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Rubin doctrine of international finance v. Greenspan doctrine …

August 30, 2005

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The Rubin doctrine of international finance (From In an Uncertain World):

1. The only certainty in life is that nothing is ever certain.

2. Markets are good, but they are not the solution to all problems.

3. The credibility and the quality of a nation's policies matter more for its prospects than anything the United States, the G7 or the international financial institutions can do.

4. Money is no substitute for strong policy, but there are times when it is more costly to provide too little money than to provide too much.

5. Borrowers must bear the consequences of the debts they incur -- and creditors of the lending they provide.

6. The US must be willing to be defined by what it is against, as well as what it is for.

7. The dollar is too important to be used as an instrument of trade policy.

8. Optionality is good in itself.

9. Never let your rhetoric commit you to something you cannot deliver.

10. Gimmicks are no substitute for serious analysis and care in decision making.

The Rubin doctrine was written by Treasury's international staff and focused on international issues, so it left off what no doubt is the central plank of Rubinomics -- fiscal discipline.

The Greenspan doctrine  (as written by Alan Blinder and Ricardo Reis):

1. Keep your options open

2. Don't let yourself get caught in an intellectual straightjacket.

3. Avoid policy reversals

4. Forecasts, though necessary, are unreliable

5. Formal optimization procedures work in theory, but risk management works better in practice, particularly as a safeguard against very adverse outcomes

6. Recessions are bad, as is growth below potential

7. Most oil shocks should not cause recessions

8. Don't try to burst bubbles; mop up after

9. The short-term real interest rates, relative to its neutral value, is a viable and sensible indicator of the stance of monetary policy.

10. Set your aspirations high, even if you cann't achieve all of them.

There are some obvious similarities: "risk management";"keep your options open"; "use models and forecasts, but treat models and forecasts with a degree of skepticism"; and "don't commit to more than you can deliver."   I suspect a shared belief in the value of optionality and in a prudent fiscal policy (even in Greenspan let his desire for less government get in the way of his commitment to fiscal prudence after 2001) laid the basis for the strong working relationship between Rubin and Greenspan.

But there are also some differences. 

Part of the difference stems from different positions - Treasury Secretary v. Fed Chairman.   Treasury Secretaries approve large emergency rescue loans to emerging economies(bailouts to their critics); they also pull the plug on rescues when the conditions are not ripe for success (Russia, 1998) and on rare occasions help to organize the rollover of short-term bank lines to a troubled country (Korea). Hence "better to lend too much than to lend too little" to emering markets facing crises works for Rubin (think Mexico), but not for Greenspan.  

Above all,  a powerful Treasury Secretary helps to determine the Administration's fiscal policy, while the Fed Chairman only indirectly influences fiscal policy choices.  Conversely, short-term real interest rates are more central to what the Fed does than to what the Treasury does. After all, the Fed Chairman actually sets short-term rates (single-handedly, according to Blinder).  

Part of the difference stems from their different political beliefs.   Rubin is a Democrat.  Greenspan decidedly is not.  Greenspan may not think markets solve all problems, but he surely thinks that they can solve almost all problems.  Rubin clearly believes the government plays a key role in creating the conditions that allow a market economy to work well.

Part of the difference stems from a different attitude towards leverage. 

In a way, that is sort of strange.  Rubin shares Greenspan's belief in risk management and his suspicious of policy rules.  See this Jacob Weisberg profile, which later became In an Uncertain World.  But even with a common intellectual framework, they nonetheless seem to have rather different assessments of the risks associated with a more leveraged economy.

Rubin consistently worries that markets tend to over-extend themselves (reach for yield) in good times, only to snap back at some point - often with damaging consequences.   Think of Greenspan's warning from last Friday and multiply the level of concern by about five.    Look at what he said on reaching for yield and leverage in this 1999 speech; I would be surprised if his tenure at Citibank has fundamentally changed his view.    He certainly is worried about the risks created by large fiscal and current account deficits

Rubin consequently was (and perhaps still is) suspicious of certain types of financial innovation that relied on lots of embedded leverage  Weisberg and Rubin report that then Deputy Treasury Secretary Summers sometimes accused Rubin of preferring the financial equivalent of wooden tennis rackets to modern graphite rackets (let alone magnetized rackets ... ). 

Greenspan seems to have a different view.  He has consistently resisted any efforts to reign in the growth of leverage, or to warn strongly of associated risks.    He tends to extol the virtues of more leverage at least as often as he warns of the risks. Financial globalization allows the US to be more leveraged, so current account deficits that would have caused concern in the past are not a concern.   Option (pay if you want to, other wise capitalize your payments) mortgages, interest-only mortgages and even simple adjustable rate mortgages provide new vehicles for more efficient financial management by American households - with lots of that "efficiency" coming from leverage.    The explosive growth of credit derivatives over the past few years (growth that has coincided with the explosive growth of assets under management by hedge funds) is just another wave of helpful financial innovation that allows more efficient risk management.

Rather than try to reign in a more leveraged economy on the way up, whether through higher rates or tougher regulation (and risk foregoing the benefits of financial innovation) Greenspan has preferred to try to manage the consequences of bubbles bursting and the associated flight to safety.  Another take on the Greenspan doctrine is reach for yield as much as you want, because if worse comes to worse, the Fed is likely to lower rates and save the day -- the so called Greenspan put.   And if markets seize up, the Fed has been ready to step in and supply liquidity.

That is not to say that Greenspan does not occasionally issue warnings.  He (following Geithner) has started to warn that the models used to value complex bets on credit derivatives (often bets on correlation) are untested.  See this speech.   He now worries about folks spending the increase in their paper financial wealth associated with what may prove to be a temporary reduction in risk premiums.  He is not quite Stephen Moore or David Malpass.  He doesn't think rising housing prices and the resulting rise in (paper) wealth make the increase in US household debt (or external debt)  totally benign.  And he considers 10-20 bp spread between two year and ten year treasuries, and the resulting low long-term rates that propel the housing market, a conundrum - not just evidence that the Fed has successfully anchored inflation expectations.   See Paul McCulley.  

Warnings, past and present aside, there is little doubt that a more leveraged economy is a key part of the Greenspan legacy.  Domestically.  And externally.  

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