Category Archives: Speculative finance

The Legacy of Alan Greenspan

Saw a clip of Alan Greenspan speaking on CNBC last week. I have noticed a few recent appearances of his where he diplomatically raised some red flags: the dangers of our financial situation, failure of the current monetary policies, upcoming market disruption, and more. Some of you may remember that Alan Greenspan chaired the Federal Reserve from 1987 to 2006. He was called “the Maestro”, the central figure in the “Committee to Save the World” back in 1999. Turned out that the world had to be saved from that committee. After he turned the Fed over to Bernanke, the Maestro was promptly thrown under the bus, blamed – deservedly so – that his famed “Greenspan Put” and ultra-low interest rates have provided fuel for the market bubbles in 2000 and 2007. While he can’t be directly blamed for the mid-90’s financial deregulation that removed protections against reckless speculation and rise of financial “crony capitalism”, he was influential enough to meaningfully oppose it – and have not done so.

But there are certain ironies in this situation. Firstly, Greenspan’s monetary policies look outright conservative compared to what his successors wrought. In 2004, Greenspan lowered the Federal funds rate to 1% for one year. Bernanke and Yellen had the rate at zero or so for six years now. The “Bernanke Put” made Greenspan’s look like a joke. Greenspan at least was cognizant of the growing bubbles, warning of “irrational exuberance” before the dot-com fiasco and of the real-estate bubble in 2007. Bernanke, on the other hand, even in July of 2007 claimed that there is no real estate bubble and that the economy will grow in 2008. Bernanke was anointed a hero that saved the global economy. The history will judge, just like it judged Greenspan. I am quite sure that after the next crisis Bernanke and Yellen will be thrown under the bus for their policies. Which they will deserve even more that “the Maestro.”

The second irony is that Greenspan used to believe in responsible monetary policies, limiting politicians’ ability to print money at will. Why did he turn away from his earlier views while at the Federal Reserve? Partly might have been his naiveté: Greenspan himself had admitted that he underestimated self-destructive ability of unchecked finance and inability/unwillingness of regulators to properly oversee the industry. More likely, like most humans he was seduced by the power of his position and adjusted his views to serve the needs of the government that was re-appointing him every four years.

I may well be wrong but from his recent appearances it seems that Greenspan may have come some of the way back to his earlier views, lobbing occasional grenades at our addiction to debt, ultra-loose monetary policies, growing inequality, etc. But his careful, diplomatic jabs are drowning in the “all is well” symphony of the economic profession that by-and-large has been captured by the state. Nobody’s paying attention.

Mr. Greenspan, if you truly believe that the current policies are wrong, that – as 17 Nobel Laureates in Economics argue – these policies are destroying the future of our children, take off the gloves, raise your voice. You are still “the Maestro”, people will listen if you speak loudly and with conviction. Like King Theoden in the LOTR, ride out one more time. You are 89. What legacy are you going to leave?

More on Impact of Extreme Inequality

In the earlier post I talked about dangers of extreme inequality: economic problems, “oligarchization” of the political order, unrest. The Spirit Level by Wilkinson and Pickett argues that high degree of inequality – more so than absolute levels of per-person income – lead to lower societal trust, increased instances of mental illness, higher mortality, obesity, lower educational performance, higher crime and reduced social mobility. They show statistical correlation based on the data from the World Bank, the World Health Organization, the United Nations, etc.

As any controversial topic, their study found detractors as documented in the link provided. Complex subjects always do. As the famous saying goes, “there are lies, damned lies, and statistics.” Still, in the end the numbers and their conclusions appear to be valid: extreme inequality damages societies. I’ll re-iterate that this is not an argument for imposition of equality but rather a reminder that this pendulum have swung too far the other way. I think that most of us intuitively understand this.

Destructive impact of extreme inequality

The American middle class that once was more than half of the country’s households has declined to about 40% of the households, mostly due to many falling into poverty. It is projected to continue to decline. Median income has been falling since it peaked in 1999. This is happening despite growing economy and rising profits – because increasingly larger share of the wealth flows to the top, especially the upper 0.1%.

In 2014, Emmanuel Saez and Gabriel Zucman from National Bureau of Economic Research published Wealth Inequality in the United States since 1913: Evidence from Capitalized Income Tax Data (at: http://gabriel-zucman.eu/files/SaezZucman2014.pdf). Wealth concentration has been high early in the 20th century, fell for fifty years, and started rising again thirty five years ago. While the relative wealth of the top 0.1% tripled, the share of the bottom 90% was cut almost in half. By 2012, these lines intersected: the top 0.1% of the US households had as much wealth as the bottom 90%. The top 0.01% – only 16,000 families – have more wealth than the bottom 130 million families.

Also in 2014, Michael Porter and Jan Rivkin from Harvard Business School published their The Economy is Doing Half Its Job study (at: http://www.hbs.edu/competitiveness/Documents/an-economy-doing-half-its-job.pdf). They found a troubling divergence in the American economy: while large companies and a minority of highly-skilled individuals prosper, small businesses and middle- and lower-class individuals are struggling. Their conclusions are blunt: such a divergence is not sustainable.

Extreme economic inequality is proven to lead to political inequality, “oligarchization” of the political order. Similar, although not as extreme, trends appear in other developed countries. The global inequality is getting worse (source: http://www.theguardian.com/public-leaders-network/2015/jan/25/davos-2015-overriding-pessimism-over-growing-inequality). The last time such wealth disparity existed was during the 1925 – 1937 period. We all know the upheaval that followed. Perhaps it’s no accident that many hedge fund managers are buying airstrips and farms in remote places, thinking that they need a getaway (source: http://www.theguardian.com/public-leaders-network/2015/jan/23/nervous-super-rich-planning-escapes-davos-2015).

How will the emerging Internet- based and robotics technologies affect the rising inequality? Past industrial revolutions disrupted existing economic models but benefited societies in the end. However, there is no guarantee that the outcome of the ongoing technological revolution will be the same. Unlike in earlier economies, in the digital age even a small relative advantage often leads to an absolute domination – the “winner-takes-all” markets. So far, the result has been acceleration of inequality: in just the past ten years, the wealth share of the top 0.1% jumped over 50% while that of the bottom 90% dropped by 25% (source: Saez and Zucman). Technology is bringing about a very different world and the question is whether we’ll adapt our policies to benefit everyone or continue with the status quo where more and more people lose ground and face a possibility of another upheaval? Erik Brynjolfsson and Andrew McAfee raise these issues, and warn of consequences of not taking action, in their bestselling The Second Machine Age: Work, Progress, and Prosperity in a Time of Brilliant Technologieshttp://www.secondmachineage.com/.

This post by no means argues for a utopian equality. Some degree of inequality is our natural state. But this does not mean that we can ignore the growth of inequality as benign. Throughout history, economic stratification commonly resulted in collapses and revolutions. To quote from a recent study:

“Collapses of even advanced civilizations have occurred many times in the past … the two features that seem to appear across societies that have collapsed: the stretching of resources due to strain placed on the ecological carrying capacity, and the division of society into Elites (rich) and Commoners (poor) … Given economic stratification, collapse is very difficult to avoid and requires major policy changes, including major reductions in inequality …”  Safa Motesharrei, Jorge Rivas and Eugenia Kalnay, Human and Nature Dynamics (HANDY): Modeling Inequality and Use of Resources in the Collapse or Sustainability of Societies, 2014, http://www.sciencedirect.com/science/article/pii/S0921800914000615.

This time is never different.