Greenspan: a tough act to follow

By Editorial staff Simon Wilson Dec 12, 2005

Has Greenspan been a good Fed chairman? Most would say that the 25 years during which Greenspan and his predecessor, Paul Volcker, have run the Federal Reserve have been stable ones, during which good monetary policy has fostered a long-term decline in inflation and helped promote stable economic growth. As a result, Greenspan’s reputation is so high in some quarters that the name ‘Maestro’ – given him in a Washington Post profile by Bob Woodward – has stuck. In recent years in particular, Greenspan has been given credit for steering the US economy away from recession in the aftermath of the triple whammy of shocks that struck it in the early 2000s: the stockmarket crash, the September 11 terror attacks, and multiple corporate scandals. Greenspan did this principally by slashing short-term interest rates quickly to keep growth ticking over. 

Does everyone agree on this?

No. Greenspan is treated like a near deity in Washington, but Wall Street isn’t so sure. Critics say that the US economy has only continued to grow because Greenspan’s low interest-rate policy has allowed a string of asset-price bubbles and because he has recklessly encouraged homebuyers and consumers to build-up massive levels of borrowing – storing up trouble to come. Analysts joke about the ‘Greenspan put’ – the (ultimately damaging) certainty of investors and consumers that whatever happens, the Fed will get them out of trouble by giving them easy access to credit. Every time the financial system and economy look like they are about to adjust to reality, says Albert Edwards of Dresdner Kleinwort Wasserstein, Greenspan turns on the fire hose of liquidity to prevent it. “The US economy is a story of wholly unsustainable prosperity built on a Himalayan mountain of debt, washed over by repeated waves of domestic asset-price inflation.” Others point to the fact that Greenspan appeared to have been as fooled as plenty of investors had been by the so-called ‘New Economy’ paradigm of the late 1990s – which supposedly justified permanently higher equity prices – and as a result took too relaxed an attitude to the asset bubble, something that helped cause unnecessary and lasting damage to the US economy. 

What effect will his retirement have?

No one knows. Richard Fellows, MD of Fisher Wealth Management, points out that the name of the new Fed chairman is almost impossible to predict – President Bush has a track record of successfully keeping his big appointments secret prior to the official announcement. “Uncertainty over who will replace Greenspan presents the world with a risk factor,” he says. “We think it will be difficult for capital markets to discount a successor in advance, but once a name is announced, markets will react quickly and decisively, positively or negatively. Until then, the uncertainty will promote continued risk aversion.” Moreover, the possibility that Bush might ask Greenspan to stay on for an extra six months to allow more time to find the right successor is only adding to that uncertainty. Greenspan might be tempted: if he stays until June 2006 he will be the longest-serving Fed chairman in history. 

So a new chairman might spook investors?

The simple fact that the apparently steadying hand of Greenspan will be absent for the first time in more than 18 years might be enough to unnerve some people. And there will be plenty for Greenspan’s successor to worry about. Last month, Greenspan hinted at the kinds of problems that might blow up in the coming years. In a speech to Congress, he warned that the economy faced “significant uncertainties” from high energy prices, rising wages and a possible housing market bubble. Other major worries hanging over the US economy include the spectre of a plunging dollar, the twin current account and government deficits, the possibility of an abrupt slowdown in China, or a collapse in consumer spending at home.

Who are Greenspan’s likely successors?

Greenspan’s fans put much of his success down to his decades-long experience as a business consultant and would like the White House to look for candidates who, similarly, claim to have both a firm grasp of economic theory and a practical sense of how the economy works in the real world. Yet the three names that keep recurring are all prominent academic economists (and Republicans) with little business experience. Ben Bernanke, 51, a Harvard and MIT economist best known for his research into the causes of the Great Depression, is said to be a favourite of President Bush. Earlier this summer, Bush appointed Bernanke chair of his Council of Economic Advisers. Martin Feldstein, 67, a Harvard professor since 1967 who masterminded the Reagan tax-cuts, is also considered a front-runner, as is Glenn Hubbard, the Dean of Columbia Business School, who is credited with planning the controversial tax cuts of Bush’s first term.

Reasons to be nervous

Investors who believe in omens and precedents have reason to be nervous about Alan Greenspan’s retirement: every new Fed chairman seems to have a major crisis to deal with soon after taking office. The very first, Charles Hamlin, took office in August 1914, a week after Britain declared war on Germany. Two years later, his successor, WPG Harding, had been in office only eight months when the United States itself joined the fray. More recently, Alan Greenspan himself suffered his own baptism of fire just two years after he took office, when global stockmarkets crashed in October 1987.

Published in Economics | More articles by Simon Wilson

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