A Conversation With Alan Greenspan

A Conversation With Alan Greenspan

Melanie Einzig

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Monetary Policy

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from C. Peter McColough Series on International Economics

Alan Greenspan discusses the U.S. economy.

The C. Peter McColough Series on International Economics brings the world's foremost economic policymakers and scholars to address members on current topics in international economics and U.S. monetary policy. This meeting series is presented by the Maurice R. Greenberg Center for Geoeconomic Studies.

LIESMAN: Welcome, folks. Thanks to the Council on—

GREENSPAN: Welcome to you.

LIESMAN: Yeah. I’ve got a little work to do. Thanks to the Council on Foreign Relations for asking me to be in this great spot here, moderating a panel with Dr. Greenspan after the historic decision yesterday by the Federal Reserve.

Alan Greenspan needs no introduction; was the Federal Reserve chair from ’87 to 2006. He served under four presidents. He was on the 1983 panel that reformed Social Security. I think we’re going to be talking a little bit about entitlements this morning; also was the economic adviser to President Ford and made a very, very important decision sometime in the early ’60s, I think, not to be a professional jazz musician but to become an economist. Was that in the ’50s, Alan, or was that the—

GREENSPAN: I hate to tell you when that was.

LIESMAN: (Laughs.)

GREENSPAN: ’45.

LIESMAN: ’45. I was giving you the benefit of the doubt there, young man.

GREENSPAN: You also were factually inaccurate. (Laughter.)

LIESMAN: Alan, I want to turn immediately to the news from yesterday. And I know you have some reluctance to talk about the Fed, comment on the current policy. But if you would, give me your reaction to the market reaction. The markets seemed to rally on this news. Why do you think that was?

GREENSPAN: Well, remember that this particular move was targeted way in advance, and the market had adjusted to it. And the only question that was out there was what was going to happen subsequently that—not what they could—not that you could actually make certain it happened, but at least what the policy was.

And as it became apparent that the Fed was going to just raise the rates and then not do a whole series of rates, then basically the markets just said the uncertainty is gone. Therefore, when you remove uncertainty, income-earning assets go straight up. And this is just a classic case of this.

I ran into it many times in the sense that the choices that we had were always do you want the market to know exactly what the plans of the Federal Reserve are or not? And it depended on a very, very technically difficult problem. How much risk do you want in the system? If there is too little risk, you’re bubble creating. And if there’s too much risk, you’re suppressing growth beyond what it should be.

And part of Federal Reserve policy is, at any particular point in time, trying to make a judgment of what type of level of risk do you want in the system? And so—but what we often did, as you know, is go change, change, change, and the markets did not respond in any of those because it knew exactly what we were doing why we were doing it. Other times we’d go up 50, 75 basis points and shock the market. Why? Because we wanted to change the—

LIESMAN: So that—

GREENSPAN: —outlook.

LIESMAN: That ’04 to ’06 period is actually criticized now as being one that created potential bubbles in that it was too regular a rate increase. And it’s something the current Federal Reserve has said we’re not following this. Was that a mistake, do you think, to have gone in that regular fashion?

GREENSPAN: It depends on how you examine the conclusion you come to as to why the crisis occurred. Remember, bubbles per se have not been toxic. We went into the 2000 bubble. The market crashed. The people who were essentially hurt were those who were on the way up. But what was critical about the sort of .com boom is that the various types of financial intermediaries which held the particular toxic asset had very little leverage. And unless you have debt, you cannot, by definition, default. And if you cannot default, you cannot create contagious defaults, which is the basis of the problems that we ran into in 2008.

So, for example, in 1987 we had no impact from the collapse in stock prices. In 2000 we had no impact. In 2008 and 1929, we had very significant impacts. Those two had in common, which were not in common with the other two, the degree of leverage that the particular institutions. Broker loans, for example, were highly leveraged. And subprime mortgages were—especially when you got into securities—were highly leveraged.

So it’s more the leverage issue—

LIESMAN: Than it is—

GREENSPAN: —than it is the issue of bubbles. Bubbles per se is not a pejorative term, if I may put it that way.

LIESMAN: I want to just ask one more question about the current policy and the market reaction and then move on to some of these other areas that we’re going to talk about. I noticed this morning the long end of the curve, 2 ¼, basically unchanged, maybe even a little bit lower in yield on the 10-year. It reminded me of the conundrum that you talked about.

How much influence would you say now the Fed has on the long end of the curve, which obviously matters, because those are the ones that are going to determine borrowing rates out in the real economy? Could you foresee a situation here where the Fed raises rates on the short end, but the long end of the curve remains stable?

GREENSPAN: Well, that’s basically what happened to us in the period when I said we’re raising rates, and the 10-year note ought to go up. Why? Because it always did. But why the federal funds rate, which is the overnight rate, should affect long-term rates was always a great mystery to me, and still is. What is not a mystery to me is that long-term rates now, in an international market, are essentially arbitraged; that the effect of long-term rates amongst many of the countries tend to converge. And the reason is they’re arbitraged.

But the impact between short- and long-term rates is a wholly different ballgame. And so I think that the presumption that you’re going to get a situation where the interest on excess reserves or the federal funds rate or even reverse repos that they’re doing is going to significantly affect the long-term rate is not indicated by any historical data that I’m aware of.

LIESMAN: Do you care to share with us a forecast you may have for the funds rate—

GREENSPAN: The what?

LIESMAN: —for the next couple of years? A forecast you have for the funds rate over the next couple of years.

GREENSPAN: What do you—I don’t even follow you.

LIESMAN: Do you have—would you care to share with us your forecast for the federal funds rate over the next couple of years? What do you expect to happen?

GREENSPAN: That’s a nimble question—deft. No. (Laughter.)

LIESMAN: No. Alan, you know, I get paid to ask questions that people say no to, so that’s OK. I’m good on that.

Let me turn now to a broader question, which is none of this would matter a whole lot if we had strong growth out there. And yet growth has been—I mean, at best you could say anemic. We’re lucky to eke out 2 percent growth. What’s holding back this economy?

GREENSPAN: Well, I think, first of all, you can not only ask about this economy—the globe. If you look at output per hour, for example, which is the critical determinant of growth, you will find that the vast proportion of countries have under 1 percent productivity growth over the last five years on average. And this includes virtually all of the OECD countries—basically obviously the Euro area, the United States, Canada—with very few exceptions, all below 1 percent, and averaging in many cases below a half-percent, and in some cases, which I think probably more for statistical reasons than economic reasons, they’re showing five-year negative productivity.

Now, the question you have to ask, well, why is this? And if you go deeper into the data, what you take a look at is the United States, because it’s perfectly typical of everybody else, what we have in this country is a very unusual and unfortunately very unstable fiscal system. Our fiscal system is now driven by entitlements on the expenditure side and a tax structure, as always, on the funds-raising side.

The entitlements are not affected by the level of economic activity. It’s elderly, which has got nothing to do with what the economy is, how many people become eligible for Social Security, and a whole series of other factors which determine essentially what the entitlements are.

I mean, for example, health costs have got very little to do with what the economy is doing. So if you have a situation in which entitlements are rising at 8 to 9 percent a year—and I might add parenthetically that it is in both Republican and Democratic administrations. And, in fact, if you want to be actually exact with the numbers, the average rate of rise in Republican administrations has been greater than the Democrats.

But this is very critical, because this rate of growth in entitlements could be funded only if the GDP growth rate is probably 3 ½ to 4 percent. Remember, these are not related issues. In other words, basically the economy does its thing. Entitlements does its thing. If they meet, all well and good. But if they don’t, then you have a real problem. And what the issue is now is that the surge in entitlements is displacing gross private savings.

And the result of that is because gross domestic savings in total, which includes negative government usually, and entitlements, have tended over the last 65 years—let’s see—50 years as a percent of GDP have been remarkably stable, like that sum, which essentially comes down to the fact that a dollar increase in entitlements reduces gross domestic savings by a dollar. But gross domestic savings is the major determinant of capital investment. Incidentally, gross domestic savings plus the current account balance is equal to—there’s the borrowing from abroad—

LIESMAN: Right.

GREENSPAN: —is equal to gross domestic investment, with a little statistical discrepancy in there. Gross domestic investment is the key factor in determining productivity growth.

LIESMAN: So let me recap, Alan, just for a second. You’re saying if we save a lot, we invest a lot. If we invest a lot, we’re more productive.

GREENSPAN: Correct.

LIESMAN: But since we’re not saving as much because we’re putting more stuff into entitlements, we’re investing less and our productivity is less.

GREENSPAN: Perfect.

LIESMAN: Awesome. (Laughter.) And I’d come back and I’d say we got all this stuff around like this.

GREENSPAN: Yeah.

LIESMAN: People have a sense of massive technological advancement out there. How can you say we are not more productive right now?

GREENSPAN: Basically because this is a different type of effect. Remember, when you’re talking about, let’s say, per capita income, it depends basically on the number of hours worked or the number of hours in the year, but it’s a per-person thing. The issue of productivity is more output per hour. The social-media stuff is more a direct-consumption thing. It does not improve productivity, but it does create other values.

Remember, when we’re in a market economy, we measure it only in terms of market values and market pricing.

LIESMAN: Output.

GREENSPAN: Output. And basically, I mean, there’s no question I couldn’t go out the door without my iPhone. Where is it? You know, all of those sort of things, because you’re getting so dependent on it.

LIESMAN: Mmm hmm.

GREENSPAN: But that actually only marginally reduces the amount of hours, and it doesn’t get picked up in the statistics. And there’s a big dispute amongst people who are productivity experts how to count this. This is a different type of value. Social media obviously have value, and people pay money for it. But how should one measure that?

LIESMAN: That was always your metric. I remember ’96, ’97, you introduced me to this notion of the earnings forecast for tech companies suggested the need was out there for these things. Therefore, they must be productivity-enhancing because we see the demand for it in the economy.

GREENSPAN: Well, remember, at that time it was information technology.

LIESMAN: Right. Right.

GREENSPAN: This was not social media. I mean, what you are looking at were very significant changes in values which do show up in output per hour. This is not. I mean, a goodly part of that is. I mean, clearly, to the extent that it cuts down the workday—I mean, for example, I get more work done with the new technologies than I could conceivably have gotten done with 10 times as many people 20 years ago.

LIESMAN: So it’s just we’re mis-measuring productivity a bit, and maybe—

GREENSPAN: Well, it’s a definitional question. You’ve got to distinguish between what the economy is for. If you’re trying to measure as material well-being—food, clothing, standards of living, the old conventional stuff—then all of the technical analyses that were done up through the year 2000 were unchanged over generations. This has created a very difficult measurement problem. There is no question that social media obviously creates something. I don’t think iPhone is social media.

LIESMAN: Right.

GREENSPAN: So, I mean, there’s more to it than—

LIESMAN: Of course, you have Bob Gordon, who you know from Northwestern, who points out this is not a train. This is not equal to the innovation of electricity. It’s not equal to the innovation of the car. It doesn’t register—

GREENSPAN: Well, just—you know, one of the really important ones was the telegraph.

LIESMAN: Right.

GREENSPAN: I mean, that hugely altered—

LIESMAN: Right, in historical. I want to talk broadly about the U.S. economy and the global economy, and perhaps we’ll get more into fixing entitlements in the Q&A with the audience. But overall, are you pessimistic about the outlook for U.S. economic growth? Do you see it as a 2 percent economy, say, over the next decade?

GREENSPAN: Unless and until we rein in the rate of growth in entitlements, yes, because the logic which you just went through has got to be broken. And the only way you broke it—break it is, remember, we added 10 percentage points—we moved 10 percentage points in GDP from financing productive capital equipment to funding benefits. You cannot do that without a very significant impact. And we’re seeing it now.

This is the reason why everyone was looking at the data and said we have to come to grips with entitlements. But entitlements are basically the third rail of American politics. You touch it if you’re running for office and you lose.

LIESMAN: So I have to go there, because this is why people hate economists, right, is because ultimately, in the utopian world, you would have more of the entitlements geared towards productivity growth, right? That would solve some of the problem.

GREENSPAN: Well, but wait a second. No, it doesn’t improve productivity growth. It is basically what—you’ve got to go back to the—

LIESMAN: I’m sorry. What I meant was that the growth of entitlements—

GREENSPAN: Oh. Oh.

LIESMAN: —would be tied to the growth of productivity.

GREENSPAN: Oh, yeah, yeah.

LIESMAN: That would solve—

GREENSPAN: It would—well, you could even be closer. Just balance the budget. I mean, for example, the reason the budget gets balanced back in the earlier years is we’re doing 3, 4, 5 percent GDP. But remember that when Social Security began in 1935, when Franklin Roosevelt signed on, it was a defined-benefit program in which cash receipts scheduled to fund the benefits were actuarially the same as they were in the private sector. We have now abandoned all pretense. It’s—you talk about the 1983 commission. We couldn’t even get something as significant as lowering the retirement—raising the retirement age, because longevity had gone so extraordinarily far since 1935. It was—the only thing we could manage in 1983 is to get it in the next century.

Now, politically you’ve got to see that’s what that was. And the pressures here are—our system is so governed by getting these entitlements—sort of once you get them—look at the word. Entitlements used to be something which the Founding Fathers talked about with respect to individual rights—liberty, freedom of the press.

These are physical-good retirements produced by whom? And you can’t answer that question very readily. And unless and until we get out of this cycle—in other words, I don’t see how we get out of the cycle and get back to 4 percent GDP growth, which implies significant rise in output per hour. It’s the only way you can get there, given the structure of our working-age population and the very large population of beneficiaries.

LIESMAN: I mean, that’s the other thing we could talk about, which is the other side of the growth equation is growth in hours worked. And could we enhance that by a smarter immigration policy and a smarter education policy?

GREENSPAN: Well, yeah. I mean, my favorite sort of problem before all of the immigration issue came up politically was I thought the H-1B program is much too small. That’s the program which enables people with special skills to come into the United States, get a green card and the like. Every other major country looks at the quality of whom they’re inviting in, and we’re not doing that. We’re restricting that very significantly.

So the answer to your question is yes. I mean, if you really want to increase productivity, you really open that program up. And anyone who got a Ph.D. in the physical sciences in the United States would be allowed to stay. Instead we kick them out.

LIESMAN: We educate them and kick them out.

GREENSPAN: Why we do this is bizarre and beyond me.

LIESMAN: Alan—tell me how Alan Greenspan listens to the current debate about—in the presidential arena on economics. And what do you hear?

GREENSPAN: What makes you think I listen to it? (Laughter.)

LIESMAN: (Laughs.) Sorry for making that assumption. What you read about the presidential debate, which I’m sure you do. Is there an intelligent debate going on? Is there a debate that’s going to lead to—I don’t get paid to ask stupid questions, which I suppose this is right now. (Laughter.)

GREENSPAN: I’m still looking.

LIESMAN: Yeah. Do you—is—do you hear anything that gives you any sense of optimism that some of these issues you’re talking about are going to be addressed? Or do you hear the opposite, that we’re going the wrong way?

GREENSPAN: I don’t know. Look, just on the basis of the type of facts which I’ve laid out, either I’m wrong in my economic analysis, which I conceivably could be—not easily—(laughter)—the point being is, look, theoretically I’m either wrong in my implicit structure of how the economy functions or I’m wrong in its implications. I have not seen anything—and I wrote a book three years ago in which I discussed exactly these issues, so it’s not something which all of a sudden has come out.

I think that we need a fundamental change in culture, and we did have it. Franklin Roosevelt created a major change in culture. Margaret Thatcher did in Britain. And, in fact, what’s very interesting about it is that culture is still there. The Labour Party, when it came in after Thatcher, did not change what she changed. And obviously Ronald Reagan made a major impact. But both Thatcher and Reagan failed in the end because they couldn’t control the budget. They both ran up against very difficult problems. I shouldn’t say they failed, but they didn’t reach the goals that they were trying to reach.

LIESMAN: We’re going to open it up in just one minute. I have one more question here, which is the markets got very excited and concerned this summer when it looked as if Chinese growth was weakening, or it finally realized Chinese growth was weakening. How big a concern does China represent to you about the overall outlook for global growth and U.S. growth?

GREENSPAN: Well, China is a very big player. It’s the major consumer of most every major commodity you can think of. Remember, China is positioned probably 50 years behind us. We went through—I remember when, you know, I used to drive up the southern shore of Lake Michigan and you had one steel company after the other in the 1950s and ’60s. They’re gone. You had huge amount of commodity production and physical—I actually, in one of my earlier books, measured the physical weight of the GDP. And the weight of the GDP was either stable or going up virtually year by year until basically in the ’60s it started to flatten out. And the actual physical weight—in other words, we had a huge downsizing revolution. Physical weight is not much different from what it was 20, 30 years ago.

China is still in the early stages of this. The reason why you can’t go to Beijing without choking is this sounds like what I went through. I remember walking down the streets in Triangle in Pittsburgh in 1951, and my shoes would crunch. It was coke-oven coal debris. And the smokestacks were all over the place. And I’d look and I’d say, boy, this is a real measure of American industrial capability—before the environmental movement came on and said, uh-uh, that wasn’t so.

But this is what China is going through. In other words, they’re moving where we were. Now, that means that they are the key controller, as we were back then, of the commodity, the physical part. They’re the biggest manufacturer. They’re the largest steel producer by far, the biggest consumer of oil and most other—I shouldn’t say—not oil, but a whole series of other commodities. And they’ve got a long way to go.

But their weakening now is being caused by the fact that China is becoming a more and more, if you’ll excuse the expression, capitalist economy. The markets are expanding dramatically. The way they handled that stock-market crash indicated to me that they hadn’t a clue what they were doing, so that this is getting away from them. They are moving towards capitalism at a very rapid pace, and I don’t think they are acutely aware of the extent to which that’s happening.

And it’s—periodically you run into cycles. And the first sign that I saw that something very different was going on is when the price of iron ore in Australia all of a sudden started to come down. And that meant essentially, since the major consumer of iron ore at the time was China, something was slowing in China. And it all accumulated from there and devastated a goodly part of the emerging world, not to mention indirectly the ECB—rather, the euro area and the United States, but not as great as they’re impacting on—

LIESMAN: And before they controlled growth through an accounting identity, right? They would increase spending to the state enterprises and GDP would rise. And now what you’re saying is it’s much more variable and inside the capitalist—

GREENSPAN: Yeah.

LIESMAN: —and market system.

GREENSPAN: Just remember what’s happened is that 34 years ago the state council, which is essentially the cabinet of China, would order a province, for example, to build 20 buildings. Don’t ask what they wanted. It was—the purpose of building them was to create the jobs, not to get the space that you might think they wanted. And they then said to a government-owned commercial bank, you fund it; so that if you apply standard national income accounting to China, that’s GDP.

LIESMAN: Would rise.

GREENSPAN: And so that they could set the level of GDP as they chose by calibrating their capital investment. What’s been happening since is that they’ve gradually moved away. They opened up a lot of the markets and had an extraordinary pace, which they didn’t expect. I mean, they did not expect that big surge that came. The reason—I spoke to them beforehand and said they didn’t expect much. They were surprised, I think, by it. And now we’re running into the effects of—remember that they are—well, they dipped their toes in allowing creative destruction to work, meaning allowing firms to default, and then they got cold feet.

LIESMAN: They didn’t like it?

GREENSPAN: They didn’t like it.

 LIESMAN: Let’s open the floor to questions, one of the great things about these CFR breakfasts. Let me start right here with this young lady.

Q: Good morning. Chairman Greenspan, thank you so much for joining us this morning. As the Federal Reserve changes its focus to the interest being paid on excess reserves, I was wondering if we could call on your historical perspective about the changing decision models of the Federal Reserve over time. Since the 1970s, so even before your time as chairman, you’ve seen a focus on things like bank credit, money supply, the overnight rate, even the unemployment rate. And I’m just wondering how much you see the changing of the Federal Reserve’s decision models changing incentives, and essentially affecting the behavior of banks and market participants, and whether you expect to see potentially any positive or negative externalities, or other unintended consequences as we shift to the interest on excess reserves. Thank you.

GREENSPAN: Well, this is a very good question because I used to sit at my desk at the Federal Reserve, and three times a week I’d get to see a report or a study or an article come in about the way monetary policy works, different channels. In a sense, we don’t yet have a full comprehension of exactly how the monetary system interacts with the physical system. In other words, the models we’re using have not worked.

The way you know that is go back and look at the history—very recent history, since 2008, for example. The Federal Reserve, OMB, CBO, most of the forecasting models all showed GDP going up. Uh-uh, start again. GDP going up, and you begin to see, we had so many false moves in this particular period that we ought to be looking and saying, well, maybe something is wrong with the conceptual framework which we’re using to understand how these markets are working. And for example, the conundrum issue we discussed before was one of these types of changes.

So I don’t think it has settled down at the moment, but the interest on excess reserves is the key variable, because remember what it has done. When we went to QE1, 2, and 3, out of necessity they expand the asset side of the balance sheet. And therefore, you create a large degree of reserve balances which by definition can only be depository institutions who have an account at the Federal Reserve. In other words, the markets will continue to adjust until the only holders of those balances are depository institutions. So that the issue of Fed policy was, how do we essentially neutralize them?

And the way you do it is you put the interest rate on excess reserve balances. When we put 25 basis points on for a sovereign issue, essentially, which is what the claim on the Federal Reserve is, very little in the way of capital requirements. And essentially a riskless asset, with no cost to the individual commercial bank, for example. So it was delighted to hold them. And while they did—some of that did get out into the commercial markets—in other words, JPMorgan, for example, withdraws a large balance at the New York Federal Reserve, would draw on that balance and make a loan to IBM.

That process is—creates the money multiplier and the expansion. There’s very little evidence that that’s going on, meaning that essentially the Federal Reserve largely neutralized the effect of QE1, 2, and 3, so it didn’t spillover into the money supplies, because you have to get your reserves going out to building outside of the simple system of the Fed buys the assets, its balance sheet goes up, that automatically create a reserve deposit. Since reserve deposits are only legally capable of being held by Federal Reserve banks, that means that the Federal Reserve could determine or could control how much in the way of those balances moved out into the market.

If you moved the rates all the way down then CNI loans, which are risky and have reserve requirements and everything, all of a sudden become more attractive. But if you keep moving the rate up, you basically neutralize the system. And the way you can tell is despite the huge increase in the monetary base, which moves directly with the asset side, the money supply, which is the transaction balance which creates economic activity and inflation and all of the rest that goes along with that, hasn’t gone up all that much. So I’m saying that the money supply has got to go up, start to accelerate before you can see any secondary expansionary effects coming from QE1, 2, and 3.

LIESMAN: Sorry, Alan, did you just make an argument for negative interest rates?

GREENSPAN: Did you just make an argument for negative interest rates?

LIESMAN: No, because negative interest rates shouldn’t exist. If you have a—you can always convert to currency if you weren’t too lazy to do it.

LIESMAN: Excellent point, though, but Lars Svensson with the Swedish National Bank—central bank—they’ve decided that it’s something that is useful for them.

GREENSPAN: Well, basically they find that people are willing to hold deposits there, and they thought if—

LIESMAN: Negative.

GREENSPAN: It’s actually enforced. It’s a tax—it’s essentially a tax.

LIESMAN: On not lending.

GREENSPAN: Yeah. In other words, if you get stuck with a claim which has got negative—has got negative yield on it, what do you do? The only thing you can do is convert to currency, which has got zero. And the point of issue is that the central bank has control of what is the aggregate happens to that. And it’s a question of musical chairs, who gets caught with the wrong side of the liability.

LIESMAN: Let’s get another question. Let me go geographically to the back, the gentleman there. It’s you, yeah.

Q: Hello. Ron Tiersky from Amherst College.

Dr. Greenspan, the issue—great issue that people are talking about a lot these days is inequality. But it seems, according to recent reports, that economic insecurity is more important to people than economic equality. Let’s imagine that this room were not filled with the people it’s filled with, but with sort of average, middle class and lower—working class Americans. How would you explain to those people the need to do something about the entitlements? And which changes would you suggest in terms of reducing entitlements, given this great worry about economic insecurity in the country?

GREENSPAN: Well, take an average low- to middle-income family, productivity is what determines their real incomes. And productivity is a—basically, as I mentioned, is a function of capital investment. And if you discourage capital investment by creating entitlements, what you’re creating essentially is something, in today’s world, is you are paying significant proportion of the GDP to people who are retired. And that’s not where this issue of the country is. The issue of the country is the younger people. It always has been and it always will be by definition.

And so the question is, if you’re an average middle- to low-income person going up—trying to go up the ladder, you’re being inhibited by programs which shifts the proportion essentially to the elderly. But the issue of inequality is basically another more interesting issue in general. That is truly a function of productivity. Back in the 1950s and the ’60s, when productivity was really moving, the question of inequality never came up. The so-called Gini coefficient, which measures the extent of income inequality, was flat. The question only arises as you get into a situation where productivity slows down. And it impacts the middle- and lower-income wage earners.

Remember that QE1, 2, and 3 did not do all that it was supposed to do. It was supposed to, one, lower real long-term interest rates and hence raise price earnings ratios on equities and on real estate. And that actually did work very well and created a lot of capital gains that did spillover into the economy. But it was also supposed to increase the general level of economic activity, which it did not. And so what we have is a very significant part of capital gains flowing to a very limited number of people.

And so you’ll find—if you want to do the econometrics here—and you’ll find that the issue of stock prices versus real wages in today’s environment says that people who are involved in holding assets which rise as a result of the QEs, they have had capital gains and higher incomes, which will always outmatch the wage levels that are created by the standard economic activity, because—not getting the details of it—stock prices grow at a rate of 7 percent a year remarkably stably. They fluctuate all over the place, and the reason they do that is everyone is scared to hold stocks. And that causes them to have a long-term uptrend, because people who are willing to hold them do well. And you have to just basically buy stocks and forget about them. People who do that do very well.

So there’s something very unusual in the system which means left to its own devices the owners of capital assets will always do better than wage earners. And the result is that if you enhance the price of stocks, you’re going to increase the inequality. And there’s no way to get around it.

LIESMAN: Hmm. There’s a question right here.

Q: Nise Aghwa (ph) of Pace University.

As you know, the Taylor rule posits that the Federal funds rate equals the equilibrium real rate of interest, this equilibrium inflation, plus the weighted average of the inflation gap and the output gap. There’s not much debate about where the gaps are, but there’s a lot of debate about where the equilibrium real rate of interest is. What are your views? Is it around 2 percent or is it around zero right now? Thank you.

GREENSPAN: Well, let’s go back and ask, where does the interest rate come from? It’s basically what economists would call the result of time preference. Time preference is the extent to which we discount claims to the future. Or, for example, somebody’s standing in line for one of these things, back when they were under huge demand, the first day. What would he give to replace—to get a position farther up on the line and get it much sooner? That that is human time preference.

Human time preference has apparently been unchanged as far back as we can go. We have data, for example, going back to—every single day we’ve got a Bank of England, since 1693—or ’94. Bank of England issues daily discount rates. Those rates have been absolutely flat through time. Go back to ancient Rome, a low—I’m sorry—a middle to upper single-digit interest rates. The question is, why? And when you look at these data going all the way back, you have to conclude there’s something inbred in human decision making. The amount of time preference is a relatively stable factor. And the reason you know that is not only are our interest rates trendless over the generations, but the rate of return on equality or any other type of asset, risk adjusted, is flat—going back hundreds of years.

So that the question here is, where is that so-called normal rate? And the figure it would say is substantially above where it is now. And I think the pressures are going to start to emerge, if they’re not already. I am frankly surprised that rates have stayed down this low this long. I don’t expect that to—for lots of reasons. It goes against human nature, and that’s not a good enemy to go against.

LIESMAN: I think the historian—economic historian Gregory Clark from the University of California, Davis, he would go back into the textile mills of the industrial revolution. Three percent was the number he came up—since the industrial revolution began was that rate that was—

GREENSPAN: Well, that would have to be a riskless rate.

LIESMAN: Yeah, 3 percent was—

GREENSPAN: Yeah. Probably not bad.

LIESMAN: This lady over here, please.

Q: Thank you. Good morning. Paula DiPerna of the NTR Foundation.

Back to IT and productivity, is it possible that the time we spend with gadgets is really dispensable, and that instead of being productive, new creativity, it’s really rehashing, reliving, recreating, redoing, sharing things that actually don’t take us forward? And so it’s dumbing down of time, actually?

GREENSPAN: You’re reproducing the argument that is currently going on. Those are the critical questions. This is human value. This is has got very little to do with economics. And the question basically is, what do we want? I mean, if we want material well-being, which obviously were, back in the 18th and 19th century, were still critical. In other words, people were still dying of starvation. And to get shelter and food, it was unambiguous what we were all about. But when we get to standards of living where we reach—and a vast proportion of the population has got a lot of leisure time and lot of leisure money—it’s not to make the judgment.

So you’re not asking an economic question. You’re asking a much broader question. And I don’t think it’s going to get solved within the context of the economics. The economics will tell you what is the material values that are produced. But those are limited to those which basically enhance physical life. They don’t stress anything about enjoyment, or pleasure, or other things. In other words, there’s always a big dispute. Should we have a GDP of happiness? I don’t know how you’re going to measure it, but have fun. But these are very important questions which go way beyond the issue of economics.

Economics is essentially restricted to a very limited part of human survival and human beings. And when we go off into many different aspects, remember that there’s a great deal about the technologies which really lower the hours input for work. I mean, I find, for example, I’m in the economic consulting business. I have a firm before I went to the Fed which had 50 people in it. I can do the same sort of stuff now with four people. And what is it? It’s basically the technology which is embodied in that.

LIESMAN: Isn’t one of the economic arguments that the economic value we get from it is at least equal to or greater than what we pay for it, or we’re being irrational?

GREENSPAN: Well, that’s the question. Are you being irrational, or are there other criteria that you employ? You’re going to find books and editorials, and all, which raise all of these questions. And I’ve not really seen a satisfactory answer, frankly.

LIESMAN: How about in the back left there.

Q: My name is Andrew Dunlop, First Eagle Investment Management.

Could we go back to the discussion of debt and contagion? It seems to me the debt with capacity for contagion is in the sovereigns today. And we’ve seen a couple of non-levered funds have liquidity problems in the sense of the mismatch between the asset and the liquidity. Do you see the leveraged funds, such as the long-term credits of the world, around with the possibility for contagion? And do you see the political will at the monetary authority level to fix it, in the same way you did when it became a contagion problem?

GREENSPAN: It seems to me that the whole issue is debt. I, for example, just recently wrote an editorial for the Financial Times—and that came out recently, a couple months ago—in which I re-raised the issue of what I thought ought to be involved in resolving the issue of debt and banking, and all that. And I concluded, as indeed I did in earlier books, that had we—every single problem that occurred in 2008, the crisis that occurred, would not have occurred if capital of the financial intermediaries was high enough, or the collateral requirements were high enough, and the issue of enforcement of basically all the statutes against criminality had been enforced. We would never have had anything like the 2008 crisis.

So I concluded that instead of something like Dodd-Frank, which is creating a shortage of paper, just so much volume of detail of every single regulation—which I don’t know how—I don’t know how you do it. I’m sorry, just parenthetically, small banking is going down very sharply. They can’t afford it. So the question is, what have we done wrong? Well, had we had, for example, a mandated capital requirement in the commercial banks of 30 percent, their rate of return on equity would not have changed because what the data show, going back to 1869 when the control of the currency first collected it, is that the rate of return on equity capital in commercial banking ranged between 5 and 10 percent throughout that period, with very rare exceptions.

And that particular set of data shows that even during a period when during the most of the second half of the 19th century capital—equity capital as a percent of assets went from 30 percent and even higher, all the way down to 7 or 8 percent in the early post-World War II period, then came back. Through all of that period, ups and downs, the rate of return on equity did not change.

Now, I think that—this is where this time preference issue comes in as well—I think that implies that if we go, gradually allows the rates of equity capital requirements to rise until we get to 30 percent, within a reasonable period of time, we could get rid of virtually all of Dodd-Frank, all the regulatory stuff, because all of that is trying to prevent people from doing something. But if you have capital high enough, it’s the shareholders of the institution, not the taxpayers, that are involved. And if they want to go out and waste the shareholders’ money, that’s the issue between the shareholders and management. But taxpayers are not involved. You can get rid of the huge complexity that we’re now involved with, and I don’t know how we’re going to get around, because it feels like half the population is employed in enforcing Dodd-Frank regulations. (Laughter.)

LIESMAN: The question raises the issue of the high-yield market, which recently had I think a pretty major hiccup as a result of, perhaps, the Fed interest rate hike. Do you have concern about the high-yield market itself? And are there other markets out there that you believe could be in dis-balance would unwind as a result of Fed rate hikes?

GREENSPAN: Well, I think that—you know, the yield went up 20 percent on some of that stuff. This is usually not a good sign. This is the way signals occur when—for example, first sign of the subprime mortgage problem occurs when BNP Paribas ends ups saying that they were having, you know, funds which are losing money. French Bank is holding funds in the American market in subprimes. I mean, what in the world was going on? That was the first sign that something was askew. And I’m a little concerned when I saw those reports, and I said this is nervous making. But I must admit that there’s—the markets are still moving ahead in their usual, wonderful form.

LIESMAN: We have time for one more question. Right here. Maybe another one. Ask Kate, she’s the boss.

Q: Hamid Biglari, TGG Group.

My question is about liquidity deterioration, Chairman Greenspan. So, there are two profound changes in markets compared to the last 10 years that have created concern. One is the reduction in the number of market participants with heterogeneous preferences or, by corollary, the increase in the concentration of market power in fewer market participants. The second is the unwillingness of broker-dealers and intermediaries to hold inventory because of the higher cost of capital, and the Volcker Rule and a variety of things. Have we created—have we planted the seeds for the next major market dislocation as a result of this change in market dynamics?

GREENSPAN: Yeah, that’s a very good question. Let me say that, first of all, let’s define what we’re talking about in a certain sense. As far as I can judge, no economic crisis, whether it’s economic or financial or whatever, occurs in the non-financial sector of the economy. And you can tell by the—frankly, the Federal Reserve has got this very extraordinarily complex econometric model which actually does very well for the non-financial part of the economy, and it did so right up to 2008. Our problems are all in finance, which spillover. And the types of issues you are raising really are essentially what individuals are mainly concerned about, financial imbalances and the like.

And if there’s enough capital in the system, you can take a lot of defaults, a lot of changes, a lot of structural issues—which go way beyond what you’re raising. But I am concerned about a number of different things, but as a central banker I was always concerned. My job was what do I worry about tomorrow. Anybody who think central banking, especially if you’re the head of a central bank, is a delightful activity, let me disabuse you. (Laughter.) It’s torture. (Laughter.)

LIESMAN: Folks, I’m sorry. I’ve gotten the hard rap from—what we call in television—the hard rap from the organizers. I could do this for another hour, but unfortunately I just want to—please join me in thanking Chairman Alan Greenspan. (Applause.)

(END)

This is an uncorrected transcript.

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