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Greenspan's big monetary adventure

By Gerard Jackson -- The New Australian

"Last year I predicted that the US economy would go into recession by December. It didn't. Let me briefly recap. Austrian theory explains in great detail why monetary booms always collapse. Because money is not neutral monetary expansion misdirects production creating what Austrians call malinvestments and what Greenspan is inclined to call imbalances. To prevent these malinvestments from emerging as idle capital and rising unemployment the central bank must continually accelerate monetary growth. Eventually it applies the breaks, usually in response to rising prices and current account deficits.

It was my belief that recession was imminent at the year's end because I did not believe, and stated so, that there would be sufficient monetary growth (what Keynesians call liquidity) to offset the growing malinvestments. I was drawn to this conclusion by the belief that Greenspan was still too much taken by the lesson of the 1920s boom to allow the massive increase in the money supply that would be necessary to sustain increasing output and consumption. This belief was strengthened by his references to the economy's growing imbalances and hints of rate raises to curb the country's excesses.

Boy, did I get it wrong. He was literally letting the money supply rip. Is the man incompetent or just confused? Still, I should have known better. This is the man who flooded the economy with $200 billion during October and November 1998, which in turn added fuel to the stock market. He followed this masterpiece of monetary wizardry by pouring a further $200 billion into the economy during the last 3 months or so of 1999, during which the banks took in an extra $80 billion in additional cash compared with $23 billion 12 months earlier. What's the betting that this cash will end up in newly-created deposits thus adding more fuel to America's consumer boom and growing current account deficit, not to mention Wall Street's hi-tech speculative frenzy?

In per centage terms this 3 month period saw the monetary base explode at an annual rate of nearly 50 per cent, with an actual rate of maybe 20 per cent or more. Reckless doesn't describe this action but criminal does. No wonder the rocketing demand for hi-tech stocks is resembling Britain's railway mania of the 1840s. (Fortunately, social security will be around to help those who will be severely wounded financially).

Certain danger signals are becoming too pronounced to be ignored. Real estate prices are leaping in certain areas and this is likely to spread, industrial commodities jumped significantly last year and margin borrowing has risen steeply, jumping nearly 50 per cent in November last year. The last, in my view, is of particular interest. The massive increase in margin borrowing is a strong indicator of a very loose monetary policy.

First, slack money encourages speculation bordering on gambling; the slacker the monetary policy the more wild the speculation. Second, loose money further fuels speculation by creating the means to expand margin borrowing. Greenspan's study of the '20s boom should have told him that. As money supply expanded so did brokers' loans. Money supply was $33 billion in June 1922 and brokers' loans stood at $1.7 billion. By September 1929 money supply had risen to $45 billion and brokers' loans were now $8.5 billion. This was $2.1 billion up on December 1928 — even though the Fed had slammed the monetary breaks on in that month so that no monetary expansion occurred throughout 1929.

So much money had been created that even a monetary freeze could not stop the stock market frenzy. Money supply can be like a great ocean-going ship: even when the engines have stopped the ship continues for some distance. The faster the engines were running the greater the distance travelled before the ship comes to a halt.

That Greenspan is unaware of the monetary damage being wrought is indicated by his eagerness to hold on to his job. Anyone with an inkling of an approaching financial iceberg would have willingly passed control of the bridge on to someone else."
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