David R. Henderson  

Response to Susan Lee

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Economist and economic journalist Susan Lee has written an attack on Alan Greenspan and a review of John Taylor's recent book that is implicitly a response to my defense of Greenspan and review of Taylor's book.

You can read both and see what you think. I won't bother repeating my arguments but I will point out two things:
1. One of the occupational hazards of being an economic journalist is using emotive language to bias your case, language that, unfortunately, can substitute for argument. Susan does this. Consider this sentence, "But now, there's a newer Greenspan--a decidedly prickly and whiny one." You might think that she would give evidence of his prickliness or whininess, right? Well, she doesn't. The closest she comes is to point out that he defends his own actions and argues that low interest rates were not due to his policies, but, rather, to increased savings from China. Of all the nerve! Actually defending himself when it's just possible that he thinks people are saying things about him that are not true. It reminds me of the old French saying, "Cet animal est tres mechant; quand on l'attaque, il se defend." Translation: "What a wicked animal; when attacked, he defends himself."
2. Susan doesn't point out that Greenspan originally made his point about interest rates being low due to increased savings from China in his book, The Age of Turbulence, which was published in 2007. Given the lags in publishing, it's quite conceivable that the section on Chinese savings was written in early 2007 or even 2006, well before it would have made sense for Greenspan simply to be deflecting blame. (H/T to Jeff Hummel for this second point.)

Comments and Sharing

CATEGORIES: Monetary Policy

COMMENTS (12 to date)
Unit writes:

But if Greenspan was aware of the China effect, why didn't he raise the rates earlier?

Ryan S writes:

Dr. Henderson, I know you and Jeffrey Hummel have written several pieces attempting to exonerate Chairman Greenspan from the charges made by some economists that he precipitated the crisis by drastically increasing the money supply and thereby depressing the structure of interest rates throughout the economy. You (and Dr. Hummel and Greenspan) argue that a large contributor to the depressing of interest rates was the recycling of Chinese savings into dollar denominated assets.

I recently read this article by Frank Shostak (http://mises.org/story/3382) where he writes that the recycling of Chinese savings is partially correct, but that this is a byproduct of the increase in the supply of dollars throughout the world by the Fed under Greenspan. Mr. Shostak's article is obviously written for a layperson audience, but I'm having trouble reconciling his critique with your position. I'm especially drawn to his point that, although the Chinese (and other foreigners) did in fact reinvest significant amounts of their savings back into the US economy, they had to first obtain those dollars from Americans, and this glut of dollars that the Chinese poured into the US economy originated first with an expansionary monetary policy via the Federal Reserve.

Is there a flaw in Shostak's argument that I am missing?

Anyway, I just want to also let you know that I appreciate the work you and Dr. Hummel are doing. I think this debate over the role that the Fed played in the whole crisis, and its overall place relative to the rest of the economy is absolutely essential at the moment. Thanks!

Les writes:

It seems to me that there would have been no mortgage crisis if:

(a)mortgage loans had been limited to 80% of the appraised value of the property,

(b)borrowers were limited to monthly repayments that were affordable in relation to their regular incomes, and

(c)borrowers had to have good credit records.

Then low interest rates would have been most unlikely to cause mortgage defaults. Therefore I find it implausible to blame Alan Greenspan for the mortgage crisis.

Greg Ransom writes:

Isn't this a false dilemma? Both Greenspan and the China money together could have set in motion a Hayekian artificial boom and inevitable bust. NOTHING in Hayek's account of the boom and bust requires that the central bank be the sole cause -- or even the primary cause.

The notion that the extreme choices of the Fed oer the last 12 years had nothing to do with the behavior of the U.S. economy over that period is simply unbelievable.

I think people are unable to see clearly because that are demanding a false explanatory choice that is not at all required.

David R. Henderson writes:

Dear Ryan S,
I think there are some flaws in Shostak's argument. I may decide to write a separate post on it because you're not the first to have asked.

Tom writes:


I don't think it is a false dilemma. If a boom was created due to an actual increase in the supply of savings, then I don't think this would have had the same effect as a Federal Reserve engineered increase in credit. In the first case, an actual increase in savings would have led to a boom that would have been sustainable. In the second case, a Federal Reserve engineered boom would not have been sustainable and led to an eventual bust. Now that we know that the boom was unsustainable and led to a pretty hard landing is very strong evidence that the conjecture of a world savings glut by Greenspan was incorrect.

Bob Murphy writes:


Rather than focusing on her comment about Greenspan being prickly, I would like to hear what you and/or Jeff Hummel have to say about the substance of her article. Obviously I am biased (since I think Greenspan dunnit), but the global savings chart alone seems to demolish the "savings glut" thesis.

However, I don't really get how global investment was consistently higher than global savings for so many years. Can anybody clarify? Was there a trade deficit with Mars?

Jacob Oost writes:

Tom's right, only an artificially created excess of credit would have a bust. One based on individuals putting up their own money for investment wouldn't have a bust like that.

David R. Henderson writes:

Dear Bob Murphy,
Two things:
1. Susan's accusation of prickliness was part of the substance of her piece.
2. I didn't want to rehash. For our response on the savings point, go to:

aaron writes:

While I disagree with Susan's characterization of Greenspan, I think she's largely correct. My intuition at the time (2000 to 2002) was that we needed tightening. And, lack of savings looked to eventually become a problem. But cheap money made it so not borrowing was simply stupid. With real rates near or below 0%, how could a person not run a deficit.

That said, her characterization of Greenspan is over-the-top. Greenspan did see the potential problems, but he let his faith in borrowers win. From The Age of Turbulence:

Over time, ever-growing proportions of US households, non financial businesses, and governments, both national and local, have funded their capital investments from sources other than their own household income, corporations' internal funds, or government taxes...

The growing (and risk-prone) tendency to borrow in anticipation of future income by a significant proportion of Americans is reflected in a persistent rise in both houshold and corporate assets and liabilities relative to income.
A detailed calculation by Federal Reserve Board staff employing data from more than five thousand non-financial US corporations for the years 1983-2004 found that growth in the sum of deficits of those corporations where capital expenditures exceeded cash flow persistently outpaced the growth of corporate value added. The sum of surpluses and deficits, disregarding sign, as a ratio to a proxy for corporate value-added exhibits as an average annual increase of 3.5%/year...

A separate and less satisfactory calculation of only partly consolidated financial balances of individual economic entities relative to nominal GDP exhibits a rise over the past half century in the absolute sum of surpluses and deficits that is 1.25%/year faster than the rise of nominal GDP...

...Since 1946 the assets of US financial intermediaries, even excluding the outsized growth in mortgage pools have risen 1.8%/year relative to nominal GDP...

...from 1956-1996, nonfinancial business debt rose 1.8% faster than gross business product, and from 1996 to 2006 1.2% faster.
A rising debt-to-income ratio for households, or of total nonfinancial debt to GDP, is not itself and indicator of stress... But debt is rising faster than assets; that is, debt leverage has been rising. Household debt as a percentage of assets, for example, reached 19.3% by the end of 2006, compared with 7.6% in 1952. Non-financial corporate liabilities as a percentage of assets for form 28% in 1952 to 54% in 1993, but retreated to 43% by the end of 2006, as corporations embarked on a major program to improve their balance sheets.

It is difficult to judge how problematic this long-term increase in leverage is. Since risk aversion is innate and unchanging, the willingness to take on increased leverage over the generations likely reflects an improved financial flexibility that enables leverage to increase without increased risk, at least up to a point Bankers in the immediate post-civil war years perceived the necessity to back 2/5 of their assets with equity. less was too risky. Today's bankers are comfortable with 10%. None the less, bankruptcy is less prevalent today than 140 years ago. The same trends hold for household and businesses. Rising leverage appears to be the result of massive improvements in technology and infrastructure, not significantly more risk-inclined humans. Obviously, a surge of debt leverage above what the newer technologies can support invites crisis. I am not sure where the tipping point is. Moreover, that late-1950s experience with consumer debt burdens has made me reluctant to underestimate the ability of most household to [manage their financial affairs].

aaron writes:

The comments on Susan Lee's article are very good.

Carl The EconGuy writes:

David, let's assume Greenspan is right -- he simply adjusted the Fed's fund rate to the market rate that was driven down by excess Asian savings looking for a safe haven.

If that's the case, what do we need a Fed and a Greenspan for? If all the Fed does is to adjust to a market rate, there's no function for it anymore. At best, it will be late, and wrong.

Same thing with the Taylor rule: it substitutes automaticity for modeling and analysis. If you like the Taylor rule, why keep the Fed?

You like to defend Greenspan, but I think you need to defend the Fed itself in order to defend Greenspan.

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