Greenspan Was Instrumental in Creating Economic Uncertainty

Friday, 13 Dec 2013 06:49 AM

By Barry Elias

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Former Federal Reserve Chairman Alan Greenspan recently proclaimed that economic uncertainty is the greatest factor plaguing our economy.

Unfortunately, Greenspan was instrumental in causing this crisis, one that will take decades to dissipate.

During his tenure as chairman from 1987 through 2006, he persistently advocated for financial deregulation to increase economic efficiency and growth. He believed strongly that lending institutions would protect shareholder equity as a matter of self-interest during this process, thereby rendering this deregulation safe and actually essential to our economic vibrancy.

In his 2008 Congressional testimony, he suggested this worldview was incorrect.

While he took great pleasure in intellectualizing complex data structures and mathematical models, he did not fully comprehend the psychology behind decision making by consumers, investors and governments. In the case of financial institutions, he did not anticipate that they would sacrifice shareholder value in order to reap huge private gains while socializing large losses.

Yet this is what happened. These losses were essentially financed by taxpayers through asset purchases by the Federal Reserve, loans and guarantees totaling more than $29 trillion over the past five years.

The financial deregulation that he promoted over his 18-year tenure led to unsound monetary policy by promoting undercapitalized, high-risk positions held by financial institutions. Greenspan strongly advocated for the repeal of Glass-Steagall and legislation to deregulate commodities trading — both bills were approved by Congress and signed into law by then-President Clinton.

These policies were catastrophic to the global economy and contributed significantly to the unprecedented economic uncertainty that he acknowledges is our biggest problem today.

It is important to note that our economic unraveling began before Greenspan took office. By decoupling currency creation from gold reserves in 1971, President Nixon ushered in the era of easy credit and debt formation. President Reagan's tax reform act of 1986 reduced the incentive for business investment by lowering personal tax rates below that of corporate tax rates.

However, Greenspan's policies exacerbated this already-unstable environment. In effect, he promoted financial engineering and arbitrage in lieu of investment and business formation, which focuses on employment and income growth.

Since 1981, investment as a percentage of GDP fell greatly, causing a 60 percent decline in the turnover of money (monetary velocity). As a result, employment and income stagnated for the masses, while the wealthy accumulated extraordinary wealth during the past three decades.

Greenspan claims that two years ago the percentage of business cash flow invested in any form of capital asset reached its lowest level since 1938. This verifies the extremely low level of investment for long-term business creation and development, which tend to be strong catalysts for economic activity, employment and income growth.

The level of excess reserves held by financial institutions that are available for lending has skyrocketed to $2.4 trillion, from $1.8 trillion six months ago, according to the Federal Reserve. Banks are loath to lend these funds, since they have many other options, such as: 1) a guaranteed a return of ¼ of 1 percent by the Federal Reserve on excess reserves, 2) a nearly 4 percent return for 30-year U.S. Treasury bonds to finance the annual deficit and rollover of existing debt and 3) proprietary trading in stocks and bonds to generate capital gains, dividends and trading revenue.

The use of excess bank reserves in this manner provides very little long-term investment in labor and capital, which discourages job and income creation.

Unfortunately, the former chairman has not identified how our resources can be reallocated to promote sound monetary policy that fosters sustainable economic growth.

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