John Cassidy Makes His Play for the Stupidest Man Alive Crown

He is definitely a contender: he writes apropos of Alan Greenspan:

Alan Greenspan Age of Turbulence - Portfolio.com: As the speculative fever raged, some old-timers and sticks-in-the-mud, myself included, urged Greenspan to raise interest rates and tighten margin requirements. He refused, on the grounds that bubbles are impossible to identify definitively. Pricking them is by no means easy, and even if you succeed, the consequences are far from certain. The best course of action, Greenspan argued, was to let a bubble deflate of its own accord. Then, and only then, you take remedial action by cutting interest rates. That was what he did. Following the stock market slump and the events of September 11, 2001, he cut the federal funds rate to 1.75 percent, a level that had not been seen since the early 1960s. Then, in June 2003, he reduced the rate even further, to 1 percent.... By the middle of 2002, however, it was clear that for whatever reason—-low interest rates, the Bush tax cuts, increased military spending—the economy was staging an amazingly robust recovery. At that point, history and economic orthodoxy suggested that the Fed should have been tightening policy rather than loosening it. Again, Greenspan went his own way...

Actually, it was not clear at all by the middle of 2002 that the economy was staging an "amazingly robust recovery." The recovery did not become anything anybody could call "robust" in any sense until 2004. Want evidence that it was not clear in mid-2002 that the recovery was "robust"? Here is what Paul Krugman was writing at the time:

July 23, 2002: Living With Bears: The bull market is now well and truly over. In fact, if you adjust for inflation the S.&P.... is now below its level in late 1996, when Alan Greenspan gave his famous "irrational exuberance" speech. So what should the responsible officials -- Mr. Greenspan, George W. Bush and whatshisname, the Treasury secretary -- be doing?

A good first step would be to stop trying to talk up the market by extolling the economy's fundamental strength... the fundamentals aren't actually all that great.... [E]ven before the sudden plunge in the markets, the data were pointing not to a boom but to a ''jobless recovery,'' in which the economy grows too slowly to make much if any dent in the unemployment rate. Indeed, the report prepared in support of Mr. Greenspan's recent testimony projected no significant decline in unemployment this year, and not much decline next year. And in the face of plunging markets we have to worry whether even that forecast is overly optimistic.

Given the definitely iffy economic outlook, shouldn't Mr. Greenspan be thinking seriously about another interest rate cut? True, rates are already very low. But if there's one thing we've learned from Japan's experience, it is that when you face the risk of a deflationary trap -- still not the most likely scenario, but not as unlikely as it seemed a few months ago -- it makes no sense to "save your ammunition," holding interest rate cuts in reserve. The time to fight deflation is before it has time to get built into the nation's psychology. True, the Fed has been concerned that another cut would panic the markets. But now that the markets have panicked on their own, there's nothing to lose...

August 16, 2002: Mind the Gap: [T]he [late 1990s] bubble years left us with too much capacity, too much debt and a backlog of business scandal. We shouldn't have expected a quick and easy recovery, and we're not getting one.... A loud chorus is already shouting "We're not Japan!" Half the time... I'm part of that chorus. But... [if] we do have a housing bubble, and it bursts, we'll be looking a lot too Japanese for comfort. A recent Federal Reserve analysis of Japan's experience declares that the key mistake Japan made in the early 1990's was... "that they did not take out sufficient insurance against downside risks through a precautionary further loosening of monetary policy." That's Fedspeak for "if you think deflation is even a possibility, throw money at the economy now and don't worry about overdoing it." And yet the Fed chose not to cut rates on Tuesday. Why?...

John Cassidy shouldn't tell lies: he shouldn't claim things were clear when they were not clear at all. His nose will grow.

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But wait! There is more. Cassidy writes:

In February, [Greenspan] said a recession was possible before the end of 2007—a comment that contributed to a 416-point fall in the Dow. In May, he put the chances of a recession at one in three.... Greenspan may have been acting strategically. His appearances in the headlines haven’t harmed the commercial prospects of his book, and they may have attracted some clients to Greenspan Associates, the consulting firm that he founded upon leaving the Fed. It was noticeable that shortly after he started using the R-word, Pacific Investment Management, which oversees the world’s largest bond fund, hired him as a consultant. Pimco’s chief investment officer, Bill Gross, is well-known for his bearish views on the economy and the stock market...

It never occurs to Cassidy that Greenspan said there was a chance of recession because... there is a chance of recession. No, that would be too simple! Instead, Greenspan is "acting strategically." Menzie Chinn notes that current betting odds on recession are between 2-1 and 50-50.

Comments

[maynardGkeynes]

I gather that Cassidy's main point, which does not seem very "stupid" to me, is that Greenspan reignited a speculative bubble after the tech bubble had collapsed. Whether it was in 2002 or somewhat later seems rather beside the point .

[Matt]

I have been looking at:

http://stockcharts.com/charts/YieldCurve.html

For some time.

If the yield curves shown for 2002-2004 are an accurate reflection of what was known then, well, they looked in reasonable shape to me, gaussian shaped, more or less, a well balanced apportionment risk across the curve.

If the system was assumed to be acting as a Hamiltonian (not Alex but the physics guy) then we would expect a momentum toward the asset side of the curve, so a rise in interest rates would boost the liability side of the curve, a countervaling force.

Hence, my logic says that a June 2003 reduction in rates was opposite of what we needed.

By Mar, 2005, the curve was beginning to mis-shape. So, if only the yield curve shape was of interest, then a spike in interest rates at the dip, when the curve began to look very shapely, followed by a few downward changes as the economy picked up.

I think Greenspan was out of phase.

[wood turtle]

Why is it considered good to have 2%-3% inflation per year, but a terrible thing to have deflation?

How much of the recovery was due to spending from such as home equity loans that have to be paid back? It seems that a consumer spending slowdown will be inevitable.

[Rob]

wood turlte-because deflation runs into the zero interest rate bound. Assume a bond that pays a nominal annual rate of 3.5% so a real rate of zero with inflation around 3.5%. Now assume deflation of 1%. To keep a real rate of zero, you'd need an interest rate of -1%, but no one would buy that bond because cash gives you a 0% rate.

So bad things can happen. Liquidity can be a big problem

[christofay]

the only deflation there was was lowering car prices due to the new cars flooding the market with the jOe BazOOka interest rates