Dear Contra Corner Reader,
Below you’ll find the transcript of a recent discussion me and my colleagues had with Alan Greenspan.
We served under the Reagan administration together and have stayed in close contact over the years. I have a tremendous amount of respect for him — but what he recently said behind closed doors SHOCKED me. To protect the identities of all involved, we’ve made each speaker anonymous. I’ll list Greenspan’s name and my own name, but refer to the others by Speaker 1, 2, 3 and so on.
Read on for “the maestro’s” mind blowing confession…
David A. Stockman
Editor, David Stockman’s Contra Corner
Speaker 1: We asked you here and, of course, we're thanking you for coming all the way from Washington up here to Baltimore. Just as background, I began actually reading the Objectivist newsletter.
Dr. Greenspan: So you didn't wait.
Speaker 1: It was a long time ago. At the time I was running an organization in Washington called The National Taxpayers Union. We were fighting waste and corruption, without much success I might add. Then I realized that I couldn't make any money in the public sector, in the public interest business, so I went and started a newsletter publishing business and that's what this is. That was started by me with a friend and that was about it. Now we are in ten different countries and many of the people you see around this table are analysts who work in various offices around the world.
I should thank you too because we are in the financial publishing business and the financial publishing business was greatly aided by that whole period, the financialization of the economy did not hurt us. In fact, our sales, it went from about 10 million dollars when you went into The Fed and now are edging up towards a billion, so thank you very much. I don't know if Goldman and those guys thank you but thank you much for that.
Dr. Greenspan: You're welcome.
Speaker 1: Right. Now we're just trying to decide, trying to understand what's going on and how a modern economy is affected by politics. Really how the world of politics intrudes on an economy and what the role, I would say, of our traditional, classical, Austrian economics is in relation to the modern world. Many of us around this table, including myself, are gold bugs, not necessarily gold bulls but we are gold bugs and we are very much in tune with the Alan Greenspan of 1966. The Alan Greenspan, as I make it out, has changed since 1966 and we're kind of wondering where that leaves us. I'm eager to hear your views on what has happened in the last 30, 40 years and particularly how the role of politics in economics has changed. I'll just leave it there and we'll come back to this later on.
Speaker 2: Thank you Dr. Greenspan for being with us here today. I was going to start with a question about Trump, but we were talking in the green room earlier and I explained to Dr, Greenspan that we were gold bugs and we were interested in hearing how, as you mentioned, somebody who was a self-declared gold bug ended up running the Fed for 19 years and how you square that circle philosophically.
Dr. Greenspan: It's all because of a fellow gold bug whose name was Martin Anderson, if you will remember quite well. He, Martin was a student of mine in one of the Objectivist seminars and he eventually got called by Richard Nixon to help on his campaign in 1967, I think. He asked me if I could be of help to them so I did. I wrote a torrid speech against commodity subsidies and I got swamped by all the right-wing republicans in the grain belt. I said this is a terrible world in which to exist. What eventually happened was I found that I could do a lot of things which changed things because I had inadvertently got put in a very important position as far as policy was concerned.
I said to myself, "Do you want to be on the outside looking in and complaining or on the inside biting your tongue on occasion?" If you're asking have I changed my views, no. Indeed, in my confirmation hearings, the first time I got into government, which was as chairman of the council of economic advisors, the senators who were sitting there saying, "What do you mean you don't agree with the anti-trust act?" They went through a whole series and would ask me questions. "Do you believe in the minimum wage?" I said, "No, sir." Everyone was going grr grr. Finally they decided, Proxmire who was then chairman of the committee said, "I'm going to vote against you but I must admit you are very smart and very straight and that's precisely the reason I would prefer that you were not on the other side …" meaning my side rather than his.
I've sort of gone in that direction but fully recognizing that if you're a government official and you're sworn in you're supposed to follow the laws of the land and that's what I did. I didn't say I agreed with them, but I did essentially follow them.
Speaker 2: We were talking earlier and you said that when you got into The Fed you sort of wanted to simulate a gold standard as close as possible with monetary policy.
Dr. Greenspan: It's basically because what the gold standard did by its nature, still does, is to create a system which is self-equilibrating. The 1913 act substituted a federal reserve system which did, in part, what the markets do or try to. As I said to Ron Paul, who was then in the same committee as Bernie Sanders who I used to go between, Ron Paul and the next questions were Bernie Sanders so I had a very interesting time. What I told Ron Paul I said, "Look, if you look closely at how they operate policy we are trying to replicate what the gold standard would do." To whatever extent we did or we didn't succeed is not the point, that was fundamentally what we tried to do.
I just basically took myself out of all supervision and regulation. I said, "These are all legal questions. I don't want to basically get involved in something I don't know too much about and whose philosophy is fundamentally in variance." That's what it is.
Speaker 2: Another of the questions that we talked a little bit about in the green room is this quote by Bastiat who said that no civilization ever survived fiat money. The other question for you, Dr. Greenspan, was Bastiat right to fear fiat money and do you think we'll ever see a return to gold or commodity-backed money.
Dr. Greenspan: Let's ask the question, why has gold been such an extraordinary factor as far back in human history as we can go? Fundamentally I don't think, there is very rare cases in which somebody would refuse gold in payment for anything, right up to today. The only conceivable explanation would be that gold is physically too heavy to move, but then you could get gold certificates, but if you put the gold certificates in … I cannot think of a single time ever in human history when gold was rejected as a means of payment for real goods and services. You cannot say that about any other currency.
Gold is a currency and essentially if you look at the data on the price of gold in terms of dollars, the pressure of gold up and down was basically moving the general price level until 1913 when the federal reserve, by its very nature, creates essentially reserve balances which replicated what gold did prior to the federal reserve. What we had basically is a very, we had, as I would put it, there used to be an old cliché when I was a kid about putting a, what was it? I've forgotten actually what it was but what it was trying to bypass electric currents …
Speaker 3: Put the Penny in the …
Dr. Greenspan: That's what it was. Putting a penny in the fuse box. I had forgotten the phrase. That's exactly right. That's what we were doing. We were presenting with the issue of a central bank, creating an indefinite amount of legal tender currency. It worked for a while and always does work for a while because human beings are such, we're flawed as well as a lot of things, in which we will accept fiat currency and have over the years. Remember, in 1775 the continental congress issued fiat currency in order to finance George Washington's armaments.
People in the very beginning were accepting it as though it were gold. Eventually they kept producing more and more until towards the end of its life expectancy the phrase occurred, "It's not worth a continental". Eventually it went from probably 99 cents on the dollar acceptability down to one or less. There has not been a fiat currency which has gone down relative to the price of gold. In other words, gold has always been the crucial determinant.
I’m in the process of doing a new book on the economic history of the United States and one of the things I'm looking back at is how the general price level moved with the price of gold 1800 through 1913 or something like that. It's really very fascinating, the extent to which there is something about gold's attraction to human beings which goes back in history as far as you can go, it's always been acceptable, it's always been the prime means of acceptance of exchange. It's always been the number one exchangeable commodity for gold, not diamonds, not silver, nor other competing types.
It is certainly true that ultimately historically fiat currencies have always ultimately ruined the economies who basically worked with them. I'm sure your colleagues from South America went through enough of 5,000% or 20,000% annual rate inflation and it disabled society fundamentally. That has never happened in a system which gold was the medium of exchange.
Speaker 2: Dr. Greenspan, do you see fiat currencies similarly disabling society over time outside of South America? Is there the same risk of what you just described of the effects of fiat currencies, could that happen here and what would it take for a return to a gold standard? Do you see that as something possible or unlikely or impossible?
Dr. Greenspan: Oh, no. What it would do would be to, you could do it merely by both houses of the congress going for it and the president signing it, it could be an act. We did have a number in 1890 … No, I'm sorry 1900, the gold standard act. We actually didn't have an act previously but we always defined the U.S. dollar in terms to total amount of gold. We could do that right now, but I don't think it's about to happen.
Speaker 2: That was my next question. The obvious corollary to that is that if fiat money has these inherent risks, why is it, what makes fiat currency so attractive to politicians? I think just to quote your biographer, Sebastian Mallaby, he said, "So long as there is a central bank that can create fiat money it will. Politicians will always spend beyond their means, confident in the knowledge that their debts can be cancelled by the printing press." Is that essentially your view?
Dr. Greenspan: Yeah. That's what the facts are. No, what is fascinating is that fiat money would not exist if it were turned down by those who are currently receiving fiat money as legal tender or whatever. If, for example … Well you couldn't turn it down if it's legal tender, that means you have to accept it, but let's just take it before it was legal tender. People did still accept it and the question is: Why? If you're a politician and you say, "Well, I may not get 100 cents on the dollar with what I'm printing, but supposing I get 80? That's the cost of the paper. We have a lot of paper, let's just print as much as we can."
During the Civil War in the south it took a while before Confederate currency lost its value. It was never backed by gold, yet in the initial stages the Confederacy was able to finance the war because it got transfers of goods and services with an ever-depreciating currency. In World War I, sure enough the price level in terms of gold went up. Fortunately the war was over before anything significant happened and we got through World War II as well, the currency didn't collapse but only because a significant proportion of the individuals were willing to hold that currency and take it as payment.
The question that you have to really ask is: What would induce the population as a whole to eschew taking paper currency as a means of legal payment, or take the word 'legal' out, as a means of payment, period. First of all, you can't really tell because if there is a taxing policy on the part of a government, one could always say, "Well I view the taxing power as creating the means by which I can get resources in exchange for the currency." It's still fundamentally a choice of what individuals want to do and the reason they do that is that they believe that it will work. It did not work, of course, in the continental currency before we had any taxing power, but it did work in the beginning. You might say that there are foolish people out there who will accept something that isn't worth anything.
Speaker 2: Dr. Greenspan, one of the issues, trends I guess, that we've been looking at is the rise of cryptocurrencies, such as bitcoin. Basically, last year in 2016 bitcoin was the best performing currency of all currencies in the world, it went up by 120% versus the dollar. Essentially that represents people eschewing the fiat currency. People are, especially from China …
Dr. Greenspan: That's a fiat currency.
Speaker 2: You mean bit …
Dr. Greenspan: Bitcoin. What is it backed by?
Speaker 2: That's a good question. I guess the difference between bitcoin and other cryptocurrencies and fiat money is that it's not issued, there's no central bank. There's no discretionary issuing authority.
Dr. Greenspan: No, I agree with that. I think … No, I mean what it does is it bides, it's basically a program, which nobody seems to know what it is, delimits the amount.
Speaker 2: Correct.
Dr. Greenspan: How they convinced somebody to start taking that in payment I've always found very peculiar because if somebody ever breaks the code it's gone. There's a huge amount of bitcoin deposits and if somebody breaks the code, I don't know what happens to that stuff. Whereas gold has got an intrinsic value, bitcoin has no intrinsic value. Silver has intrinsic value. Diamonds have intrinsic value. Bitcoin doesn't. People chase things for weird reasons and if they are willing to accept fiat currency, why not bitcoin? They think it's going to go up and there's other people who are going to pay more, they buy it.
Speaker 2: You're not buying bitcoin?
Dr. Greenspan: No. After that? I would prefer to eschew to big gains because I can get big gains theoretically by going to Las Vegas and throwing coins.
Speaker 2: Just moving on a little bit but still related to the biography, which a lot of us here have read. Mallaby writes in The Man Who Knew that an affluent democracy is simply not willing to let its financiers go bust. I'm just wondering, do you agree with that and if it's true, what are the consequences if we as an affluent democracy aren't able to let corrections happen, which obviously …
Dr. Greenspan: Why is … Sebastian Mallaby is a good guy, I like him, he's a friend of mine, but what I wrote, instead of his quoting …
Speaker 2: Oh, I'm sorry.
Dr. Greenspan: Anyway, rephrase the question.
Speaker 2: Do you think that in our democracies the financial authorities are willing to let corrections happen and if they aren't willing to let corrections happen, what are the consequences for our societies because …
Dr. Greenspan: You have to understand that people will make these decisions as human beings and they're making trade-offs in a period when the degree of uncertainty is at a maximum and you literally don't know what's going to happen, but you're in a position where you are making the judgements of what is done and you don't really know, and can't know, because of the nature of uncertainty what the outcome is going to be. What there is a tendency to do, and this is true of all human decision-making process, is you'll go for that which gives you the least risk.
In the short-term, if you have a breakdown like 2008 the maximum short-term probability of coming through it is to basically buy up the whole system. Since the central bank can print as much as it needs to, there is no limit so you can stop any crisis cold merely by just buying up everything. The trouble is, what do you do then? If there is that sort of action taken several times, you engender a degree of uncertainty in the marketplace, which essentially destroys the viability of the structure.
Remember that free markets existed before Adam Smith in 1776 wrote his tome. The reason that is important is that the markets evolved on the basis coming out, really it was the first time that property rights really meant individual property rights with the Enlightenment and really mattered, but it created a degree of exchange in the creation of wealth, which what Adam Smith did was identify what was happening. It wasn't that he came up with a wide abstraction of something, he was watching how this system, which seemed to be working, worked.
As far as I can see, what we've been trying to do ever since is to work around it but when we were on the gold standard it was very simple. The issue was that the monetary authorities, which was the Treasury Department, always had one central theme to maintain the gold standard, meaning maintain whatever currency is issued is convertible into gold bullion at a fixed exchange rate. If you look at the price level, as best we can measure it in GDP or Department of Labor terms, and the price of gold in 1794, they moved together. They don't move much but move together and they arbitrage.
The question is basically that we have had several occasions when we almost defaulted on payment. There was the very famous episode in 1895 when JP Morgan bailed out the U.S. Treasury. There were other occasions when, for example Andrew Jackson, he incidentally was the only president of the United States who had a year in which the debt, not deficit, the debt was zero. He had it for three straight years and those were the only times in American history when that existed. The reason that's important is that he had to do a lot to get that debt down to zero and that tells you the pull of what the gold standard was doing. He hated fiat currency.
Speaker 2: Do you recognize the risks inherent in that interventionist approach? Is that something that you were aware of in your tenure at the Fed, that if you were trying to prop up asset prices perhaps in the '87 crash or beyond that there would be risks inherent to that and maybe that was a weighing up of risks but
Dr. Greenspan: Yeah, no. Every time you took an action, unless you're absolutely certain, which there are certain occasions when you can be, but rarely. It's always a probabilistic issue. I can tell you, 18 1/2 years I did that and it wasn't fun. Everyone may have said, "Well look, he's having a lot of fun there." No, because, you know, it's … The first thing I ran into was the crisis … When I was in office just a couple of weeks in 1987 and we had that extraordinary collapse in prices. Jerry Corrigan, who was president of the Federal Reserve Bank in New York on that fateful day said … I had just been there and I was trying to find which door was which … "It's all up to you, Alan." I said, "What do you mean it's all up to me?" He says, "You're going to make the key decisions here. That's the way we work." I said, "Thank you very much Dr. Corrigan. That was very helpful."
I did sleep seven hours that following night, which I always thought was the best thing I ever did. You're dealing with risks and the whole question is risk. There is no risk if you're on the gold standard, it happens automatically. If you want to take the choice between the bureaucrats, risk adjustment to make decisions and automaticity, which up until 1913, really and I would basically say it was William Jennings Bryan in 1896, a very famous speech before the democratic convention, which was the first basic wedge in the system, and from there actually going through … Woodrow Wilson was definitely not really for the gold standard in one sense, but it was a mixed bag and we went technically until 1933 until Franklin Roosevelt literally took us off the gold standard, in the sense that we still obviously did exchange with other central banks but so far as the population was concerned we weren't allowed to hold gold because it was too valuable.
Speaker 2: Would it be a better system in your view to go back, put it that way.
Dr. Greenspan: If we had a society …
Speaker 2: If you could.
Dr. Greenspan: If we had a society which is willing to do it, certainly. Basically the reason the gold standard broke down was that there was a fixed structure of exchange rates which worked very well and the system worked very well to a point where the largest, the biggest critic of the gold standard, which was John Maynard Keynes, before 1913 the system was working very well. Everyone was for it and it did work, but what happened was World War I created a differential impact on all of the people who were on the gold standard and most wanted to go back to what the exchanges were prior to 1913, which you couldn't do because the devastation was asymmetric. The U.S. obviously had very little impact.
The pound sterling in 1913 was selling at $4.86 per dollar, $4.86 per pound sterling. The British wanted to go back at that same level and indeed it was Winston Churchill who was then chancellor of the exchequer who took them back and forced it back and in that act essentially destroyed what was left of the gold standard. It fell apart and when the Bank of England ran out of gold there was a presumption that all hell was going to break loose.
Speaker 2: Thank you for that. I think at this point we're going to open it up to the floor.
Dr. Greenspan: Does anybody care what's happening in the last 10 weeks or so?
Speaker 1: I'm going to follow along on that. The risk of the fiat currency system after 1971 was clearly consumer price inflation which happened. You predicted it early on, I believe, then we had it and then Paul Volcker came in and got ahead of it and engineered a deflation in consumer prices that will last then for another 20, more than 20 years, 30 years. Then the risk after that was the risk of an inflation of debt after Paul Volcker. Interest rates coming down, debt going up. What are the odds, or what is the possibility that a Fed chief now or that a Federal Reserve could now engineer a deflation of debt, get ahead of it?
Dr. Greenspan: You can't engineer a deflation of debt unless they're going to get people who are willing to unwind the transactions. You have to always ask, and you can't ask the question in general terms, what debt between which parties and what conditions. I think the most interesting question is, could somebody do the types of things that Volcker courageously did in that act to take what was essentially … We were almost getting into the position where people were saying we look like Argentina or Brazil. It turned out that if Volcker were not there, that system could really have exploded and people were throwing brick bats at him and he had the guts to stand still, knowing that that was the right thing to do.
Speaker 1: Could somebody do it now?
Dr. Greenspan: That depends who they are. It's got to be a person who has the ability to implement it. In other words, it's not only a desire to, but having an institutional ability to do it and that's without knowing in advance who they are and what it is but we very obviously in the last eight years we've gone into a stagnation, which incidentally has pretty much been for the last 10 years worldwide and that stagnation has led to an extraordinary collapse in the growth of output per hour which meant that standards of living were freezing at very low levels and in all human history whenever you get a situation where the population feels deprived one way or another, things aren't going well, it begins to revolt.
The revolt here is Brexit, Scotland, Italy. I can go through a whole series of things which are just now beginning to brew, but you cannot have a democratic, or I should say, I hate to use … The problem I have with democracy is that 51% can legally annihilate the other 49% so a pure democracy is never what the American system has been, it's always been a constitutional representation of government. Going evermore from where we are now to more and more democracy is not working for us, but without knowing in advance who are the individuals making the judgements and how are they going to make it and what's the institutional structure to do that?
For example, John Adams was always terribly fearful of a tyranny of the majority and he shortly was looking at the French Revolution, 1789. It could be part of the problem, which I haven't, I probably could think about well that's rebellion where everyone saw one of the faults of human nature and there's no way except looking into our own psyche and say, "How in the world did you get that way?"
Speaker 2: Would you like to present a question to Dr. Greenspan?
Speaker 4: You've already mentioned a fellow countryman of mine when you talked about Adam Smith so if you don't mind I'm going to ask a question in the same accent but even if I asked it, so if you have any problems with my accent let me know and I'll try and rephrase. I really want to ask you about your insight into the thinking of central bankers and the policymaking that's been going on for the last eight years when we've had extraordinary monetary policy from zero interest rates to negative interest rates to quantitative easing, qualitative easing, all of the terms which I call "institutionalized theft".
I want to ask you about institutionalized theft. Do central bankers think about the consequences of their actions for households and consumers who have saved all their life, who have expected a compounding effect in their savings, which I understand was very clear over a very important compound interest was the most important equation in the world, but they're now expected to assume no compound interest, no increase in savings. They get to the end of their working days and what they're faced with is nothing to compensate them for not locking in. In fact, I think there's one … You've mentioned Brexit and you've mentioned Donald Trump to a certain extent, Scottish independence.
Dr. Greenspan: Donald Trump would not have arisen if interest rates on savings, instead of being on average half a percent per year for five to eight years, if that didn't happen, Donald Trump would not be president of the United States.
Speaker 4: I would also argue it wouldn't have happened if interest rates had been above zero as well. The reason for saying that is that when I look at the results of Brexit and Trump inevitably brings Brexit immigration in the UK and yet most of the people who voted for Brexit don't work. They don't have a problem with immigrants taking their jobs but they have a problem with having to save more and more every year in order to eke out an existence. What was the thinking of central bankers about keeping interest rates so low that it's tumbling people in to a very different political movement now.
Dr. Greenspan: Let me tell you. There's one thing that bothers me considerably, which nobody makes any mention of. There is in the European central bank a mechanism as it exists of necessity where the European Central Bank is made up of the central banks of the European, Euro area and there's a thing called TARGET 2, do you know what TARGET 2 is?
Speaker 4: Yes.
Dr. Greenspan: TARGET 2 at this particular stage is turning out to be an extraordinary large transfer from Bundesbank to essentially Italy and Spain and most recently the European central bank. That means the Bundesbank is lending money to the European Central Bank and the question is, it's big numbers. We're talking 700-800 billion Euro. This can't go on indefinitely because at some point somebody's going to have the courage to move Greece out. Greece is in the ECB by accident. They came in under false pretences and the government, immediately following the government that got Greece fraudulently into the ECB said the numbers were all wrong and if they were actually the numbers used they would not have been in, but nonetheless they let them stay. That was a terrible mistake. The Greek personal savings rate right now is -20%. You cannot run an economy at -20% savings rate.
Something is going to happen there. My view is it's either going to be Greece. It conceivably could be Italy. The funny part of it is that the second largest contributor to the net flow in lending to Spain and Italy is Luxembourg. They've got some steel and they've got a few other things and they've got some banks, but it is extraordinary what is going on in this system while the total assets of European Central Bank continue to go straight up. What would happen if there was a default of the Euro?
In the United States, if there were a default on the dollar the U.S. Treasury could always … For example, if the Federal Reserve went into default the U.S. Treasury would bail it out but what do … There is no comparable vehicle to help the system. I'm very worried about … Nobody is … Mario Draghi, whom I know and he's a very good guy, is just talking like we'll do whatever is required. Well at some point somebody's going to say, "I don't want to accept Euros."
Speaker 2: Dr. Greenspan I think we're going to, just in the interest of time, keep it moving. David Stockman would you like to enter a question?
David Stockman: Alan, in all the years we've worked together in Washington I was so busy making policy and improving the world that I didn't really have time to do my reading on monetary history and theory. You were kind enough to get me a job on Wall Street as an investment banker and so I didn't have anything useful to do and I did catch up. One of the great things I found along the way was an essay, brilliant, written in 1966 called Gold and Economic Freedom. It really dropped the scales from my eyes and, as I recall, you were the author.
Dr. Greenspan: Who was the author of that?
David Stockman: I wondered first what you were doing at the Fed after I read that article about how well the world worked before 1913 when we didn't have a Fed. Seriously I think an important point you made in that article, which is totally forgotten in the fog of today's Keynesian and central bank activism is that there were five or six recessions between 1870 and 1913. They were all short-lived and they happened because banks got, as you use this great phrase, "over-loaned". There was a limited supply of gold, the credit expansion stopped, the economy adjusted and then things moved along.
During that period, which you would never know from listening to the debate today, real GDP grew by 4.2% a year for 43 years running and even if you take all the immigration out, that was 2.6% on a per-capita basis. That compares to 0.4% in the years since 2007, and is the reason we have Trump. My question is, if we don't go all the way with Ron Paul but go to your point that The Fed was originally meant to replicate the gold standard, what would be wrong with freezing what was done in 1913 when Carter Glass basically said, "This is a banker's bank. There was no open market committee. There was no buying and selling securities. There was no legal authority to either buy public debt or use it as collateral."
The whole point was a discount window in 12 locations around the country where the marketplace would decide whether cash was needed. They would bring good collateral, mainly business loans, and the market would decide the rate at which credit expanded in the economy and The Fed was simply a back-up, a banker's bank, to discount loans and provide liquidity. It was only in 1923 that they discovered the open market committee and began …
Dr. Greenspan: By accident they discovered …
David Stockman: … Yeah, by accident and we know the reasons, right …
Dr. Greenspan: Yeah.
David Stockman: … By accident, plus it was only World War I that gave the Fed the authority to own government debt and we were off to the races at that point. My point is, what would be wrong with going back to the banker's bank, abolishing the FOMC, revising or repealing Humphrey Hawkins, which I'm happy to say I voted against when I was in Congress, and simply let the interest rate determine, the market determine the interest rate and let the Fed provide on a passive basis, no central planning, no targeting of inflation or …
Dr. Greenspan: What's the point of the central bank then?
David Stockman: The point of the central bank was to provide back-up liquidity to the banking system.
Dr. Greenspan: Giving them a discount loan.
David Stockman: Yeah, through the discount window passively …
Dr. Greenspan: Which like the Bank of England did 1694 to date.
David Stockman: In other words, I'm saying if it's too radical to say abolish the Fed, end the Fed, why not? Carter Glass is a great icon, at least in the modern world because everybody thinks Glass-Steagall should have been maintained, whether true or not. Why not go back to Carter Glass' banker's bank, put the Fed out of the activist, money-management targeting, interest rate targeting, yield curve managing of stock market supporting business and simply let the market drive, market clear interest rates which we desperately need? The most important price in capitalism is the cost of money and debt and the whole idea of the Fed is to control the cost of money and debt so it's not capitalism. That's what I learned from your essay and I've been wanting to catch up with you for a long time to find out why I'm wrong for my conclusions.
Dr. Greenspan: The problem, David, today is that if … You would need a majority of both houses of Congress to get an act which was sufficiently solid to enforce that. Remember that the original Federal Reserve Act had gold requirements for the currency and for other things. The issue is so long as you have this, what I call, I guess it's the fiat money premium which I was discussing before, namely human beings are willing to take worthless money in exchange for goods until they learn better.
If we were all wholly rational we wouldn't do that and the system would work without any further … In other words, fiat money would not work in the essential sense, unless it were backed by something. Now I grant you that the coercive action of government in taxation policy can substitute for gold but nothing much else can. But if you're always in a position where every time we run into a problem we change the law … In the Social Security thing we kept making believe we had this fund which replicated a defined benefit program and it didn't, it was essentially a fictitious organization, as you would know better than anybody, but it didn't stop us. Congress went ahead and just, if you ran into a problem you just change the law. It's that psychology which really was lost with 19 … Well, I'd say World War I changed the whole structure.
David Stockman: Can I just follow up though because if, in theory, the Fed is trying to replicate the role of gold and you basically in that same essay proved that Milton Friedman was wrong and Bernanke was wrong about what caused the Great Depression, it wasn't because the Fed failed to go on a printing spree or QE in 1930-33, it was because in 1927 there was a massive expansion of the Fed's balance sheet to get interest rates down to help England that it set the price of, resume too high.
My point is, despite all of that history, if we go to a certain date that I'm quite aware of, you are too, August 1987, the balance sheet of the Fed happened to be 250 billion at that time, today it's four and a half trillion, let's round. That's 23X in less than three decades. The GDP then was five trillion, it's 18.5 today, that's 3.5X. All right, so how do we have a stable world when the balance sheet of the central bank is expanding at 23X over that time and the GDP grew by only 3.5? It caused an enormous increase in debt in the economy from 11 trillion when you started to 64 trillion today. Are we creating an end game that is unsustainable the longer we pretend that this all makes sense?
Dr. Greenspan: Oh God, no. It could maintain for quite a while. What we're doing is our entitlements, which were legally mandated, are rising at such a pace that the data show unequivocally going back to 1965 that the sum of gross domestic savings plus entitlements as a percent of gross domestic product has been a constant, which means it wiggles a little bit but … I shouldn't say it's a constant, but has no trend. That means, assuming that the driving force is entitlements, which it's got to be because it's mandated, every dollar increase in entitlements decreases the gross amount, the amount of gross domestic savings, by one dollar.
Since we can borrow from abroad and have now built up a debt of eight trillion dollars, because our current account balance continued to erode, we're now in a position where we have a situation where we can no longer keep gross domestic investment at a higher level in gross domestic savings or, in fact, even close, so that we're going to be in a position now where gross domestic investment, because it's not being funded, will start to decline as a percent of GDP. If that happens, productivity growth will slow from where it is even now and that means that GDP per capita is going to rise hardly at all.
If you ever wanted a corrosive effect that will create … What we're seeing, for example, in Brexit and what we're seeing … You look all over Europe and what you can see is a very clear indication of the discontent because standards of living are barely growing. There's no substitute for prosperity. We were doing terrifically well in the years immediately following World War II but when you get to a situation just like now, Donald Trump said basically we've been on this system for quite a while, it doesn't work, let's try something fundamentally different. Now what you have to admit is Donald Trump is fundamentally different.
Speaker 2: Dr. Greenspan, we have time for hopefully two more questions, short ones.
Speaker 5: Dr. Greenspan, we know almost everything about the crisis of 2008 by this point, but there's one very important thing that we don't know, in my opinion, and that's how, what was your thinking about the fiat money creation that was being carried out by the central banks of the trade surplus countries? They created trillions of dollars between 2000 and 2007 and they invested 70% of those into U.S. dollar denominated assets, mostly Treasury bonds.
For instance, during the conundrum years, mid-2004 to mid-2006, foreign exchange reserves went up by one and a quarter trillion dollars and 900 billion of that was held in U.S. dollars, and invested mostly in Treasury bonds. That was enough to finance the U.S. budget deficit for those two years entirely with 200 billion dollars left over. Doesn't that explain the conundrum and how did you think of that at the time?
Dr. Greenspan: I don't think it does. If you look at double-entry bookkeeping in the national accounts, the type of transactions you're talking about don't directly affect that. That is, if you get a central bank, let's say the case in which is the most general way, in 2008 the Federal Reserve, because everyone wanted to hold dollars, which I found very fascinating as it was as late as … Remember, we were a fiat currency, we were a weak fiat currency, but stronger than everybody else so through that crisis reserves were U.S. dollars and the Federal Reserve made a large number of swaps, which were temporary exchange of dollars for lira, for euros, any foreign currencies of other central banks.
They were unwound shortly thereafter so it's not … The basic problems are, you get bubbles because human nature is what it is. People get euphoric. We know by experience that fear is a far more formidable force in human activity than euphoria and as a result, for example, recessions go down far more sharply than recoveries and the stock market behaves exactly the same way so that you've got these very odd patterns. Without getting into too much detail, most economic models that work try to integrate human nature into the asymmetries that we're seeing. What I've seen at the moment that you would not have gotten a crisis in 2008 if we took, say, eliminated Dodd-Frank completely and merely substituted a significant increase in equity capital requirements in the commercial banking industry for everything else.
The reason I say that is we have data going back in the United States to 1869 since the beginning of the control of the currency and that shows that income, net income of commercial banks to equity assets has been a remarkably stable five …
Speaker 5: I'm sorry, could I interrupt. This wasn't a glut, this was a central bank, the PBOC, printing money, buying dollars and buying treasury bonds, pushing up their price and pushing down their yield.
Dr. Greenspan: Everybody does that but you can't push the yield down if the market's running against you.
Speaker 5: You were trying to push them up with 425 billion …
Dr. Greenspan: I wasn't there.
Speaker 5: There were rate hikes in 2004, 5 and 6 but the ten-year bond yield didn't go up …
Dr. Greenspan: No, what happened then is what I call the conundrum.
Speaker 5: Yes.
Dr. Greenspan: We thought, what we thought was that we had to tighten the markets and as we did the only tool that we had was the federal funds rate and historically we did not trade in the long end of the market.
Speaker 5: My question is, the long end didn't go up because the PBOC was printing RMB, buying dollars and buying Treasury bonds.
Dr. Greenspan: No, that's not the reason. The reason was that the Cold War came to an end and the Berlin Wall came down and you have a huge increase in the number, it was something like a billion people came out from behind the iron curtain and tried to integrate with the remainder of the world's economy and obviously the economic ruin behind the iron curtain that was exposed when that wall came down was a great shock to everybody. You had all of these semi-skilled people moving into the west and there was enough of a downward pressure on wages because big new supply occurred that you've got interest rates going down.
For example, I remember extraordinarily well that Mexico was able to issue a 20-year peso-backed bond at a reasonable interest rate, not terribly much above the United States. This is within a relatively few years. Remember in 19 … I'm trying to think, it was when Mexico was about to go bankrupt, which was 1984 and it had Tesobonos, which were basically not backed by anything and we bailed them out, the United States bailed out Mexico at that particular point. They were able to come back very few years later with a 20-year issue in pesos and they couldn't … For decades, I don't think they ever were able to issue a 20-year peso-denominated anything.
Speaker 5: The creation of 10 trillion dollars by the foreign central banks between 2000 and 2014 had no impact on the global savings glut?
Dr. Greenspan: We don't know because you can't tell. There were so many forces at play at that time it was difficult to separate them. We were confronted with the fact that with this huge increase in savings, because remember, the income that was previously behind the iron curtain countries was not spent, they saved a good part of it because there were no institutions for savings. That drove down the long-term rates in the market of both the U.S. dollar and all other rates. In that type of condition you've got a very difficult problem on the part of the Federal Reserve who was trying to raise rates but the flood, the savings glut, was coming from the movement of funds from behind the iron curtain, basically.
These were people who were literally blocked off until you got a huge increase and the rates kept going down for a number of years. I don't know whether, to what extent you can attribute anything to anything, but that was critically the major factor in retrospect.
Speaker 2: Dr. Greenspan, I think we have time for one last question from and then we'll wrap up. Thank you.
Speaker 3: Okay, I'm the odd man out. I'm not an Austrian and I have no unrequited love for the yellow metal but I did see the sausage factory in Congress. My question is, in the late '90s we had a good deal of financial deregulation along with the repeal of Glass-Steagall, Commodity Futures Modernization Act, followed by roughly two trillion in tax cuts under the Bush administration. The results may not have been very happy in terms of feeding the asset bubble in equities and real estate. My question is: Trump entering office is proposing tax cuts roughly three times the size and he wants to get rid of Dodd-Frank, which he says is strangling the economy.
Dr. Greenspan: I agree with him on this.
Speaker 3: Are we setting ourselves up for another asset bubble on top and, if not, why aren't we?
Dr. Greenspan: Because it's not going to happen that way. It's very difficult to perceive how we're going to get with the big problems if they're going to show up. Actually David ought to be talking to this. Can you imagine what they're going to be staring at in February when they start looking at the budget numbers? The issue isn't going to be do you have a big tax cut, but do you have a big tax increase? None of that is going to happen, but I think the real danger here is the fact that we've allowed this issue of a huge amount of entitlements to rise as we age and to keep adding to them.
One of the things that the Bush administration did was to have a huge increase in the number in Social Security. No source of revenues.
Speaker 3: Medicare, prescription drug.
Dr. Greenspan: Yeah. The reason they could do that is Congress passed it. If you're going to have this sort of fiscal policy, we're at the edge of some fairly questionable issues of what happens. This is a non-sustainable outlook. There's no scenario I can conceive of. I've listened to the debates. The word 'entitlement' never came up once and the reason is entitlements are the third rail of American politics. If you're running for office and you mention them, you lose. How are you going to run government on that? I do not know. Trump may have some magic formula which he hasn't divulged to anybody, but I don't see where we go from here.
Speaker 2: All right. Thank you Dr. Greenspan. I think that wraps it up. Thank you very much for your time.
Dr. Greenspan: This was the most unusual conversation I've had and I've enjoyed every moment of it.
Speaker 2: Thank you.