Why Alan Greenspan could not stop the 2000 recession
Gerard Jackson
"There's no need to panic", said the captain of the USS Titanic, as a recessionary iceberg came looming out of the monetary fog. "Everything is in order. Full steam ahead. Or is it reverse? No matter. I'll just press this button marked 'I' for interest, or is it idiot? Maybe it really means imminent or even impress. Anyway, it's the only button on the bridge. Heck, what kind of ship is this?"
Did this Montypythonesque conversation take place at the Fed? Was Alan Greenspan really a cunningly disguised John Cleese? Does it really matter any more?
Perhaps Greenspan didn't panice. Perhaps he just liked playing Titanics. Whatever, it's not really funny and it certainly did not work. During his reign at the Fed Greenspan has tended to treat the money supply the way a drunk would treat a truck load of free booze — as if there were no tomorrow. But tomorrow always comes, and so does the day after. The 2000 recession was the day after. This meant that his 0.5 per cent rate cut would not do the trick.
Some financial writers, even in Australia, have clocked on to the uncomfortable fact that America was faced with an inverse yield curve, meaning that short term rates were higher than long term rates. This was a worry because even they were aware that an inverse yield curve is a good indicator of a forthcoming recession, though most of them don't really know why.
Differences between long term and short interest rates cannot persist in a free market; arbitrage would eliminate them. The rule here is when long term rates exceed short term rates the central bank is playing loose, especially loose, and fast with the money supply.
Eventually, short term rates must rise once the bank is forced to apply the monetary brakes. Even so, when real forces begin to make the presence felt it is my belief that these could tend to apply an upward pressure on short term rates even before the central bank acts.
Where did this leave Greenspan's 0.5 per cent cut? No where, is the answer. From 1997 to the end of 2000 M3 grew by $1.64 trillion. December of that year saw broad money exploded by a stagger $100 billion plus.
And yet some indicators from the National Association of Purchasing Managers Index showed that manufacturing was having problems as early as March 2000. Later in the year an NAPM show that the index had dropped to 43.7 per cent, the lowest since April 1991.
We can now see that Greenspan's massive monetary injections of late 2000 did not prevent a slowdown, though they did, in my opinion, delay it for several months. The lesson here, or so it appears, is that it now seems that ever bigger monetary injections are needed to prevent recession.
Well, that's just flat wrong. There comes a point that no matter how big the injection the recession comes anyway. Now America did not reach that point and it never will because that would literally be one of massive inflation and no Fed well ever go that far, at least I hope not.
Now I have pointed out before, a number of times actually, that the down turn in the so-called business cycle starts in manufacturing and not at the point of consumption. Economic commentators have observed that manufacturing had been contracting but consoled themselves with the delusion that "robust consumer spending will continue to drive the economy." Greenspan knew better. His rate cut was not aimed at consumption but manufacturing.
The Austrians point out that a profit squeeze can emerge before the central bank initiates a credit crunch. This happens because costs, meaning prices of inputs, rise faster than the prices of firms' products. The usual situation is that demand for the products drops off but costs continue to rise, signalling contraction.
The NAPM showed that companies were paying more for their inputs even as production and sales were falling. The word for this situation is bad.
The only way a rate cut could have stimulated output in these industries was by raising the demand for the products to the extent that it continued to offset rising costs. The phrase for this situation is accelerating inflation.
I wrote in January 2001: "It now looks very much like recession and liquidation are not far off."
Note: I think I have to make it clear that when I say that an economy is going into recession I don't mean that employment is rising, that comes later. I mean that certain industrial indicators are showing the symptoms of a looming recession.
That is why I have written at certain times that the US economy looked as if it is entering a recession even though aggregate figures indicated otherwise. It is because they are aggregates that they are so misleading.
Gerard Jackson is Brookes' economics editor
BrookesNews.Com
Monday 8 November 2004