President Bush’s recent announcement that he will renominate Alan Greenspan for a fifth term as chairman of the Federal Reserve Board elicited mostly favorable reactions from a wide range of economic and political pundits.

At the critical end of the spectrum, economist James Galbraith, in an op-ed entitled “Greenspan, The man who stayed too long,” called the 78-year-old Greenspan “a man who spent the first [part] of his central-banking career fighting an inflation that did not exist.”  Better targeted is Galbraith’s complaint that Greenspan has excessively turned the growth of the money supply off and on when selective credit controls would have sufficed.

More typical of public reaction is the gushy editorial by George Melloan, “The Money Man Everyone Loves,” which appeared in the Wall Street Journal.  Starting with the stock-market crash of 1987, Melloan credits Greenspan with so skillful a manipulation of the Federal Reserve that “it’s no wonder that Mr. Greenspan is widely regarded as a miracle worker . . . ”

Mr. Greenspan’s appointment by President Reagan in August 1987 followed a parade of chairmen in the 1970’s who had failed to contain inflation and, consequently, presided over stagflation.  Paul Volcker, who served from 1981 to 1987, manfully reduced the runaway inflation that he inherited but could not extinguish the inflationary bias of the U.S. economy while being forced to accommodate sizable federal deficits.

>The experience that Greenspan brought to the job was reasonably appropriate, but it did not include specific money-market-management credentials.  A New York University Ph.D., he had served as a successful private economic consultant and a former chairman of the Council of Economic Advisors.  A free-market monetarist, he was a student of money markets and financial institutions.  As chairman of the Federal Reserve Board, he assumed responsibility for managing the stability of the money supply; for stabilizing economic growth and price levels; for preserving the domestic and international value of the dollar; and for serving as the most senior of the regulators of financial institutions.

The economy was sending mixed signals when Greenspan took the helm in 1987.  Capacity utilization and average weekly hours in manufacturing were rising, and the unemployment rate was declining.  On the other hand, inventory-to-sales ratios were declining, as were housing starts.  What Greenspan appeared to focus on, however, was inflation, in the forms of consumer-price increases, stubbornly holding at around four percent; rising producer prices; stock and bond markets that were both overvalued and rising because of speculative demand; and a rapidly growing trade deficit accompanied by a declining dollar.

Greenspan reduced the growth of the money supply, which caused the 1987 stock-market meltdown.  To his credit, stocks were kept afloat by the Fed’s provision of generous liquidity, and the market recovered.  The message, however, was loud and clear: The new monetarist chairman would not accommodate excessive inflation of prices or securities and would defend the value of a dollar at home and abroad.  So far so good.

The Fed then tightened the money supply beyond the initial shock required and continued to restrain M1 (public currency, travelers’ checks, demand deposits) until 1989, with a consequent decline in M2 (M1 plus savings accounts, time deposits under $100,000, and balances in retail money-market mutual funds) through 1992.  The weak sectors of the economy joined with tight money to precipitate the recession of 1990-92.  Inflation was finally suppressed, the decline of the dollar was arrested, and the trade deficit declined because of an upsurge in exports.

It is doubtful that Greenspan intended to be as heavy-handed with the money supply as he was from 1987 to 1989.  He faced the problem of determining the actual size of the federal deficits compared to the budget and how much of the deficit required “sterilization” by the Fed to prevent a resurgence of inflation.  At that time, the rescue of the U.S. banks and thrifts was predicted to add $225 to $275 billion to the federal deficit; the actual gross amount was about $225 billion, $165 billion net of recoveries.  Also, the 1986 Tax Reform Act, supposedly “tax neutral” (no net tax increase), raised $110 billion more in personal and corporate income-tax monies from 1987 to 1989 than if these taxes had remained at the same proportion of GDP as in 1986.  This resulted in lower deficits than expected, requiring less “leaning against the wind” than anticipated and less monetary restraint.  Such is the result of relying on central banking, particularly the restriction of the money supply as a sufficient control.

Greenspan and his Fed do deserve a medal for coming to grips with “no reserve” banking, which was the root cause of the runaway inflation of the 1970’s and its stubborn residue during the 80’s.  Closing down insolvent savings & loans and banks in the United States was not sufficient.  The imposition of “risk-based” capital standards on U.S. lenders, which increased capital requirements relative to speculative rating of assets, went to the root cause.  However, that required the subsequent negotiation of the Basel Accords, which imposed the same reserve standards on our OECD trading partners that regulated the euro, which had generated a large and continuing source of excess inflationary dollars.

The next period, which raises questions about Greenspan’s regulatory skills, was the recovery and boom of the 1990’s.  At the beginning of 1992, Greenspan’s >belated expansion of M1 fostered an economic revival.  By 1994, the Bank Credit Analyst (BCA) speculation index warned of excessive stock speculation, and, by 1995, the BCA valuation index found extreme overvaluation; nevertheless, the Fed continued to supply credit and held interest rates down.  The stock market accelerated its merry rise, with no Fed response.

The economy, growing rapidly without inflation of goods and services (thanks to rapid productivity increases), seemed sound, but runaway asset inflation in both the stock and fixed-income-security markets was becoming apparent.  Yet the Fed continued to feed the money supply, instead of increasing margin requirements for securities lenders.  By 1997, corporate earnings before interest, tax, and depreciation (EBITD), as well as earnings after tax, peaked, while the stock market continued to soar.  A hesitation in the market in 1998 was followed by a further rise in 1999, as the Fed supplied additional bank reserves for Y2K, which flowed into security markets further stimulated by “go-go” earnings from accounting frauds.  As the Fed started to remove excess Y2K reserves, the market tanked.

The feeding frenzy on Wall Street came to an end, with brokers bitterly blaming Greenspan for not continuing to pour fuel on the fire.  The real problem, however, had been the excessive and prolonged expansion of Wall Street’s credit.  Over three trillion dollars was lost, primarily in individual portfolios, which was disproportionate to losses suffered by the brokers who had profited from the boom.  Nor did the three million workers who lost their jobs benefit from the securities “bubble.”

This runaway stock market threatened a collapse of the economy like that of 1929.  The burgeoning derivatives market—which found six U.S.-based banks holding over $25 trillion in derivatives by the year 2000, a value larger than the entire U.S. stock market—compounded the danger.  This risk was shrugged off by the merchant banks—now too big to be allowed to fail—who claimed offsetting positions that limited their exposure (assuming that losers on derivative bets are just as likely to pay as winners are likely to insist on being paid during a meltdown).  If this was true, why did the Fed feel obliged to bail out Equity Funding when it became insolvent, representing only a small percentage of this derivative market’s holdings?  Is this derivative market as closely regulated as necessary, or, like the stock market, does it have too much political clout to be held accountable to the public interest under Mr. Greenspan’s benign regulation?

A recovery was made possible by grossly excessive liquidity that has pushed securities yields to depression levels for retirees living on their savings and by a $400-billion federal deficit to be repaid (with interest) in the future.  Record home sales and ownership has also helped, paid for by record personal debt.  The reemergence of inflation is now a clear danger.

Alan Greenspan’s record as chairman of the Federal Reserve, while meritorious in many respects, clearly leaves room for improvement.  He could have helped us avoid the violent swings from boom to bust through better Fed management, particularly by using timely selective credit controls on Wall Street instead of waiting until tightening of the money supply was necessary to put the brakes on the economy in general.  In that respect, Galbraith’s criticism is valid.

Clearly, it is time for a change.  Those who run the U.S. economy should seek to maximize the long-term prosperity of all Americans, not just the short-term windfalls of Wall Street and its related international bankers.