Alan Greenspan ‘The Age of Turbulence’
His legacy casts a long shadow. Fifteen years later the book is as relevant as ever for a simple reason. The economy is cyclical and history repeats itself. Therefore we are destined to revisit and relearn the past. Alan Greenspan, the five-times Chairman of the Federal Reserve System has lived through many crises. Here are the takeaways that are still relevant.
The world economy has been growing for many decades at 3% on average. Shall it speed up in certain period above that level – it is bound to slow down thereafter. This cyclicity is inevitable. The reason is simple.
Imagine a new set of technologies have been introduced. Shale gas or shale oil drilling and extraction solutions are improved. New capital flows into the booming industry. Rapid expansion follows. New producers enjoy the boom. Older producers face competition. Increased supply drops the prices, some companies go bust, the industry takes a hit. Sentiment may fall. The contraction begins.
This creative destruction, a term coined by Joseph Schumpeter, is as unavoidable to the economy as Darwinian evolution to nature. The businesses compete in many ways similar to the natural selection process that persists the past billion years here on Earth.
Alan has been researching the trends and collecting stats about the state of business as a partner in the Townsend-Greenspan firm for decades. He then was invited to be Nixon’s adviser, but actually worked for Gerald Ford helping to reign in inflation. In the 1970s the world economy had two consecutive oil shocks that drove inflation into the double-digit territory. Now, in 2022 we observe heightened inflation again. Let’s see what happened half a century ago.
Nixon’s administration wished to quell inflation through regulations, restrictions, price controls and pressure on the business. Guess what? Fixed prices lead to queues at the fuelling stations. Restrictions to the quantity of gallons lead to lost mobility of the population. Constraints on consumption hit the transportation industry. As Alan said, that market forces eventually always win. It is impossible to limit the prices and not face deficits and lost productivity as a result.
This means that nowadays any limitations and constraints will lead to deficits. Guess what we observed with the baby formula this year. It disappeared for a simple reason. Once domestic production decreased due to closure of one of the production facilities, regulations on imports basically prohibited the arbitrage that could have happened in an open economy.
Inflation persisted through the seventies and into the eighties. The Federal Reserve in the US is independent from the government. So, when Paul Volcker became the Chairman, he could implement a decision that would have killed the political career of any president. He decided to fight the inflation by putting constraint on the money supply. He hiked the rates and monies became expensive. This led the economy into recession.
Reagan was the president at that time and he coined the famous saying that recession is when your neighbor loses his job and depression is when you lose yours. Ronald was lucky. The recession that occurred due to strict monetary policy by Volcker was short and collateral damage was limited. Inflation dropped and investments restarted propping up the economy. Reagan successfully got re-elected riding the boom.
When Greenspan was offered the position of the Chairman of the Fed the inflation was largely gone and the new threat was facing the economy. The growing budget deficit that could disrupt the belief in the sustainability of the government finance. It was unimaginable for Alan to hope for longer term growth of the economy when the state finances were in the red.
George W.H. Bush persuaded the Congress to adopt the stance to balance the budget and to have spending in check while he had to break his famous ‘Read my lips’ promise not to raise taxes. The legislation was enacted. Bill Clinton won the election and continued the policies of the previous president. We know what happened next. Booming 90-s and the budget in the black with proficits reaching hundreds of billions of dollars. It is hard to believe today that quarter of century ago the national debt of the US was decreasing.
Then we had the Bush Junior, lower taxes, abolished stance on the balanced budged. Alan Greenspan left. Ben Bernanke got chosen for the Chairman position instead of Glenn Hubbard. The mortgate crisis ensued. The Great Recession slowed the world for several years. The money supply followed the ever expanding budget deficits. And we observed booming debt alongside with utterly underfunded social security obligations. The excessive money spilled over into the assets prices. Then inflation re-appeared.
The question is what Alan Greenspan would have done nowadays.
His legacy stipulates that low inflation is a must-have for a longer term growth of the economy. Volcker dealt a heavy blow to the inflation. Alan Greenspan managed a soft landing in the year of 1995. The Fed today continues to hike the rates, but does it slower than Volcker did for the fears to drive the economy into the recession.
Alan’s book is brimming with examples of hard decisions that hurt in the short term for the benefit of the future growth. Controlling inflation, even though it slows down the economy, has always worked. Because high inflation erodes confidence, derails investment decisions and undermines belief in the ability to save for the future.
Thus, upon finishing reading the book, I think that if Alan was the Chairman today he would have done what Paul Volcker did. The Fed is independent and can do that.