Steve Hanke takes a look at the evidence and concludes that Alan Greenspan is simply b*llsh*tt*ng the public when he directs attention to a “global savings glut” and claims that the Federal Reserve has no responsibility for the current boom and bust cycle. Quotable:
What is a bubble? There are many types. One type is created when the Fed’s laxity allows aggregate demand to grow too rapidly. Specifically, a demand bubble occurs when nominal final sales to U.S. purchasers (GDP – exports + imports – change in inventories) exceeds a trend rate of nominal growth — a trend rate that is consistent with “moderate” inflation — by a significant amount. During Mr. Greenspan’s 18-year tenure as Fed chairman, nominal final sales grew at a 5.4% annual trend rate. This reflects a combination of real sales growth of 3% and inflation of 2.4%. But there were deviations from the trend …
The last big jump in nominal final sales was set off by the Fed’s liquidity injection to fend off the false deflation scare in 2002. Fed governor Ben Bernanke (now chairman Bernanke) set off a warning siren that deflation was threatening the U.S. economy when he delivered a dense and noteworthy speech, “Deflation: Making Sure it Doesn’t Happen Here,” on November 21, 2002. He convinced his Fed colleagues that the deflation danger was lurking. As then-chairman Greenspan put it, “We face new challenges in maintaining price stability, specifically to prevent inflation from falling too low.” By July 2003, the Fed funds rate was at a then-record low of 1%, where it stayed for a year. This produced the mother of all liquidity cycles and yet another massive demand bubble.
During the Greenspan years, and contrary to his claims, the Fed overacted to real or perceived crises and created three demand bubbles. To obtain a better handle of the mother of all liquidity cycles, observe that, by late 2001, the central bank had already pushed the effective Fed funds rate below the 3%-4% range for the neutral rate (a rate consistent with long-run price stability).
The effective rate stayed well below the neutral range until early May, 2005. The pattern for the real effective Fed funds rate was similar to the one followed by the nominal effective rate. By late 2002, the real rate had dropped into negative territory, where it stayed until mid-2005. It’s not surprising that Stanford University Professor John B. Taylor, in his highly critical book on the Fed’s pre-crisis policies, Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis, concluded that there “is clear evidence of monetary excesses during the period leading up to the housing boom.”
The most recent aggregate demand bubble wasn’t the only bubble that the Fed was pumping up .. the Fed’s favorite inflation target — the price index for personal consumption expenditures, less those for food and energy — was increasing at a regular, modest rate. Over the 2003-08 period, this metric increased by 13%. The Fed’s inflation metric signalled “no problems.” But abrupt shifts in major relative prices were underfoot. Housing prices measured by the Case-Shiller index were surging, increasing by 44.8% from the first quarter in 2003 until their peak in the first quarter of 2006. Share prices were also on a tear. The most dramatic price increases were in the commodities. Measured by the Commodity Research Bureau’s spot index, commodity prices increased by 92.2% from the first quarter of 2003 until their peak in the second quarter of 2008.
The dramatic jump in commodity prices was due, in large part, to the fact that a weak U.S. dollar accompanied the mother of all liquidity cycles. Measured by the Federal Reserve’s trade-weighted exchange index for major currencies, the greenback fell by 30.5% from 2003 to mid- July 2008. As every commodity trader knows, all commodities, to varying degrees, trade off changes in the value of the U.S. dollar. When the value of the U.S. dollar falls, the nominal dollar prices of internationally traded commodities — like gold, rice, corn and oil — must increase because more dollars are required to purchase the same quantity of any commodity. Contrary to claims by Messrs. Greenspan and Bernanke, the Fed played a central role in blowing asset bubbles, shifting relative prices and creating massive distortions in the economy …