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Former Fed Chairman Alan Greenspan Surveys the State of the World Economy

A Conversation with Alan Greenspan

Speaker: Alan Greenspan, President, Greenspan Associates LLC
Author: Diana Farrell, Director and Global Leader, McKinsey Center for Government, McKinsey & Company
May 7, 2014
Council on Foreign Relations

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FARRELL: You will have in the handout bios, of course, Chairman Greenspan needs no introduction. And we have so many interesting things to cover today that I'm going to jump right away into the conversation.

Because there is so much to talk about, we will try to cover a range of topics, which will mean that we won't get to hear all you have to say on any given topic.

But I will ask questions for the first half hour or so and then turn it over to the audience. So, if you have questions, we'll bring the mike over and -- and have you put (ph) them (ph).

But let me start with the U.S. and the current situation. We've had some mixed news lately. We had pretty flat GDP growth in the last quarter. On the other hand, we had an unusually strong jobs report for the last month.

Where are we, in your view? Do we see the economy finally recovering and on the other side of this recession? Or is this another false start?

GREENSPAN: That's the toughest question. Why don't we -- why don't we leave that 'til last?

(LAUGHTER)

First of all, let me just say that the first quarter is going to be revised down to probably minus 0.7 or 0.8. The numbers are extraordinarily weak.

But fortunately, there are data that come -- if you look at the monthly pattern, it's improving through the quarter and April looked fairly good, as far as we could judge.

We don't know exactly how it -- how it's going to play out. But the important issue is that we are seeing certain signs which we haven't seen before.

There's one little statistic -- several statistics that I use. We watch railroad freight car loadings and weight them by industrial production. And they have moved up fairly decidedly in the last several weeks.

Most importantly, for the first time, we've actually seen commercial and industrial loans break out of a very narrow band.

And the reason this is important is with the very large amount of reserve balances held by the depository institutions, it's going to require a very specific breakout before all of those monies, which are sitting net idle -- and they've been sitting net idle for months and a couple of years, really.

There's no evidence that QE1, QE2 or QE3 is actually filtered into the economy, with the exception of causing asset prices to go up. But if you look at the flow of where the funds are moving, they're just stuck dead in those deposits, earning 25 basis points.

They're starting to move. And the way you can see that is that part of those reserves are being drawn on to make commercial and industrial loans, which is the most sensitive part of the financial system. All of that is good.

I'll answer the -- the last part of the question at the very end when I'll have more -- I'll have more information.

(LAUGHTER)

But the real interesting question here is have we been going through, for the last five years -- the last five years, a particular type of economy which essentially makes these false starts inevitable because we're running up against ceilings?

I think the answer to that question is yes. And I think that it's essentially a very deep-seated problem, best described by the fact that there is an extraordinary pall of a lack of confidence in the system.

But rather than just think in terms of psychology, what I do is I take a look at where are the weak points in the economy?

One of the things that I think is very useful to do is to take the gross domestic product and instead of breaking it down into consumption expenditures and government spending and business spending, take the whole GDP and segregate each item and calculate its life expectancy.

Software is three to five years; industrial buildings, 35 years; haircuts, one month.

(LAUGHTER)

But you get a very interesting statistic. Because what that shows is that all of the shortfall that now exists in the economy is the result of a decline of assets with life expectancies of greater than 20 years -- mainly structures, but not wholly that.

But just as importantly, what you find is that -- that it is not a fixed point -- at 20 years, things stop.

You can start with software, which is the shortest of the capital investments; that's doing rather well. And short-term equipment is doing well.

But 18, 19-year life expectancy industrial equipment is not; and long-term capital structures are doing extremely poorly and have barely recovered.

FARRELL: Now, if you -- if you hone in on this long-term investment question, is this a structural aspect of our economy now -- that value is being created with less assets? Or is this something around the investment psychology that's preventing people from making rational investments that would be longer term?

GREENSPAN: Well, I think the best thing to do is to ask -- where do those numbers come from?

And one of the things I find very useful -- first of all, structures, of course, is two-fold. It's non-residential and residential. They both have fundamentally the same cause, but they're obviously very different economic phenomena.

But what I do for the business part is I take a look at two things. One is the -- the share of liquid cash flow, which corporations choose to invest in illiquid long-term assets.

That's a very extraordinarily useful measure of the long-term confidence of business, because it doesn't ask you what they think. It looks at what they do -- not what they say. Who cares?

But what they're doing is exactly what you think they would be doing in a period such as this.

That ratio, which during periods of boom, has gone up very significantly; the ratio has basically gone up to capital investment being 50 percent higher than cash flow. That's rare, but it gets there.

The day that that -- the -- the freakish (ph) -- from -- from 2009 was the lowest ratio of investment to cash flow since 1938 -- I should say peace time.

But more -- just as importantly, there is another indication of the -- the -- the actual pattern is not linear. It actually accelerates the farther out it should go into the distant future.

And the way -- way you can tell that is that the spread between five-year U.S. Treasury notes and 30-year bonds is -- I think is extremely elevated slope, meaning that the rate of discount is going up very rapidly.

But that ratio now or that -- that slope is the largest in American history.

FARRELL: Now, are these investors scared unnecessarily or are they being wise? Because, in fact, you know, if you can create $18 billion of market cap as WhatsApp did with very little capital investment, very few employees -- better off focusing your money on those short-term investments than trying to build the capital that will require malls and roads and -- and whatnot.

GREENSPAN: Well, actually, before I went to the Fed, I spent a good deal of time in corporate board rooms discussing capital projects. And I could tell you how they do it and why -- or what -- what you see in those board rooms is very informative.

You find that there's a specific project which the chairman of the board or the chief executives are terribly desirous of getting -- it -- a director's authorization.

And so, they get a product manager and he comes up and he gives all these wonderful things about this new -- new investment and it's going to have an after tax rate of return of 20 percent over a protracted period and all the bells and whistles.

And somebody asks, "What is the variance of that forecast?" And if he says, as he would have to, "Well, we -- there is a not insignificant probability that the investment could be minus 10 percent" -- gone.

(LAUGHTER)

And it is fascinating to watch how the response to a very wide spread is very negative. So, it's not so much what people think; it's what their ability is to see into the future.

I mean, for example, one of the reasons that it's very difficult to get authorization for a long-term assets -- not only in the United States, but every place else -- is that you've got, specifically in the United States, an impossible notion of where tax rates are going to be 20 years from now; there's almost no way.

Twenty years ago, we could, because it was a pretty -- there was a pretty standard view of what they might be.

But now, we're dealing with all sorts of things, including climate problems, environmental problems and now, of course, the resurrection of the Cold War, to a greater or lesser extent.

These are not irrational reactions. These are basically fundamental causes of uncertainty. And so, I look at the business sector basically in the context of what is an average long-term expected rate of return and the -- then what the variance is to the extent that you could -- you can use it.

And there is -- we've recovered some -- some from the lows. And I think that's the reason why we're getting some of this sort of rise in commercial industrial loans and things that are moving.

But the problem is that if this all begins to cause long-term interest rates to start to move; that is going to stop dead in the water.

And what will cause the interest rates to move, basically, is what is the effective capacity of the economy. And if as a number of people suspect that we've got major problems in our labor market where a very significant part of the potential workforce is not working -- but more importantly, we're retiring part of the best part of our labor force and it's showing up. And you can see it -- the data are very disturbing.

On the issue of physical capacity capability, we have -- we have a considerable amount of slack, but it's distorted. And we've got -- the real problems, as we said before, are basically in the long-term assets, mainly construction.

And as you could expect, there are huge problems in part of -- part of the economy, which is very largely in that area.

If, for example, you take a look at a proportion of structures -- if it's residential or non-residential, the GDP -- those numbers are from -- from the peak in 2006 down through 2011, that went down 5 percentage points of GDP.

Now, not all of that is short-term, but we are going to get reasonably long-term losses right now. And it's going to be very difficult to get the economy through enough capacity to get it really moving.

FARRELL: There's some real caution on the U.S. But since we do want to touch a couple of regions, let me move to another area where there's a lot of question as to what the future holds, but very critical to the global economy, which is China.

Is China stalling, finally, after decades of extraordinary growth? Or can it restore this very high growth model for another decade? What will happen and how will its contribution to the global economy evolve?

It is now technically the largest economy, on a PPP basis. And does that mean anything?

GREENSPAN: That's because of their purchasing power parity. That -- that's a wonderful statistic, but they're not there yet.

China's a very interesting case, which I think -- you start off 20 years ago. The per capita GDP -- or I should say the United States -- was 40 times what it was there. Now it's five times and it's closing.

The problem that disturbs me is that as you close the gap, what we -- what we -- what we see is very substantial productivity increases. That's -- that's the only way to get the type of growth you see.

But it is turning out that virtually none of it is indigenous. All of it is basically borrowed or whatever you -- words you want to use.

But the -- there -- there's a very interesting study by Thomson Reuters and they -- that it's been doing for the last several years. They've been asking -- they've been trying to figure out who are the hundred most innovative corporations in the world.

The latest report -- 45 were American; zero were Chinese. And this -- it raises a very interesting question as to whether that's an accident.

In an authoritarian state, the issue of innovation is very difficult -- or I should say this basic indigenous innovation. Of course innovation is something nobody thought about before. If they thought about it, it's not innovation. The problem that you have however, is that if you have restraint occurring in the society about where you -- what you can think about, what you can talk about, and even though China is changing, I think in a very positive direction, it's doing so very slowly.

And so that the issue of going outside the conventional wisdom, which is what basically happens, that is very difficult to do in an authoritarian state. They cannot do it in Russia, they cannot do it in China, they surely cannot do it in North Korea. And that's going to be a problem.

FARRELL: You mentioned Russia, which of course dominates the headlines today with Ukraine situation and otherwise. What's your sense of how big an issue for the global economy is the current Russia situation, both their role in the energy world, the sanctions that the U.S., the E.U., may put on them, either now or in the future, is this a big additional source of uncertainty from your point of view, or marginal?

GREENSPAN: Well I was involved in studying up the sanctions against Iran early on, and I was fascinated in the extent to which the issue of the power of the American banking system and their correspondent banking, that we were able to actually get some really significant impacts, which really were beginning to work.

But it's very different in Ukraine, because there's really nothing you can touch, and when you can touch it, it hurts us more by comparison, like NATO. It hurts NATO more than it hurts us, or rather hurts them.

And the reason for that is that I've always thought that Europe made a mistake in not trying to wean itself off Russian natural gas. I think I can't remember the number again, I think something like a third -- a third of Eurozone's gas is probably coming from -- directly from Russia.

And it may be more than that, I'm not sure, but natural gas is not like crude oil. Crude oil you can move around physically, and it's very easy, and if, for example, the Russians were to cut off their shipments of crude oil to the rest of the world, we could rev up, there's maybe 2-3 billion barrels a day, excess in Saudi Arabia, which could be perked up, and Lord knows what's happening in North Dakota. I mean we're just doing an awful lot there.

But natural gas is very tricky. The only way we can get gas to Europe is by liquefaction, and we -- up until three or four years ago, we were going to be the major recipient of liquefied natural gas, and we had built up all these facilities, and then all of a sudden this Mitchell corporation in Texas devised frackery-- fracking, and it changed the world wholly around.

"In an authoritarian state, the issue of innovation is very difficult—or I should say this basic indigenous innovation. Of course innovation is something nobody thought about before. If they thought about it, it's not innovation."

And what we're -- what we're seeing now is that we don't have facilities, as far as I remember, that are -- will go online to ship the stuff from, for example, the North Dakota fields out into the European pipelines. That's at least a year away, and certainly even much more than in volume.

And the reason is, is that liquefaction is a very expensive operation, and the boats that you have to employ to get it there is another factor which is very critical. So it will be a long time before we can create from our fields a significant solution to the European....

Because another aspect of liquefied natural gas which is very relevant to this, is that because it is such a difficult process, most of the new facilities are committed in advance. In other words, you don't build a plant to export liquefied natural gas unless you guarantee the markets, which means you have to sign contracts.

And so this is not going to happen easily here, but the Russians have, in the past, shut down the flow of gas through Ukraine ...

FARRELL: So another big source of uncertainty that I'm hearing, I know you've mentioned ...

GREENSPAN: Well this is a big one ...

FARRELL: And you're saying that it will have a significant impact, at least in the short term, because not too much can be addressed.

GREENSPAN: Well we're fortunate in a certain sense that the winter was rather mild in Europe, and that meant that they built up inventories of regular gas, and so it's not going to hit Europe until you get into the fall and early winter.

But if the Russians decide at some point to turn the knob, I don't know what we'd do about it. They were turning the knob before we had the really obvious, at least in my judgment, Putin deciding that it was a mistake to break up the Soviet Union, let's put it back all together -- let's put it back together again. And working at that. And he has a very considerable weapon.

FARRELL: So he could have a huge impact on Europe, but of course even before Russia and Putin's Ukraine adventure, Europe has been a source of pretty significant instability, and we seem to have subsided from the panic days of 18, 24 months ago. Is it over? If they can bystep the Russia thing, is Europe going to be OK, or what is your sense about how robust the ...

GREENSPAN: Well this is another statistic that I collect every week, which is the size of the ECB balance sheet. And you could see the crisis emerging as all of a sudden it started up as all of that -- and essentially what the ECB was doing was taking the -- taking the sovereign credit embodied in the euro, and lending it out, first with very strict conditions on the metric (ph), which didn't help the situation.

And then finally, with this other monetary transaction thing, in which they basically considered, and it worked, but, it worked -- there's no drawing on that facility. But Europe got to the point where if it didn't work, I mean if it didn't stop the run in say Greece, Portugal, Spain, Italy, there was no other place to go.

See, in the United States, if our banking system fails, our sovereign credit of the federal government can bear without. But in Europe, what they have only is the euro and the individual members which don't always agree with each other, in fact rarely do, and you have basically two euro areas. It's the periphery and – it's north and south, and I sat in in the very early stages of 1994, '95, '96 ...

FARRELL: You were an early skeptic of this experiment.

GREENSPAN: I would show up in Basel, Switzerland, where the Bank for International Settlements would host the G10 governors. And it was just fascinating because the G10, which of course was 11 countries, had regular Sunday dinners, it was no staff, nothing.

And because -- with the exception of Canada, Japan and the United States, they were all European, I would -- I had -- I was sitting there at the birth of the euro, which was fascinating to watch, before they had a name for it.

And they were all acutely aware that there were cultural differences which were significant. And they basically were trying to replicate the type of monetary system which the United States had, which was with the 50 individual states, with a single currency.

And there was a recognition that you couldn't logically say that cultural differences and differences in language and the like were not a problem. But there was a remarkable conviction on the part of the European central bankers that it could be made to work.

And maybe because most of them looked for -- you know, had seen two major wars on the European continent in less than 30 years, and they were always looking to the future as to what we could we do to prevent that.

And so it wasn't so much getting the euro, but it was another step towards political integration of the EC. And so you could see that's where they were going. In any event, the general notion was, to be sure, the Italians and the Spaniards are different from the Germans and the Austrians.

But when we get them all into a single currency, the Italians would behave like Germans. Well that might have seemed a crazy view, but the markets believed it, because what you see for example with the Italians, is that my recollection was that the spread of lira-denominated bonds was 500 basis points over the German bund.

And as we approached January 1st, 1999, the beginning of the official euro thing, we collapsed that spread down to about 20 basis points. And so everyone said well, the financial markets believe it, maybe it is true, and indeed, for a decade, the system worked extraordinarily.

I couldn't believe it, but there it was in front of my eyes, they made it work. The problem is in retrospect, we realize that there was such a global boom going on that there was no such thing as non-competitive nations, because everyone could sell everything they could make.

But with the 2008 crisis, the whole thing opened up, the spreads opened up dramatically, and back to where they were prior to the onset of the euro. Remember prior to the onset of the euro, it was not that.

That -- Greece and Portugal and Spain and Italy somehow managed, they all had serial devaluations, and their unit -- their unit costs continued to rise relative to the northern -- northern European groups.

And the result of that was that when they came together, there was only one currency, you couldn't devalue anymore. But for ten years, they didn't need to. But when you ran into the break in 2008, the whole thing unwound.

And the ECB was very limited in what it could do to help, because it was constructed by the Maastricht Treaty, which was Germanic in virtually every respect. And indeed the euro was supposed to be replicating the Deustche mark.

But from day one, the day the show, that none of the southern European countries basically behaved like northerns. And in fact the book I finished last year, I go through this in some detail. It's very interesting to see how it -- how it evolves.

But where we are now is that Mario Draghi basically took the European Central Bank out of Maastricht, and said whatever is required to save the euro, we will do. And the reason why that was working was Angela Merkel was very concerned about the euro breaking up, because that would mean that the subsidy that the Germans were getting with a weak euro relative to the shadow Deutsche mark would be eliminated.

The Germans had a big export competitive advantage, so that they had reasons to want to keep it together, the Greeks wanted to keep it together, and everyone wanted to keep it together. And so when Draghi basically said we'll do whatever has to be done, the markets believed it, they didn't have a single loan of the so-called -- of the monetary transactions, which was the name they put on that particular facility.

And the whole thing turned around, but never fully, because there's a thing called target two, in the European Central Banking system, which is the intra-central bank net lending to each other.

And all of the 17 countries are members of that. And when you look at who is lending to whom, it's sort of obvious. But net -- the Germans, major, and the Netherlands, and Finland and the like, were net creditors, basically Spain and Italy are the two big debtors.

That is still existing, in other words, the amount -- the amount of net lending has come down between the north and the south, but it's still there, and is not evident to me that the cultural differences have been resolved, so a very long answer to a very short question.

FARRELL: Another source of uncertainty, we've left a few places of the world off the table, Latin America, Africa, others we can come back to them in the questions, but I know you're all eager to ask some questions. If you don't I have plenty more to go, but let me now turn it over to the audience.

I ask you please to raise your hand as one of these -- the microphone will come to you, and please hold the microphone close to your mouth so we can hear you properly. Yes, why don't we start right here.

QUESTION: My recollection is that when you had to testify before Congress, you were really mystified by the '08 collapse. And I guess my question is what kind of metrics you used to evaluate. Sounds to me as if you're using the metrics that are now coming out in Piketty's new book. Maybe you understood all this before, but I guess my question is what do you think are the metrics the rest of us oughta understand in terms of evaluating ...

GREENSPAN: Are you talking -- well it's ...

QUESTION: Capitalism, and the ...

GREENSPAN: You know, this is a different -- there's a whole series of questions implicit in that. Let me just tell you there are two issues, let me do it one at a time. I always presumed that individuals acted mainly rationally, but a significant part of it was irrational in the way they decided.

But, since it's very evident that progress is only made through rational insight, syllogisms, that everything else sort of washed out. In other words, the telegraph was not invented by somebody who had an intuition. He had to go think it through.

So that I always thought that it would wash out and the irrational would be -- wouldn't be there, and the people acting in their own rational long term interest, would essentially sustain the system, and indeed we had -- through 2007, we had been through an extraordinarily long period of economic stability, with very little weakness, and it's a very unusual period.

But what happened in 2008, September the 15th, 2008, I remember the day very well, Lehman defaulted, and a fundamental thing happened. It was the greatest financial crisis in world history. To be sure, it wasn't the greatest economic crisis, that was the Great Depression.

But for the first time ever, all financial markets shut down, and most importantly, the overnight markets. And that required sovereign credit coming in, and eventually it created a system which basically tried to hold -- tried to hold the thing together, which it did.

The difficulty that I have with my view, was that that was not supposed to happen. It's the first time it ever happened, and it probably will not happen again for 50 years. But it will happen, and it will happen because where my flaw in my reasoning was that animal spirits so to speak, actually have a systematic capability of acting -- people -- people get fearful, or euphoric in a very systematic, demonstrable way.

So I just -- this book I was mentioning I wrote last year, I sat down and said to myself, where was I wrong? How did I miss the most important thing in economics in my lifetime? And you know, what is it that caused the boats to back up outside of Singapore within days of that, never happening before?

In the United States, the last time we actually had markets shutting down, was in 1907, when the call money markets shut down for one day, it -- that's the overnight rate back then. It never shut down during the 1930's, and indeed it's an unprecedented event, which I'm in the process still of bringing together how to figure it out ...

FARRELL: You were not the only one who missed this one. But if I may, let's turn to a few other questions, because I know there were several hands up ...

GREENSPAN: Just one quick issue on -- we'll come back to the ...

(CROSS-TALK)

FARRELL: ... more generally, ahead. I was going to wrap up with that. We had a question all the way on the back, please.

QUESTION: Your meetings with Chinese officials, did it ever occur to you to suggest perhaps they could form a study group on Atlas Shrugged?

GREENSPAN: No, it never -- it never did, but I will tell you something, I had a very close relationship with Ju Rarji (ph), and I will tell you, for someone who was born, bred and educated essentially during the cultural revolution, I had never run into anybody who knew more about how capitalism worked than Ju (ph).

So the answer to your question is no, I never did, but I had a suspicion I might never had -- I probably didn't need to.

FARRELL: Great. We have a question right here in the front.

QUESTION: My question is really directed to both of you, and it starts off with the observation that Diana did some exceptional work, I think, around 2005, and thereabouts, talking about the extraordinarily large global liquidity problem that we were seeing emerge, I think it was historically large.

"Where my flaw in my reasoning was that animal spirits so to speak, actually have a systematic capability of acting—people get fearful, or euphoric in a very systematic, demonstrable way."

And I've always thought that that was really one of the reasons why the financial markets got weaker and weaker and weaker. It was really hard to deal with all of this liquidity in there. I'm wondering, both of you, what's your view on the, you know -- that liquidity and what it did to the markets, and the financial markets in specific. I'm also very curious about your views on Japan, and how they're QE experiment is apt to work.

FARRELL: Well I'll only state the facts, because I'm sure people want to hear, but I think you're right in saying some of the work that we'd done, honed in on an interesting dynamic, which was in 1980, the stock of financial assets was one time GDP, global GDP. By 1990, it was twice, by 2000 it was three times global GDP.

And so this level of leverage, that the value of financial assets, over the underlying flow of economic activity, was demonstrating a characteristic that we'd never seen before, and we didn't call it either when we were looking at this, but we certainly knew this to be a different dynamic. But your thoughts on that, I think, would be great.

GREENSPAN: Well what the data shows, and indicated at the very beginning, is that we did have QEs essentially, first developing here, and then the Bank of England, and then it spread around the world.

There is evidence that it had a significant impact on asset prices, basically because if you force down the real long term rate, the cap rate on real estate goes down, the price earnings -- the earnings price ratio goes down in the stock market.

And we had an asset explosion all over the world, in other words, you know, people parochially think that the housing boom and the stock market boom, the dot com boom, were a U.S. phenomenon.

They were, but you find it everywhere else. I mean in the housing boom, housing prices in the United States went up about on average. Not only that, but we had very much the same thing in Canada and Australia, without the secondary consequences of the toxic subprime problem. So it wasn't -- it's -- these things just were everywhere.

FARRELL: Did you want to say a word on Japan as well?

GREENSPAN: Well Japan had ...

FARRELL: The same issue, of course.

GREENSPAN: Japan was growing at 4 percent a year for years, and I don't know if you remember Herman Kahn (ph). Herman Kahn (ph) wrote a famous book forecasting that in the 21st century, Japan would overtake everybody, just in time to miss it.

And I was having a very interesting conversation with Kiichi Miyazawa, who then was finance minister, just after the crash, and he was prime minister prior to that. And I went through my let the markets liquidate, et cetera, rhetoric, and explaining how it was working in Japan.

And it implied that the loan losses would require very significant bankruptcies, and I said, you know, we -- resolution trust corporation, actually much of the -- we did exactly the same thing very successfully, the very same story.

And I went through this, and Miyazawa with his perfect English, sat there and listened to me, and then he smiled and he said Alan, you're quite correct on your diagnosis of what's happening here, but you just do not understand Japanese culture.

For a bank to call a loan which bankrupts a company, induces a loss of face, and that is culturally not acceptable. And I think that's the reason, fundamentally, that Japan was caught up in a very cultural bind, where to do the type of liquidation required after the huge boom -- remember that the value of real estate in the palace in Tokyo was equal to the value of the real estate in California. Now that tells you that something was awfully skewed.

FARRELL: We have a number of questions. I see here microphone came up. If people can't -- can people still hear in the back? Great. Yes, hand all the way in the back.

QUESTION: Thank you. I have a question on another new book that came out recently, it's Michael Lewis' book about high frequency trading, Flash Boys. My question is have you read it already? What do you make of Mr. Lewis' statement that the stock markets in the U.S. are basically rigged because of the way that high frequency traders can actually manipulate market prices?

And if not, generally speaking, what in your view is the economic and social added value that this type of trading adds to financial markets, and should they be regulated more strictly? Thank you.

GREENSPAN: Well, let's first start off with the issue of what those types of organizations do. The first thing they do is they make money. Now if they make money, they have to be buying low, and selling high. That is precisely what market stabilization is.

And what the difference is in this fast trading, is a matter of degree. There was a regulation of the Securities and Exchange Commission, of -- in recent years, which requires that when an audit comes in to a broker, he is required to seek out amongst a whole series of potential sources, for the highest bid, or offer.

That takes a matter of seconds, but the technology has so extraordinarily changed over the -- over recent years, that people who want to front load the actual transaction, have the capability of doing that.

Now it's -- first thing, all of the data indicate that the cost of transactions in the stock market have come down very significantly in recent years, and they all relate to this particular issue, so that the question is, is the market rigged?

The answer is in an odd way, it is rigged by the SEC regulation. If they would repeal that, I think you would find that the ability of all these people to compete with one another, would disappear in that the convergence would occur in a manner which everyone would get the lowest -- the lowest bid, or the -- would able -- would able to get the lowest transaction costs.

I don't think the market is any more rigged than it ever is, but I don't know what rigging the market is without being very specific about what they do, and in most instances, it's either a structural problem in the market itself, which can be changed, or it's a regulation which is creating an unnecessary impact.

FARRELL: Question, just pick (inaudible) second row.

QUESTION: Can I get you back to Japan, you talked about Japan in the past, what about Japan in the future? Are you optimistic about Abenomics? Arrow one and arrow two, monetary and fiscal seem to be getting recently good reviews.

Arrow three, growth policy, not getting good reviews. There are some also who predict that perhaps Japan will be the center of the next major global financial crisis. What's your assessment of how Abenomics will do?

GREENSPAN: Well, Japan's got a very major problem in the sense that the population is aging. And more importantly, if you look at the way, over the years, financial markets have worked during periods of normal interest rates, you would find that the JGBs would be -- ten-year JGBs would be yielding 1 percent, when the rest of the world at ten-year maturities would be yielding 5 and 6 percent.

And the reason, of course, as I'm sure you're aware, that the issue of Japanese savings, which was the reason of the postal saving system, which create a huge amount of money going into yen-denominated assets.

And the reason that it didn't go abroad, largely, was because of the fact that what Miyazawa told me, it's essentially it's a patriotic issue involved here, and it's a cultural issue, and they just didn't do that sort of thing.

So that you tried-- there's very little in the way of Japanese residents buying in dollar-denominated, or Deustche mark-denominated anything at the time. And I think that that still exists. It is not a problem now because everybody is at 1 percent on a ten-year, but I don't think it's going to stay that way.

And I think the real problem of Japanese policy is going to emerge when there is a significant increase in global interest rates, which will happen eventually. But there's also another problem here, in the sense that Japanese, for decades, had a significant current account surplus.

And that surplus has come down and down and down, and at some point it's going to turn negative. Basically as the population ages, and as more and more consumption, and more and more necessarily lack of -- lack of savings, because they're consuming the savings, and that means that the current account does indeed come down.

But at the point they go to a current account deficit for a protracted period of time, it necessarily means they're going to have to borrow money in the global markets at global interest rates.

And with the size of the stock of the yen-denominated Japanese debt, that can create some real instabilities. So I'm worried about what can happen there. It hasn't happened yet. The Bank of Japan is a very sophisticated operation, and I always got along with them extremely well, and learned a great deal about what they do. They are acutely familiar with all of this.

FARRELL: Let's try to squeeze in a couple more questions. We've got one gentleman in the back, third row up from the back. Please introduce yourself.

M: Chairman Greenspan, you haven't said very much about the role of emerging markets, apart from China as an engine of global growth, and there is much in the literature suggesting that this is a secular phenomenon, as opposed to a cyclical phenomenon. I'm wondering if you might opine about what you see the role of emerging markets being in terms of driving growth over the next ten years or so.

GREENSPAN: Well let's go back to the issue of the end of the Cold War, when the Berlin Wall came down, and the economic ruin behind the Iron Curtain was far greater than anyone had anticipated. That caused a dramatic change in third world nations who would be – were largely neutral, as you remember at the time.

And almost all of them abandoned various different forms of Fabian socialism and collective types of markets. Now remember that Nehru was a pure Fabian socialist in a -- in an orthodox sense.

I mean he really, seriously believed that you could run India with a bunch of excellent technocrats, and it didn't work, but it became obvious that none of that worked in the Soviet Union, and so you've got this huge change in China, the Asian tigers.

The whole third world, in effect embraced capitalism, and you've got this extraordinary change, especially in China, in the extent of GDP in the developing nations. And for a protracted number of years, the growth rate in the developing nations were almost twice that in the developed world.

They created major increases in savings because they couldn't consume all the new income, and they eventually led to that savings glut, which Ben Bernanke originally identified, and created a dramatic change in the structure of third world, or developing nations, and the developed world.

That is coming to an end. The rate of growth in the developing world, especially in some of the -- I mean Latin America is an obvious case where, no doubt Venezuela and Argentina holding down the whole system.

And it's also true, I mean India is not making the progress that China has made, and I'm -- I don't know whether they're going to eventually conclude that China is still a developing nation, but it's going to run into the fact of its inability to create indigenous innovation.

And so I think that the big movement in the increasing in the share of the GDP in the developing world in the sense of global GDP, I think that is now questionable. The only area which is still functioning are the Asian tigers, who still are formidable. But -- and there are certain Latin American countries that are doing very well. But that sharp divergence, I think, it's my judgment, is probably over.

FARRELL: Let me -- we're coming to the end, and we've been very -- we'll be very disciplined about ending on time, but maybe I'll loop it back to the very beginning. You brought up Piketty's new book.

Who would have thought that a French economist book would be the top sell -- number one top seller. Quick question for the audience, how many of you have read the book? How many of you have read reviews of the book? There we go.

At its core, he's asking fundamental questions about capitalism, which has been the topic that you are a big spokesperson for. What do you think of his ultimate diagnosis about capitalism yielding an income concentration, a wealth concentration model, and what do you think about his policy proposals?

GREENSPAN: Well it isn't capitalism, it's something else. The question is, what is it that is create -- everyone know what the Gini coefficient is? It's a measure of the degree of income ...

FARRELL: I think we can assume people know.

GREENSPAN: ... and wealth inequality. Well the Gini coefficient has been rising fairly conservatively recently. But there is a fundamental problem that I discuss in my book a year ago, in which you've got -- the best way of putting it would be that there is no evidence in human history that the intelligence level on average has changed.

That is -- you read Euclid, or Newton, and Einstein, they all are extraordinarily perceptive, at about the same level. You've got a compositional change, but there is no evidence that the average IQ of the human -- human population has changed.

On the other hand, you've got an issue of ever-increasing technology, which is basically irreversible because ideas build on ideas build on ideas. And we're finding even now, that the issue, the system is becoming so complex because what causes rising standards of living is a rise in the share and the ratio of assets, in an economy, to hours.

And all the basic data very clearly show that per capita GDP is very closely related to the proportion of capital that's employed over the number of hours worked. That's been the case since cavemen developed tools.

But the problem here is there is no evidence that the degree of technology is slowing down. It does mean that fewer and fewer human beings have the capacity to work in it, and to make it function.

That means that their marginal product is increasing all the time, and so you have individuals who contribute to the wealth of the nation in ever-increasing proportion. We're getting to the point that the depth of the technologies are such that fewer and fewer people can function in it.

"We're finding that we're getting an ever smaller group of people can run the system. And that's creating a very marked rise in the Gini coefficient."

At the end of World War II, the United States had a work force which was basically, the median was high school graduates. They had the capacity to operate steel mills, assembly plants, the automobile manufacturers.

The technology of the time, so that the -- that the cutting edge technology could be handled by people back then with essentially a high school education. That has gradually and increasingly changed, and we're finding that we're getting the -- an ever smaller group of people can run the system.

And that's creating a very marked rise in the Gini coefficient. Strangely enough, Piketty talks in terms of the rates of the term, but essentially he's saying the same thing that I am, the education system in the United States can't move fast enough.

The one thing I think we can do -- and I think that income inequality is a very dangerous political phenomenon. One thing we can do to be very helpful instead of talking, is to take H1B immigration quotas, which limit the amount of people who can come into the United States with high skills.

Everyone in this room is being subsidized by the fact that we don't allow our competitors to come in from abroad. All of our incomes would be lower. That would do more to solving the issue, at least temporarily -- it won't do it permanently, but temporarily, then most anything else I can think of.

FARRELL: We could continue this conversation all afternoon, I am sure, but it is one-thirty, and I will let you all get back to work. But very importantly, thank you so much Chariman Greenspan. Fantastic (inaudible). Thank you.

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