SPEAKING FREELY The Greenspan legacy
By Adam Hamilton
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January 31, 2006, marks the end of a financial era. The longtime chairman of
the Federal Reserve, Alan Greenspan, will retire after 18 years at the helm of
the United States' central bank. Widely
lionized at the pinnacle of his career, Greenspan's legacy will profoundly
affect investors worldwide for many years to come.
As Greenspan's tenure as the most powerful man in the financial universe is
debated among investors today and historians tomorrow, his many decisions will
be dissected and evaluated. But I fear most of this debate will overlook the
most foundational and crucial issue. Before Greenspan's actions are considered,
the very notion of the Fed itself ought to enter the limelight.
The Federal Reserve is not a capitalistic entity compatible with free markets.
Instead it functions just like the miserably failed old-school
command-and-control communism model. The core philosophy of the Fed and its
Federal Open Market Committee that controls short-term interest rates is that
mere mortals meeting in secret like a conspiracy cabal are better suited at
setting the price of money than the free markets.
Regardless of who leads the Fed, the whole organization exists because price
controllers, no different from those in 20th-century Russia, think they alone
can divine the price at which the supply of savings equals the demand for
savings. The price of money, or interest rate, leads savers to decide how much
of their income to save and debtors to decide how much of someone else's
savings to borrow.
Of all the goods and services available on the planet, the price of money is
probably the most important one to ensure is not manipulated. Interest rates
act as signals to direct capital from unproductive uses to productive ones,
which helps build great wealth for nations when the free markets dictate
interest rates. But when manipulators try to manipulate interest-rate signals
artificially, capital is misappropriated and wasted, leaving nations poorer.
Bubbles are the ultimate case in point. Whenever too much paper money floods
into a financial system, which is the inevitable result of artificially low
interest rates, it floods into some class of goods or services or investments
and inflates prices far beyond where they would be if interest rates were set
by free markets. It is ironic as the destination of this excess capital
determines whether it is good or bad in investors' minds.
When artificially low-interest-rate-driven excess money floods into technology
stocks or tract houses in suburbia, Americans rejoice and think it is a great
thing until the resulting bubbles inevitably burst and wreak great pain. But if
this same excess money drives up the prices of general goods and services and
commodities such as gasoline, the inflation is considered bad. Indeed, the
Greenspan Fed spent much time trying to jawbone money into inflating
politically correct assets such as houses instead of politically incorrect ones
such as commodities.
So before we delve into Greenspan's record on monetary inflation and interest
rates, realize he is as far away from being a free-market capitalist as one can
possibly be. He is a communist-style elitist who believes that the price of
money and even money supplies should be centrally planned as if by the
Communist Politburo. This is no less ridiculous than the idea of the Fed
mandating the price of every dinner, every pair of shoes, or every book sold in
America. History has proved time and time again what an asinine idea central
planning truly is.
So how did Alan Greenspan, price fixer and market manipulator, do in his years
at the Fed? His record is mixed. Initially he showed some constraint and tried
to fight inflation, the scourge of the middle class, but five or six years into
his run he started to embrace and nurture inflation. Amazingly in
monetary-growth terms he wasn't a great deal better than the horrible Fed
chairmen of the 1970s, Arthur Burns and William Miller.
Our first chart looks at 45 years of annual broad money supply (M3) growth
compared with annual price inflation as measured by the Consumer Price Index
(CPI). From a free-market standpoint, the more stable a money supply, meaning
the slower it grows, the more prosperity it generates in all socio-economic
strata of society. The faster money supplies grow, the harder life becomes for
average Americans with slowly growing incomes.
these charts run from 1960 to the end of 2005. I chose this scale because I
wanted to be able to see the results of Alan Greenspan's decisions in context
with history. The blue-shaded area to the right marks Greenspan's tenure.
Before we get into the Greenspan years, though, it is useful to recall all the
financial pain of the 1970s, which was caused by excessive monetary growth and
the severing of the remaining gold standard.
Note the red M3 line above, which is the year-over-year growth rate in the
broad US money supply. For virtually the entire 1970s the Fed was allowing the
money supply to expand at a breakneck pace, usually exceeding 10% a year. With
so much new money flooding into the system, the supply of real goods and
services on which to spend it just couldn't keep pace. So relatively more money
was chasing after and bidding up the prices of relatively fewer goods and
The result of this excessive monetary growth spawned by the Fed artificially
manipulating interest rates far lower than the free markets would have set them
was the massive inflation of the 1970s. The blue CPI growth-rate line above
tracks some of this, with costs of living rising 12% and 15% in just a year
during their worst spikes. Everything in the US became more expensive in the
1970s and Americans felt poorer since incomes didn't grow as fast as money
This was such an enormous problem for the nation that, like an elephant in the
living room, even Washington and the Fed couldn't hide it under the rug. So
Paul Volcker, the Fed chairman for the eight years before Greenspan's
appointment, finally let interest rates float high enough in the early 1980s to
strangle the damaging monetary excesses out of the system. Volcker also ensured
monetary growth rates continuously declined in the 1980s, which drove down
inflation to multi-decade lows.
When Greenspan became chairman in August 1987, the Fed was doing about as well
as it possibly could for a communist-style command-and-control price-fixing
entity. Monetary growth rates continued to fall, inflation was acceptable, and
other than the flukey October 1987 stock-market crash, Greenspan had it easy.
All he had to do was not mess around with interest rates and keep the Fed from
mucking around too much in money supplies by buying and selling US Treasuries.
And Greenspan was largely successful at this in his early years. Broad monetary
growth continued lower and inflation stabilized for the first time in decades.
But for some reason near the beginning of 1995, Greenspan forgot about his
mission to keep prices stable by not allowing excessive monetary growth. The M3
annual growth rate began to rocket higher and challenged 11% in the late 1990s
and exceeded 13% in the early 2000s.
As you can see on the chart above, after 1995 monetary inflation exploded
upward to staggering rates not witnessed since the 1970s. Whenever excessive
money supplies are pumped into the pipeline of an economy, they will have to
find a home somewhere. Typically this is in the form of general price inflation
shown in the CPI growth spikes of the 1970s. But strangely, in the mid-1990s
the CPI ignored the monetary surge and a major discontinuity was created.
Some believe that Bill Clinton's re-election effort ahead of the 1996
presidential elections involved cooking the books in terms of government
statistics. If the CPI was reported to be low through the use of such
statistical wizardry as hedonic deflators, then the stock market would thrive,
Americans would feel happy about the economy, and the Democrats would win
another term. Whether this was the reason or not, the CPI seemed to stop
reflecting true monetary inflation in 1995 or so.
With no gold standard and no accountability in the official inflation stats the
markets watched, Greenspan allowed M3 growth to rocket up to 1970s levels. This
was the fuel for the massive stock-market bubble of the late 1990s, as we'll
see in the next chart. Alan Greenspan warned of "irrational exuberance" in 1996
and then he inexplicably kept feeding the very stock-market bubble he saw
growing. Eventually he even bought into the New Era nonsense and foolishly
believed the "productivity miracle" justified extreme stock prices.
By the dawn of 1999 Greenspan seemed once again to get concerned and start
pursuing Fed policies for lowering the blistering monetary growth rates. But
then Y2K came along and everyone including the Fed was scared so it injected
huge amounts of new money into an already frothy system. Then the Nasdaq crash
of early 2000 led to another long surge of increasing monetary growth in an
irresponsible attempt to bail out stock speculators.
All of this excessive 1970s-type monetary growth created the situation in which
we find ourselves today, with prices of goods and services rising as the Fed's
monetary promiscuity floods into the general economy. In terms of monetary
growth, Greenspan didn't do much better than the terrible 1970s Fed chairmen
and he certainly utterly squandered the inflation-fighting legacy of his
History will rightfully remember Alan Greenspan not as an inflation-fighting
hawk, but as a socialist Keynesian advocate of endless inflation that betrayed
his own principles expressed earlier in life. In 1966 Alan Greenspan wrote an
awesome essay, "Gold and Economic Freedom", in which he said the following: "In
the absence of the gold standard, there is no way to protect savings from
confiscation through inflation ... Deficit spending is simply a scheme for the
"hidden" confiscation of wealth."
In light of his surprisingly poor monetary record, Greenspan's legacy will be
remembered as one of the confiscators of Americans' wealth whom he once
despised. His senseless inflation contributed to the moral decay of the US,
gutting the purchasing power of retirees' savings and ensuring that most
American families would have to have two wage earners in order to keep a
semblance of middle-class living.
If you are blessed enough to have surplus capital to invest and not live on a
fixed income like older or less fortunate Americans, you may not be worried
about inflation. Last spring I had a discussion about the Greenspan record with
the chief executive officer of a medium-sized publicly traded US corporation.
As one blessed to earn a lot of money, he couldn't care less about inflation
and didn't seem to understand how damaging it is to average folks. Well,
Greenspan's policies also inflicted enormous pain on the wealthy investor class
This next chart shows the actual M3 money supply versus the S&P 500.
Excessive monetary growth courtesy of the Greenspan Fed directly kindled the
dangerous stock-market bubble of the late 1990s.
investor class can often earn more than enough to stay ahead of inflation. Who
cares if a hamburger at McDonald's costs US$20 if you are earning $500,000 or
more a year? But Greenspan's pro-monetary-inflation policies at the Fed also
caused literally trillions of dollars of damage to investors. If there was one
individual alive who could have greatly moderated the 1990s stock-market
bubble, it was Alan Greenspan using his Fed.
Early in his career he continued Volcker's policy of disinflation, slowing the
monetary growth rate, as the red actual M3 line above shows. When Greenspan
took the reins at the Fed there was well less than $4 trillion in circulation.
But in 1995 when Greenspan suddenly became a manic inflationist, he unleashed
the floodgates of monetary growth just like the failed Fed chairmen of the
1970s. M3 literally started soaring.
As these torrents of paper money freshly created out of thin air cascaded into
the economy, many of them gravitated to the stock markets. The surge in
monetary inflation that started at the Greenspan discontinuity marked the very
moment in time when the US stock markets left a reasonable normal growth ascent
slope and went parabolic. While the Fed-fed equity bubble may have been fun for
a few years, its ultimate consequences were, are, and will continue to be
After five years of relentless monetary inflation pouring into stocks, by March
2000 the flagship S&P 500, the 500 biggest and best companies in the United
States, was worth about $13 trillion, a staggering sum of capital. Yet all this
was only an inflation-fed fiction just like past bubbles. These companies
didn't have the earnings to support these tremendous valuations, but investors
just bid them up indiscriminately anyway because Fed money kept flooding in.
But the Greenspan bubble, like every other bubble in history, eventually had to
end. It topped in March 2000 and its first Great Bear downleg lasted until
March 2003 or so. Over this period of time the S&P 500 companies lost about
40% of their bubble value, about $5.5 trillion in these elite companies alone.
This loss is just mind-blowing, and it damaged the investor class immeasurably.
Monetary inflation hurts the wealthy too when the bubbles it creates suddenly
pop and wreak great havoc.
At this point Greenspan, if he had loved free-market capitalism, would have
acknowledged he screwed up in the late 1990s with his monetary promiscuity and
he would have stepped back to let the necessary painful readjustment happen.
But instead he did the dumbest thing he could possibly do, something that fits
in with his true character as a central planner and market manipulator. He
brazenly attempted to bail out stock speculators by slashing interest rates to
artificial half-century lows.
Before we get to our next chart showing Greenspan's unbelievably aggressive
interest-rate manipulations, note that the red M3 line exceeds $10 trillion
today as he leaves the Fed. Why is everything getting more expensive today,
from food to medical care to insurance to cars to houses? Because under
Greenspan's watch the Fed allowed US money supplies to rocket 185% higher. This
is becoming such an embarrassment that the Fed is actually going to quit
tracking and publishing M3 in a couple months to hide its horrific Greenspan
Our final chart compares one-year interest rates with the value of the US
dollar. After the 1995 discontinuity the dollar went on a wild ride that ended
soon after Alan Greenspan attempted to bail out stock speculators upset that
they were foolish enough to buy in to a massive bubble. While the Fed's primary
mandate is to not grow the money supply very fast in order to prevent
inflation, the stability of the dollar's purchasing power is a related mission
and the Greenspan Fed failed miserably on this front too.
money supplies grow too rapidly and inflation and inflationary expectations
take root as they did in the late 1970s, the only way to sop up all of this
excess liquidity is with far higher-than-normal interest rates. Greenspan's
predecessor understood this and was willing to be unpopular in order to get the
US economy back on track. For nearly six years straight in the early 1980s,
one-year interest rates exceeded 10%.
At times during this painful period of sopping up excessive 1970s monetary
growth, 30-year fixed mortgage rates exceeded 18%. Thanks to the massive
Greenspan inflation of the late 1990s there is a very good chance Americans
will again see mortgage rates well into the teens before his inflation is
purged from the system. Folks with adjustable-rate mortgages will be ripped to
shreds if this happens, all courtesy of the Greenspan legacy.
Early in Greenspan's career he established the precedent of slashing interest
rates rapidly for long periods of time in a Keynesian attempt to plan and
manage economic growth centrally. It appeared to be successful at the time, but
now a decade later the folly of this approach is quite evident. If interest
rates hadn't fallen so far in the early 1990s, then the speculative culture
that helped drive the stock-market bubble would probably not have taken root to
such an extent.
But the biggest mistake Greenspan made was when he launched his bold gambit in
early 2001. Even though artificially cheap money had never stopped a bubble
bust from fully running its course in history, Greenspan's supreme hubris led
him to try anyway. He didn't want his precious public image and acceptance
tarnished (read Bob Woodward's excellent Maestro to learn of Greenspan's
love of status), so he decided to bail out stock speculators. Rather than
letting stock speculators learn from their own mistakes, Greenspan mollycoddled
For a free-market society to work, people must be free to succeed or fail.
Failure is more important than success in many ways since it teaches the best
lessons of life, builds character and wisdom, and lays the foundation for
future successes. By trying to buoy the stock markets with artificially low
interest rates, Alan Greenspan attempted to short-circuit countless valuable
financial lessons from the bust. Instead of becoming more conservative and
learning just as speculators in the 1930s had, in the 2000s speculators
exercised the Greenspan Put.
A put, of course, is an options contract that protects an investor from
downside by guaranteeing him a selling price regardless of market conditions
for a period of time. Greenspan's bailout was widely seen as putting a floor
under the stock markets which encouraged 1999-style speculative excesses all
over again such as we see in Google today. Stock speculators never learned the
lessons they should have in the past five years.
When speculators and businesses aren't free to fail, it creates a huge moral
hazard problem. After all, if the Fed is going to pull out all stops to keep
capital cheap and flowing into the stock markets, then why not continue to bet
aggressively? Rather than being wise and prudent and deploying capital in
sectors that really needed it like commodities infrastructure, the Greenspan
bailout encouraged a renewed tech-bubble focus.
But Greenspan's Gambit of artificially low interest rates created other
problems. Capital markets rely on a balance between savers and debtors, between
savers earning a fair return on the income they didn't spend and debtors paying
a fair price for the income they didn't earn. When interest rates are not where
the free markets would set them, the saver-debtor transactions are no longer
mutually beneficial and capital flows are grossly distorted.
Thanks to Greenspan aggressively punishing prudent savers to subsidize wanton
debtors, savings rates in the US fell to all-time lows. Rather than save
capital and put it into productive assets that will make the United States a
stronger nation, many Americans instead stuck it into overvalued real estate
and created the housing bubble. The bursting of this second Greenspan-spawned
bubble in housing will be far more devastating than the stock crash since it
will affect all Americans with a mortgage, not just the wealthier
In light of Greenspan's inflationist record, I suspect his legacy won't be very
positive. He made many poor anti-free-market decisions as a command-and-control
price fixer and it will take years or decades for the consequences of these to
work through the system. For instance, because of the Greenspan bailout the
current stock bear is likely to last 17 years instead of just a few as in the
early 1930s, and we are only six years into it today. Thanks, Mr Chairman.
And when the housing bubble spawned by Greenspan's attempt to bail out stock
speculators with artificially low rates bursts, watch out. Markets are cyclical
and artificially low prices are always followed by higher-than-normal ones to
balance things out regardless of what the manipulators want. Hence the price of
money is headed a lot higher. The economic pain as real-estate prices correct
in most places and crash in some is going to be tremendous. It is all courtesy
of Alan Greenspan's brazen interest-rate manipulations.
I realize this is a heavy and sobering narrative, and I don't like the
Greenspan legacy either. There are a few bright spots, though, ways investors
can capitalize on Greenspan's sorry legacy. We are continuing to focus on these
opportunities and are being blessed with excellent realized profits on our
During the latter two-thirds of Greenspan's reign, his highly inflationary
easy-money policies led to enormous misallocations of capital into first tech
stocks and then houses. With capital flowing into these counterproductive
bubbles, industries that really needed this very capital starved and withered.
This contributed to a massive structural undersupply of crucial commodities.
And this capital-starved commodities industry is highly physical, unlike
information industries that can be wished into existence overnight. It will
take more than a decade to find and deliver enough oil, natural gas, copper,
gold, silver, and other key commodities to meet today's demand. And not only
are commodities prices rising because their producing infrastructure was
starved in the 1990s, but Greenspan's massive monetary inflation is also
filtering into commodities, boosting them directly too.
Many stock analysts are now researching elite commodities producers and
developing tools to time trades in these companies. While many investors have
already been blessed with awesome gains since this commodities bull market
launched, odds are the best is yet to come. Astute investors will capitalize on
some of the massive capital distortions that need to now be righted thanks to
The bottom line is that Alan Greenspan, despite his huge fan club today, is no
different from the Communist Party bosses of Russia before the Cold War ended.
Rather than sitting back and letting the invisible hand of the free markets
determine the price and growth rates of money, Greenspan chose to play God and
horribly messed everything up like all other would-be demigods in history.
Price manipulators always fail in the end.
Greenspan's legacy is one of a failed market manipulator and price fixer, a
dangerous enemy of free-market capitalism in sheep's clothing. In five or 10
years from now once the full spectrum of the consequences of his highly
inflationary and moral-hazard-ridden policies become apparent, I suspect
Greenspan will be remembered as a goat, not a guru, a blight on the United
States and its economy.
Adam Hamilton is an analyst at Zeal
LLC. His weekly essays analyze current market trends from a contrarian
perspective to provide investors with information to grow their capital. He has
been published or quoted in the Wall Street Journal, GOLD Newsletter, The
Silicon Investor, Fall Street and The MoneyChanger.
(Copyright 2000-06 Zeal Research. Used by permission.)
Speaking Freely is an Asia Times Online feature that allows guest writers to have
Please click hereif you are interested in