When alan greenspan retires in January, after eighteen and a half years as chairman of the Federal Reserve Board, he will have served longer than any previous occupant save William McChesney Martin Jr., who held the job for nearly 19 years. A lot happened during the Greenspan era – two wars in the Persian Gulf, various currency crises, three stock market meltdowns – but no topic interested him as much as the revolution in information technology.
Greenspan will ever be associated with the bubble in high-tech stocks – first for warning, in 1996, that investors might be succumbing to “irrational exuberance,” and later, after stock prices had soared and investors truly had succumbed, for presiding over the collapse. Greenspan’s critics tend to focus on his enthusiasm for Silicon Valley before the crash; his defenders point out that, after all, the stock market has begun to recover. Both points are somewhat tangential to his real legacy. Greenspan’s primary interest was never the precise level of tech-stock prices: it was how the computer was transforming American society.
“Virtually unimaginable a half-century ago was the extent to which concepts and ideas would substitute for physical resources and human brawn in the production of goods and services,” he told an audience in 1996. At that time, the chairman drew comparisons between the computers of our day and the innovations of earlier eras. Four years later, Greenspan was advancing the proposition that our era was indeed different. “When we look back,” he said on January 13, 2000, “we may conceivably conclude…that…the American economy was experiencing a once-in-a-century acceleration of innovation…[and] it is information technology that defines this special period.”
In August 1987, when Greenspan took the reins at the Fed, information technology was still relatively young. Mainframe computers had long been a staple of American industry, of course, but most Americans did not yet own PCs, and as Greenspan was to observe, “the billions of dollars that businesses had poured into” computer technology “seemed to leave little imprint on the overall economy.” The Internet as we know it did not exist. And oh, yes, the Nasdaq was barely above 400. Greenspan, of course, had nothing to do with creating technology, but as a central banker he allowed technology to influence economic policy to an astonishing degree. Did he get the big picture right?
The proper duty of the Fed chief was forever defined by Martin, who served from 1951 to 1970, as to “take away the punch bowl just as the party got going.” Thanks to Robert Bremner’s new biography Chairman of the Fed: William McChesney Martin Jr. and the Creation of the American Financial System, we have a deeper understanding of how complex this job can be. Greenspan isn’t mentioned in the book, but his shadow hangs over it. Between them, Martin and Greenspan dominated central banking for half a century – a period that saw the U.S. economy reassert itself after the calamity of the Depression; fall siege, during the 1970s, to the worst bout of inflation in recent history; and then recoup in the great boom of the 1990s. Bremner’s book, on bookstore shelves during Greenspan’s last year in office, stirs us to an uncomfortable contrast. How are we to reconcile the failure of the puritanical Martin with the success of Greenspan, who can be accused not only of failing to remove the punch bowl, but also of spiking the punch?
Greenspan’s infatuation with the peculiar punch being ladled out in Silicon Valley is a matter of record. To cite but one example, in April 2000, when dot-com fever was at its peak, he spoke at the White House Conference on the New Economy and warmly referred to the “prescience” of security analysts who were then touting tech stocks at lunatic prices. “There are many who argue, of course, that it is not prescience but wishful thinking,” Greenspan acknowledged. “History will judge.”
History did judge. The bubble popped, and yet the fact is that Greenspan’s overall record is one of price stability and robust growth, dampened by a pair of only mild recessions. Meanwhile, the humorless Martin, who essentially equated speculation with sin, somehow managed to let inflation careen out of control.
Both men entered office as orthodox inflation hawks, and both eventually adopted more-nuanced – one might say more-relaxed – views toward restraining prices. Aside from a shared passion for tennis, however, that is where the similarities ended. The straitlaced Martin, born in 1906, learned macroeconomics from firsthand experience, much of it painful. His grandfather lost his grain business to the depression of 1893, and Martin spent his early career, as a broker and then as a reformist president of the scandal-ridden New York Stock Exchange, trying to emerge from the suffusing gloom of the Great Depression. Contrariwise, Greenspan’s education was intellectual and faintly bohemian: the conservative economist, who grew up in Washington Heights in Manhattan and studied at the Juilliard School of Music, emerged from Ayn Rand’s salon and, improbably, the swing band in which he blew his clarinet.
A Bumpy Ride
As Fed chief, Martin patiently worked to free the central bank from executive control in the aftermath of World War II and to reassert a system of market rates. His reward was to have President Truman label him a “traitor.”
Martin also had difficulties with President Kennedy. The economy had grown sluggishly under Eisenhower, and Kennedy was anxious to energize it. He adopted a Keynesian prescription: tax cuts and deficit spending. This was the same tonic President George W. Bush would later adopt. Martin, though, worried about deficits. As a central banker, he frowned on the idea that “a little bit” of inflation could be benign. “There is no validity,” Martin countered, to the notion “that any inflation, once accepted, can be confined to moderate proportions.” This would prove more prophetic than even Martin feared.
Under Lyndon Johnson, domestic spending soared, just as the United States became deeply involved in Vietnam. Martin correctly sensed that LBJ was underaccounting for the war’s cost. He fretted to LBJ that the United States was “heading toward an inflationary mess,” and despite LBJ’s pleading, in December 1965 the Fed raised rates, decisively. Then, after having fought off LBJ, Martin inexplicably crumbled. He felt committed to the administration, and he perceptibly – and tragically – shifted his emphasis from managing interest rates to working on the president to balance the budget.
In retrospect, he missed, or underestimated, the salient trend of his era. It wasn’t budget deficits (though they were real) but incipient inflation. By the time Martin retired in 1970, prices were rising at a 6 percent annual clip. Inflation would exceed 13 percent before Paul Volcker, appointed in 1979, brought it down. When Greenspan began his first term as chairman, inflation was 4 percent; clearly, he does not deserve the credit for taming it. But it would be a while before markets realized the dragon had been slain. And just as Martin had to flout public opinion in the 1950s, tightening monetary policy despite fears that a new depression lurked around the corner, so Greenspan had to break with the postinflationary mindset. The New Economy was his ticket.
As a Wall Street economist, Greenspan was well positioned to recognize technology’s impact. Wall Street, which in the 1970s had nearly drowned in the physical paper brokers generated, was one of the first industries to productively use computers. Not only did they speed trading, but they made new forms of trading, and new financial instruments, possible. To Greenspan and others, it appeared that technology would break down barriers, promote competition, and lessen the need for regulation. “New technology,” he noted, “has fostered mergers that allow firms to take great advantage of economies of scale and thus reduce costs.”
Greenspan was perhaps too infatuated with technology to appreciate its potential for mischief. He was consistently, and inexcusably, lax in pressing for rules that would govern the new finance. And if technology had led only to mischief, he would have been a failure. But of course, technology has mainly been a blessing, not least for allowing firms to make more of their resources. Greenspan sensed that far earlier than almost anyone.
The pivotal moment came in September 1996. The economy was picking up steam, and labor markets were tight. According to conventional analysts, businesses would be forced to pay more for labor and to pass on their costs as price hikes. Preventing inflation, the argument went, meant raising interest rates. But inflation was falling. Greenspan saw that “something else might be going on,” recalls then Fed governor Alice Rivlin. His hypothesis was that IT investments were making businesses more productive. If so, pay raises wouldn’t really be “raises”: workers would simply be receiving greater compensation for greater output.
And yet, even though business had been pouring money into computers for years, the official data indicated that the rate of productivity growth remained low. “Why have our recent productivity data failed to register any improvement?” Greenspan asked in a speech. “Is it possible that much of the frenetic activity [involving computers] is mere wheel spinning, and as a consequence, very little real value added is being produced – or maybe ever will be?” Greenspan didn’t think so. A majority of the Fed’s governors wanted to nip the inflationary threat, even before it was visible, by raising rates, but Greenspan insisted that rates remain stable. The boom continued for four more years. This had profound social consequences, as it was only after 1996 that real wage increases began to dribble down to middle- and lower-income workers. Nonetheless, inflation remained quiescent, and sharply higher productivity was soon visible in the official stats. Greenspan’s bet had nothing to with dot-com stocks; he thought technology was making the rest of the economy – steel, finance, retail – more efficient. And so it was.
He was wrong about tech stocks, and his endorsement of the Bush deficit may turn out to be grievously wrong. But Fed chiefs, ultimately, are paid neither to pick stocks nor to balance budgets. As Martin understood, the central banker has two primary tasks: maintain stable prices and promote growth. Alas, the banker who famously stood watch over the punch did not fare as well as the musician with an ear for the pulse of computers.
Robert Lowenstein’s most recent book is Origins of the Crash: The Great Bubble and Its Undoing.
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