Alan Greenspan's recent words and Federal Reserve Board actions to raise nominal interest rates have left many economists and financial analysts wondering if they are on the same planet he inhabits. Especially puzzling was his appearance before the House Banking Committee on Thursday, February 17, 2000, and his March 6 Boston College speech—following which the Dow dropped almost two hundred points. The market still shivers after every speech he makes in anticipation of more Fed interest rate hikes.
Among other things, at the Banking Committee appearance Greenspan portrayed recent increases in productivity as a problem because, "the pickup in productivity tends to create even greater increases in aggregate demand than in potential aggregate supply."
It does so, he argued, because increases in productivity stimulate optimistic forecasts of corporate earnings, which in turn spur stock prices upward, generating consumer perceptions of increased wealth and increasing their spending.
At Boston College he said that "overall demand for goods and services cannot chronically exceed the underlying growth rate of supply" and that the "vigilant Federal Reserve" would work to "effect the necessary alignment" of the two.
The bottom line is his view that stock prices should rise no more yearly than the rise in nominal consumer incomes. The implication is that the Fed will increase interest rates to dampen the rise in asset values as well as curb resultant consumption expenditure.
Add to this the Fed chairman's apparent unwillingness to define "money" for the Banking Committee and a real puzzle seems to confront the financial community. "What in the world is he talking about and what is the chief federal MONEY policeman going to do to us and our present prosperous times?"
My view is that Alan Greenspan is actually a "crypto-Austrian School" monetary theorist whose public statements are a smokescreen for his real views. Those views translate into counter-cyclical policies that he thinks will avoid the inevitable consequences of the present expanding money-and-credit-fed stock market "bubble" and present spending spree.
And those views stem from his tryst with Austrian economics about forty years ago when he was an independent economic consultant and member of Ayn Rand’s "inner collective" of Objectivist intellectuals.
Some support for this position is found in notes I took while an undergraduate economics major in the early 1960s from tapes of Greenspan’s course on "The Economics of the Free Society," offered through the Nathaniel Branden Institute—an Objectivist lecture bureau. Following a summary of portions relevant to the current monetary argument, I place it in the context of Austrian business cycle theory, current events, Greenspan pronouncements and recent Fed actions.
There are at least four reasons for thinking it unlikely that Greenspan’s economic views have changed drastically since those halcyon days of Objectivism:
1. Alan Greenspan was in his mid-to-late-thirties then and a successful, independent economic consultant in New York. Either he was teaching what he believed or he was a rank hypocrite. For what little he was probably being paid, and the public nature of the lectures he gave and recorded, it is virtually impossible to think that he would bother with hypocrisy. The opportunity costs would seem prohibitive.
2. Before Objectivism experienced the schisms of the late 60s, I was in a conventional graduate program in economics and sick of it. I wrote to Alan Greenspan, outlining my dissatisfaction and asking his advice on continuing in my program or transferring to another university. In his reply of December 9, 1966, he commented that other academic "Objectivists" "...have had much the same difficulty" and "have generally completed their Ph.D.'s (as difficult as it was for each of them) and thereafter continued their education." The tone was sympathetic and the advice collegial.
3. Alan Greenspan was for several years a close associate of Ayn Rand--one of the most brilliant and assertive intellects of this century. Too many others got skewered [one need only recall Joey Rothbard’s "trial"] for him to have remained in that inner circle through deception and sycophancy. He must have believed what he taught—and presumably practiced--as a very successful economic consultant.
4. Several of the other members of the "inner collective" [e.g. Murray Rothbard, Nathaniel Branden, George Reisman] went on to achieve a degree of fame in their respective professions similar to that achieved by Alan Greenspan as Fed chairman. To my knowledge, not one repudiated his earlier views or drastically altered his basic philosophical or theoretical foundations. Greenspan would be the lone example if his views now are not developments from earlier foundations.
If his views now are developments from earlier ones, what were those earlier ones and how can they provide a basis for some understanding of Greenspan’s current words and actions? First, a summary of the relevant course notes.
In the first lecture, "Money" was defined as "that COMMODITY [emphasis mine] which serves as a medium of exchange and can therefore be used as a store of value; it is that commodity which is universally acceptable by all participants in an exchange economy as payment for their goods." He went on to stipulate that it must be durable (like metal) and a luxury (in order to be scarce and of high unit value).
There was emphasis on the desirability of a gold standard [and later in lecture 6 an assertion that an international gold standard would tend to minimize world business cycles.] and, in a mini-history of American banking crises during lecture 8, a reference to the creation of the Federal Reserve System as "a historic disaster."
More interesting for Austrians was his discussion of "time preference" and "the rate of future discount." This occurred first during lecture 4 on production theory. Producer goods were asserted to have current value based on future production possibilities. Further, the right to receive material values in the future was of value currently and that present worth was always less than its future worth. Human beings were said to live in the present and to have time preference, that is to discount future goods values, including money—those goods only having value in the first place because, in time, they become present goods.
The rate of future discount (RFD) was argued to be directly related to the uncertainty of the future from the viewpoint of the individual decision-maker. It is not derived from market phenomena, but determined by psychological factors and is the basic parameter of the free economy. The specific definition of the rate of future discount was given as "the percentage amount by which the individual reduces claims to future money in order to express it in terms of present worth." The higher the RFD, the lower the present worth.
For producers, the RFD was said to depend on the extent of material productiveness of producer goods and to tend to be equal to the rate of profit, adjusted for time. Profits themselves accrue from the use of production goods and depend on their physical characteristics. The stock market is the organized trading of old machinery. It was then asserted that there would be a tendency for stock prices of a company to equate to the purchase price of newly manufactured production goods used by the company and to vary with the prices of new production goods.
Most importantly, at this point it was argued that the stock market was at the central core of the value preferences of a free economy and thus was the regulator of the production of production goods.
My notes on lecture 5 are fragmentary; however, the RFD was again referred to as determined by psychological factors. Then, it was said that the average return on invested capital was also not determined by the market but equal to the average RFD. Next, it was asserted that the average wage level was higher the lower the RFD and, because government intervention raises the RFD, it lowers the average wage. In lecture 8 Greenspan said that while the banking system acts to dampen the RFD, during the 1930s government actions increased uncertainty and thus upped it.
The last lecture in the series included an argument that the use of force in a free society is immoral; that the greater the amount of intervention by government the more immoral—and the less productive—the society; and that laissez-faire is the most moral and most practical form of society. It is the only form of society based on the philosophical principle that each man is an end in himself. Much of the last lecture was devoted to arguing the practicality of laissez-faire.
Of course, all of the above refers to a completely free society and, because the United States of America is not one, any argument based on the ideas expressed in this course would have to be adjusted for the differences. Still, the basic structure is there and I think such an adjustment possible, as follows.
To relate Greenspan's 1960s argument to Austrian production theory is difficult. The reference to time preference and the RFD appears to mix consumption views with production and profit rate ones. Sticking with the production side, the RFD would seem to be the interest factor that reduces the total expected value of future first order goods ("present goods") to provide a limiting total value for current higher order goods ("producer goods") to be used to produce those future first order goods. The profit rate (adjusted for time) would equal the RFD if the actual total current prices of higher order goods were equal to that value limit. The RFD thus depends on the expected value productivity of higher order goods and the expected length of the production period. Competition among firms would set the prices of higher order goods so that the profit rate would tend to be equal to the RFD.
For stock prices of a company (I assume Greenspan meant the total paper asset value of the firm) to tend to be equal to the purchase price of newly manufactured production goods used by the firm (I assume he meant the value of all its material assets) those material assets would have to be purchased at present values set by the RFD applied to the expected future value of production. This would make stock prices of firms specializing in higher order goods production rise more than those in lower order goods production during an expansion period.
And for the stock market to be said to be the regulator of the production of production goods, increased stock prices would have to reflect increased expected future production values and, thus, justify increased production of higher order goods.
According to the Austrian monetary theory of the trade cycle, a period of bank credit expansion drives nominal interest rates below real ones. Then, the structure of production begins to lengthen as investment in higher order goods industries expands more rapidly than that in lower order goods industries. Stock prices of the former rise more rapidly than those of the latter firms.
Consumer spending also increases as unemployment drops and wages and salaries rise, until inflation kicks in as higher order goods producers bid resources away from lower order goods producers and consumers suffer forced saving. Profits in lower order goods producers begin to lag. Unless the credit expansion can be accelerated, nominal interest rates will eventually rise to curb higher order goods production and turn boom into bust.
Turning to current events, Fed actions and Greenspan pronouncements, it is notable that there is no widespread agreement on what the money supply has been doing the past few years. The Fed seems to have lost interest in it and is focussed on the federal-funds rate; the chairman of the Fed avoids defining it; and many commentators note how many things seem to function as money today, as well as how many billions of dollars have been exported to the rest of the world to finance international transactions and domestic markets of countries too numerous to mention. Consumer saving is at an all time low, while borrowing to finance consumption has recently accelerated.
Productivity in the last quarter of 1999 is estimated to have risen at the fastest clip since 1992. Wage and salary increases are still relatively low, but medical, retirement, and other non-pecuniary benefits are multiplying at a rapid pace.
Prior to Fed actions to raise the federal-funds rate five times within the last year (and recent Greenspan comments on the stock market, productivity, consumer spending and bank lending), stock markets were setting records for asset growth. And, even since then, the technology heavy (read, very higher order goods oriented) NASDAQ set new records.
Add to this the complication of cartel-led rising energy prices, as well as rising steel, construction materials, and other basic higher order goods prices—and it would seem that there is ample grist for an Austrian mill.
Now, to speculation. If Alan Greenspan is a crypto-Austrian, and does not wish to wait for the "natural correction," but believes it is possible to forestall it, he might do the following: If he sees no way to control the rate of money supply growth, he might raise the federal-funds rate slowly to put a profit squeeze on higher order goods producers and shorten the structure of production, to adjust it more closely to apparent consumer preferences.
This would also raise the RFD, as uncertainty increases, and lower stock prices, productivity rates and wage increases. Unemployment would begin to rise and consumer spending to slow. What he might hope for is to finagle a soft landing, rather than experience the sort of 1930s "correction" for which the Fed is famous among Austrians.
It is not the "alignment" between aggregate demand and aggregate supply that Greenspan is really addressing. It is the relation between consumer and producer demand in the context of the structure of production of lower versus higher order goods. Credit expansion is the cause, but demand and supply control is indirect by means of nominal interest rates in our contemporary economy, where money is not a commodity and the Fed cannot directly control money and credit expansion.
