan during Monday's intervention. The key comforting mantra now is a
benign "orderly decline" of the dollar which the current market is
famous for anything but orderly.  With Fed Funds rate at 1% and zero
inflation or even real deflation, all debts are instruments of negative
returns.  Thus debt has become a drag on the economy by its depressing
effect on profitability. Yet the zero inlfation or worse, real
deflation, that justifies low interest rates seems to be the cause of
many problems in the economy, such as falling corporate profits caused
by the lack of pricing power.  Corporate profit in 2003 came mostly from
the effect of a falling dollar on non-dollar revenue of corporations
whose stock prices and dividend payouts are denominated in dollars.  A
look at commodity prices shows some interesting trends.  The DJ-AIG
Commodity Futures rose from 110.276 to 135.269 in 2003. Comex spot Gold
rose from $347.6 to $415.7 per troy oz. Gold futures traded above $425
an ounce for the first time in more than 15 years in New York Monday,
extending its watershed rally on the first trading day of 2004 as
investors continued to diversify out of the beleagured dollar. But Nymex
crude futre oil rose only from $31.20 to $32.52 in 2003 and #2 hard KC
wheat rose hardly from $4.1525 to $4.1725 per bushel.  Anyway you slice
these data, agriculture is heading for trouble and agriculture and oil
are the only two sectors not experiencing inflation.  From the look of
things, the economy is a long way from getting out of the woods, which
is why Greenspan's self congrtulation is premature.

Be that as it may, Greenspan balanced his optimism with some caveats:
"But the size and geographic extent of the decline in inflation raises
the question of whether other forces have been at work as well.  I am
increasingly of the view that, at a minimum, monetary policy in the last
two decades has been operating in an environment particularly conducive
to the pursuit of price stability. The principal features of this
environment included (1) increased political support for stable prices,
which was the consequence of, and reaction to, the unprecedented
peacetime inflation in the 1970s, (2) globalization, which unleashed
powerful new forces of competition, and (3) an acceleration of
productivity, which at least for a time held down cost pressures."

The so-called political support for stable prices contradicts the budget
deficits of the Reagan and G.W. Bush administrations. Globalization did
contribute to domestic price stablility through global wage arbitrage
but it produced an overvalued exchange rate for the dollar and loss of
jobs at home.  As for productivity, the productivity boom in the US was
as much a mirage as the money that drove the apparent boom. There was no
productivity boom in the US in the last two decades of the 20th century;
there was an import boom. What's more, this boom was driven not by the
spectacular growth of the American economy; it was driven by debt
borrowed from the low-wage countries producing this wealth.  The
acceleration of productivity is accomplished by someone else doing the
producing.

Greenspan said; "In recognition of the lag in monetary policy's impact
on economic activity, a preemptive response to the potential for
building inflationary pressures was made an important feature of policy.
As a consequence, this approach elevated forecasting to an even more
prominent place in policy deliberations."

This is a self-delusionary observation.  The speed and scale of
uncertainties in the new paradigm make forecasting a game of weeks not
months, much less years. Certainly it is not possible to forecast
terrorist attacks with any certainty except that it will happen and can
happen anytime.  Froecasting is a dubious game to begin with for those
who do not have the power to control their own destiny.  There was a
time the Fed did not have to farecast; its policies determined the
future.  The Fed's reliance on forcasting of the economy to set reactive
policies is an act of abdication of its authority.

Greenspan smoothed over his role in causing the 1987 crash and his
subsequent over-reaction by saying: "After an almost uninterrupted stint
of easing from the summer of 1984 through the spring of 1987, the Fed
again began to lean against increasing inflationary pressures, which
were in part the indirect result of rapidly rising stock prices. We had
recognized the risk of an adverse reaction in a stock market that had
recently experienced a steep run-up--indeed, we actively engaged in
contingency planning against that possibility.  In the event, the crash
in October 1987 was far more traumatic than any of the possible
scenarios we had identified. Previous planning was only marginally
useful in that episode. We operated essentially in a crisis mode,
responding with an immediate and massive injection of liquidity to help
stabilize highly volatile financial markets. However, most of our
stabilization efforts were directed at keeping the payments system
functioning and markets open. The concern over the possible fallout on
economic activity from so sharp a stock price decline kept us easing
into early 1988. But the economy weathered that shock reasonably well,
and our easing extended perhaps longer than hindsight has indicated was
necessary."

Greenspan reaction to 1987 was directly responsible for the debt bubble
decade of the 1990s from which the global economy has yet to recover.
The short deep crash and short mild recovery scenario has continued into
2004 in a long term downward spiral. What Greenspan has done is to
palliate sharp palliative recessions with long term gradual economic
decline.  The end of the business cycle is brought about by the gradual
decline of the economy.  In his speech, Greenspan presented his view of
this gradual decline by crediting rate reductions for mild recessions
but explaining modest recoveries with Keynes' liquidity trap without
acknowledging Keynes, by calling it "financial headwinds".

Greenspan gave the Fed and himself credit for raising the Fed funds rate
300 basis points over twelve months that he claimed "apparently defused
those nascent inflationary pressures" in 1994 and claimed success for a
"historically elusive soft landing" in 1995 and even went on to claim
"the success of that period set up two powerful expectations that were
to influence developments over the subsequent decade. One was the
expectation that inflation could be controlled over the business cycle
and that price stability was an achievable objective. The second
expectation, in part a consequence of more stable inflation, was that
overall economic volatility had been reduced and would likely remain
lower than it had previously."   This claim is simply not support by
facts.  Greenspan engineers a soft land by having the economy overshoor
the runway, heading for an embankment of "air-ball financing" based on
anticipated future earning that never materialized.  But Greenspans
characterized the distorion of history as follows: "Of course, these new
developments brought new challenges." In particular, the prospect that a
necessary cyclical adjustment was now behind us fostered increasing
levels of optimism, which were manifested in a fall in bond risk spreads
and a rise in stock prices. The associated decline in the cost of equity
capital further spurred already developing increases in capital
investment and productivity growth, both of which broadened impressively
in the latter part of the 1990s.  The rise in structural productivity
growth was not obvious in the official data on gross product per hour
worked until later in the decade, but precursors had emerged earlier.
The pickup in new bookings and order backlogs for high-tech capital
goods in 1993 seemed incongruous given the sluggish economic environment
at the time. Plant managers apparently were reacting to what they
perceived to be elevated prospective rates of return on the newer
technologies, a judgment that was confirmed as orders and profits
continued to increase through 1994 and 1995. Moreover, even though
hourly labor compensation and profit margins were rising, prices were
being contained, implying increasing growth in output per hour.  As a
consequence of the improving trend in structural productivity growth
that was apparent from 1995 forward, we at the Fed were able to be much
more accommodative to the rise in economic growth than our past
experiences would have deemed prudent."

Greenspan was referring to the debt bubble that fueled the dot.com and
telecom boom and subsequent bust, not to mention the rise of structured
finance, derivatives, which could not have been possible without the
explosion in the securitization of debt.

Greenspan's fantasy continued: "We were motivated, in part, by the view
that the evident structural economic changes rendered suspect, at best,
the prevailing notion in the early 1990s of an elevated and reasonably
stable NAIRU (non-accelerating inflation rate of unemployment). Those
views were reinforced as inflation continued to fall in the context of a
declining unemployment rate that by 2000 had dipped below 4 percent in
the United States for the first time in three decades.  Notions that
prevailed for a time in the 1970s and early 1980s that even high
single-digit inflation did not measurably impede economic growth were
gradually abandoned as the evidence of significant benefits of low
inflation became increasingly persuasive. Moreover, the variance of GDP
growth markedly lessened as inflation tumbled from its double-digit high
in the early 1980s. To preserve these benefits, we engaged in our most
recent preemptive tightening in early 1999 that brought the funds rate
to 6-1/2 percent by May 2000.  Our goal of price stability was achieved
by most analysts' definition by mid-2003. Unstinting and largely
preemptive efforts over two decades had finally paid off. Throughout the
period, a key objective has been to ensure that our response to
incipient changes in inflation was forceful enough. As John Taylor has
emphasized, in the face of an incipient increase in inflation, nominal
interest rates must move up more than one-for-one."

The fall in unemployment in 2000 was the result of the dot.com and
telecom frenzy, nothing more, and the rise in the Fed fund rate to 6.5%
punctured the debt bubble and placed deflation as a threat to economic
well-being for the first time since 1930.

Greenspan did acknowledge in passing: "Perhaps the greatest irony of the
past decade is that the gradually unfolding success against inflation
may well have contributed to the stock price bubble of the latter part
of the 1990s.   Looking back on those years, it is evident that
technology-driven increases in productivity growth imparted significant
upward momentum to expectations of earnings growth and, accordingly, to
stock prices.  At the same time, an environment of increasing
macroeconomic stability reduced perceptions of risk. In any event, Fed
policymakers were confronted with forces that none of us had previously
encountered. Aside from the then-recent experience of Japan, only remote
historical episodes gave us clues to the appropriate stance for policy
under such conditions. The sharp rise in stock prices and their
subsequent fall were, thus, an especial challenge to the Federal
Reserve.  It is far from obvious that bubbles, even if identified early,
can be preempted at lower cost than a substantial economic contraction
and possible financial destabilization--the very outcomes we would be
seeking to avoid.  In fact, our experience over the past two decades
suggests that a moderate monetary tightening that deflates stock prices
without substantial effect on economic activity has often been
associated with subsequent increases in the level of stock prices.
Arguably, markets that pass that type of stress test are presumed
particularly resilient. The notion that a well-timed incremental
tightening could have been calibrated to prevent the late 1990s bubble
while preserving economic stability is almost surely an illusion."

First of all, there were no lack of loud warning from all quarters as
the bubble developed.  I posted on Nov 6 1998 tp the IPE (International
Political Economy) list the following:

US financial assets a bubble?

The distinction between a bubble and reality can only be perceived after
the bubble bursts. So the question is a conceptual dilemma.
Some useful observations can be made about US financial assets at this
juncture.
US financial assets are built on debt. Debt is not intrinsically
objectionable if it is properly collateralized by real assets.  Yet as
economists know, money is created whenever two parties enter into a
mutual debt obligation (Hyman Minsky). The size of the invisible money
pool created by financial derivatives is now many times (no one knows
how many) the amount of M3. One firm alone, LTCM, commanded open
positions of US$1.2 trillion financed by 100-fold leverage. That is the
entire daily transactional value of the world's foreign exchange
markets. Another hedge fund (Tiger Management) can suffer an asset
evaporation (loss) in the amount of US$20 billion in 6 hours by a 10%
appreciation of a single currency (yen) against the USD.
This invisible supply of virtual liquidity supports an artificial level
of asset value very much detached from fundamentals, and the unbundling
of their underlying open private contracts will inevitably cause drastic
readjustments in asset prices in the formal markets.
The secuitization of debt blurs the all important dividing line between
debtor and creditor, and allows an economy to borrow from itself, not
just against its future, but against its current and less sophisticated
debt. The collateralization of debt by more sophisticated debt has
characteristics of a bubble. The broad dis-aggregation of risk to
maximize transactional surplus (profit) ultimately leads to the
socialization of risk (transferring it into systemic) while the
privatization of profit (in the name of capital formation) remains a
sacred prerequisite. Under the accounting rules of capitalism, capital
cannot exist until ownership is specifically assigned. Thus
socialization of capital is a self contradiction in terms and must stay
off the balance sheets of the system. To own assets, even the government
must act as if it is a corporation, i.e. a "person". Public pension fund
assets and other forms of collectively owned assets must have the
governing characteristics of "private" capital in order to participate
in the US economic system. Such assets enjoy no prerogative to invest
negatively for the common good because the ultimate definition of the
common good is profit.  This formula will lead to the hollowing of the
center - a classic definition of a bubble.  Whether or when the bubble
will burst depends on government's ability to extend its elasticity
which is not unlimited. To support the market, government need more
power and intervention which in turn destroys the market. As is already
apparent, the Federal Reserve is reduced to an irrelevant role of
explaining the economy rather than directing it.  With every passing
month, Greenspan sounds more like a lecturer in Econ 101 rather than the
central banker of the world's biggest economy. Another characteristic of
a bubble is that no one inside can escape without bursting it or for
that matter, has any incentive to.  Except that the laws of physics are
generally not forgiving. Bubbles will burst by their very nature. End.

Greenspan, notwithstanding his denial of responsiblity in helping to
cause the bubble, had this to say in hindsight: "Instead of trying to
contain a putative bubble by drastic actions with largely unpredictable
consequences, we chose, as we noted in our mid-1999 congressional
testimony, to focus on policies "to mitigate the fallout when it occurs
and, hopefully, ease the transition to the next expansion."  He meant
the next bubble.

Now Greenspan has the gall to congratulate himself: "During 2001, in the
aftermath of the bursting of the bubble and the acts of terrorism in
September 2001, the federal funds rate was lowered 4-3/4 percentage
points. Subsequently, another 75 basis points were pared, bringing the
rate by June 2003 to its current 1 percent, the lowest level in 45
years. We were able to be unusually aggressive in the initial stages of
the recession of 2001 because both inflation and inflation expectations
were low and stable. We thought we needed to be, and could be, forceful
in 2002 and 2003 as well because, with demand weak, inflation risks had
become two-sided for the first time in forty years.  There appears to be
enough evidence, at least tentatively, to conclude that our strategy of
addressing the bubble's consequences rather than the bubble itself has
been successful. Despite the stock market plunge, terrorist attacks,
corporate scandals, and wars in Afghanistan and Iraq, we experienced an
exceptionally mild recession--even milder than that of a decade earlier.
As I discuss later, much of the ability of the U.S. economy to absorb
these sequences of shocks resulted from notably improved structural
flexibility. But highly aggressive monetary ease was doubtless also a
significant contributor to stability."

This is like the naval architects who designed the Titanic, having
failed to isolate the ships compartments from contagious flooding and
having failed to provide sufficient lifeboats on account of the ship
being unsinkable, would claim that at least there were enough time and
life boats to save some of the women and children,  Many lives were
ruined and good companies bankrupt by the Fed "strategy of addressing
the bubble's consequences rather than the bubble itself."

Greenspan went on to lecture about the wisdom of managing the
consquences of risk: "The Federal Reserve's experiences over the past
two decades make it clear that uncertainty is not just a pervasive
feature of the monetary policy landscape; it is the defining
characteristic of that landscape...  As a consequence, the conduct of
monetary policy in the United States has come to involve, at its core,
crucial elements of risk management. This conceptual framework
emphasizes understanding as much as possible the many sources of risk
and uncertainty that policymakers face, quantifying those risks when
possible, and assessing the costs associated with each of the
risks.....  However, despite extensive efforts to capture and quantify
what we perceive as the key macroeconomic relationships, our knowledge
about many of the important linkages is far from complete and, in all
likelihood, will always remain so. Every model, no matter how detailed
or how well designed, conceptually and empirically, is a vastly
simplified representation of the world that we experience with all its
intricacies on a day-to-day basis....A year ago, these considerations
inclined Federal Reserve policymakers toward an easier stance of policy
aimed at limiting the risk of deflation even though baseline forecasts
from most conventional models at that time did not project deflation;
that is, we chose a policy that, in a world of perfect certainty, would
have been judged to be too loose.  As this episode illustrates, policy
practitioners operating under a risk-management paradigm may, at times,
be led to undertake actions intended to provide insurance against
especially adverse outcomes. Following the Russian debt default in the
autumn of 1998, for example, the FOMC eased policy despite our
perception that the economy was expanding at a satisfactory pace and
that, even without a policy initiative, it was likely to continue doing
so. We eased policy because we were concerned about the low-probability
risk that the default might trigger events that would severely disrupt
domestic and international financial markets, with outsized adverse
feedback to the performance of the U.S. economy.....The 1998 liquidity
crisis and the crises associated with the stock market crash of 1987 and
the terrorism of September 2001 prompted the type of massive ease that
has been the historic mandate of a central bank. Such crises are
precipitated by the efforts of market participants to convert illiquid
assets into cash.... In the crisis that emerged in the autumn of 1998,
pressures extended beyond equity markets. Credit-risk spreads widened
materially and investors put a particularly high value on liquidity, as
evidenced by the extraordinarily wide yield gaps that emerged between
on-the-run and off-the-run U.S. Treasuries....No simple rule could
possibly describe the policy action to be taken in every contingency and
thus provide a satisfactory substitute for an approach based on the
principles of risk management....Our problem is not, as is sometimes
alleged, the complexity of our policymaking process, but the far greater
complexity of a world economy whose underlying linkages appear to be
continuously evolving." One gets the impression from Greenspan's speech
that the greatest threat to the US is not terrorism, but unmanagable
risk to the economy that he permits by policy. There is another problem
of Greenspan relying on macroeconomic modelling of reality.  Most model
builders assume reality to be rational and orderly. In fact, life is
full of misinformation, errors of judgement, miscalculations,
communication breakdowns, ill will, legalised fraud, unwarranted
optimism, prematurely throwing in the towel, etc.  One view of the
business world is that it is a snake pit. Very few economic models
reflect that perspective.

Then confessing the Fed's obession with single dimensional financial
manipulation, Greenspan said: "Under the rubric of risk management are a
number of specific issues that we at the Fed had to address over the
past decade and a half and that will likely resurface to confront future
monetary policymakers.  Most prominent is the appropriate role of asset
prices in policy. In addition to the narrower issue of product price
stability, asset prices will remain high on the research agenda of
central banks for years to come. As the ratios of gross liabilities and
gross assets to GDP continue to rise, owing to expanding domestic and
international financial intermediation, the visibility of asset prices
relative to product prices will itself rise. There is little dispute
that the prices of stocks, bonds, homes, real estate, and exchange rates
affect GDP. But most central banks have chosen, at least to date, not to
view asset prices as targets of policy, but as economic variables to be
considered through the prism of the policy's ultimate objective."

Thus according to Greenspan, keeping asset prices high and product
prices low is now the sworn aim of the central bank.  Of course, the
largest component in low product price is low wages and the largest
component in high asset price is also low wages.  The two combination
adds up to one thing, low wages at all cost.  And how do you keep wages
low?  Ship jobs overseas and keep domestic unemployment high. This is
the pugnacious economics of Grenspanism.

Federal Reserve Governor Ben S. Bernanke said in a speech the following
in the same meeting that the risk of a dollar crisis is ``quite low.''
In response, the dollar fell to a record against the euro and the lowest
in more than three years versus the yen in New York. The dollar weakened
against the yen even as Japan sold its own currency.  Bernanke's
comments added to speculation the Fed will keep its target interest rate
at a four-decade low of 1 percent, half that of the European Central
Bank, well into 2004. The dollar weakened to $1.2683 per euro at 7:27
a.m. in New York, from $1.2586 late Friday, after sinking to $1.2697.
Versus the yen, the dollar fell to 106.26 from 107.07.  If the Fed isn't
concerned about the dollar's fall, the Treasury is not about to beacuse
the weak dollar is a long term problem and the Treasury needs a good
economy for the election in November. Demand for the dollar has waned in
the past year as US interest rates stayed lower than in Europe,
discouraging some international investors from buying the debt sold to
finance a record U.S. budget deficit.  The yield spread between dollar
and euro bovernment bonds is over 50 basis points.

The dollar's decline, which makes overseas goods more expensive for
Americans to buy, should not raise inflation expectations because
imports have only a ``modest'' weight in the goods and services
purchased by consumers, Bernanke said.
The European Union suggested it is unconcerned. ``There is no new
position,'' said Gerassimos Thomas, a spokesman for EU Monetary
Commissioner Pedro Solbes. ``We want a stable and strong euro.''
Bernanke said that judging the dollar's strength or weakness solely
against the euro may also be misleading because its value against the
currencies of major trading partners is about 7 percent above its
average in the 1990s and 17 percent above the low it reached in 1995.
Gold prices rose to their highest in almost 13 years in London as the
dollar's slide boosted the metal's appeal as a store of value. The U.S.
Dollar Index, which tracks the dollar against a basket of six major
currencies, fell to 86.37 from 86.92. The index dropped 15 percent last
year.

The Bush administration welcomes the dollar's decline, which may boost
sales and manufacturing jobs in an election year. U.S. exchange rate
policy is set by the administration rather than the central bank.
Employers in the U.S. probably added 148,000 workers last month,
according to the median forecast of economists surveyed by Bloomberg
News in advance of a government report on Friday. Fifty- seven thousand
jobs were added in November, about a third of the expected growth.
Traders are predicting the euro gaining to $1.30 by the middle of January.
U.S. Treasury Secretary John Snow told Bloomberg News last month the
currency's drop had been ``orderly.'' While he and Bush regularly
endorse a ``strong dollar'' they say they want markets, not governments,
to set exchange rates.  Markets are seldomn orderly.
``The depth of international financial markets and the integration of
global financial markets means that the risk of a dollar crisis is quite
low -- not zero -- but quite low,'' Bernanke said during a panel
discussion at the American Economics Association meeting. The day
before, Greenspan gave all kinds of examples on how low probability-
high impact events should be pre-empted by the Fed, even if it should
create imbalance further down the road.  It is a price the Fed is
willing to pay and glad paid in the past.  Now the options are either a
continuing fall of the dollar or higher interest rates to choke off the
recovery.

The U.S. economy expanded at an 8.2 percent annual rate in the third
quarter of 2003, the fastest pace in almost 20 years. Bernanke said
forecasts of 4 percent growth next year are ``reasonable'' that he
wouldn't be surprised if growth exceeded that level. Growth has not been
accompanied by inflation or strong hiring in part because output per
hour, rose at a 9.4 percent annual rate in the third quarter, the
fastest pace in two decades. The Fed's preferred inflation indicator,
the personal consumption expenditures index minus food and energy, rose
at 0.8 pace for the 12-month period ending November. The FOMC chief
strategist and director of the Federal Reserve Board's Division of
Monetary Affairs said the central bank ``sharpened'' its commitment to
better economic performance at its Dec. 9 meeting by maintaining the
phrase ``considerable period'' to describe the outlook for the low rates
and by linking "continuing policy accommodation to the low level of
inflation and slack in resource use.''  It is a strategy of Robert
Lucas' "rational expectation" theroy showing how expectations about the
future as framed by policy makers influence the economic decisions made
by individuals, households and companies.  But the strategy only works
if the Fed unabashedly exercises control over the ecconomy, something
that Greenspan's reactive aprroach has not convinced the market.


\Henry C.K. Liu