It is human nature to extrapolate in straight lines, to take what is as what should forever be. In economic statistics, tail risks continue to live outside the tails because the math can never get past that limitation. No matter how sophisticated the “jump diffusion” tendencies, no one can predict inflections. This is not to say there aren’t warnings, usually there are. But institutional inertia particularly with regard to apparent prosperity is a powerful force of destructive capacity.
In 1927, John Maynard Keynes confidently declared, “there will be no more crashes in our time” such was his faith in centralized man. Despite the error revealed in disastrously in just three years’ time, in August 1971 President Richard Nixon famously appropriated Milton Friedman’s earlier declaration that “we are all Keynesians now.” Friedman’s quote was, he later claimed, taken out of context by a December 1965 Time Magazine article with John Maynard Keynes’ face glaring on the cover. In 1968, Friedman said of his attributed affability towards the economist, “We all use the Keynesian language and apparatus; none of us any longer accepts the initial Keynesian conclusions.”
Nixon’s use of the quote was still far too similar even to where Freidman was protesting; interventionist policies would be the only way forward. Friedman agreed, only split into the monetary realm where so many others at that time were working it through fiscal policies.
Just nine years after Nixon declared everybody one, the Joint Economic Committee of the United States Congress confirmed nobody was left to be – on the fiscal side. The disaster of the Great Inflation was palpable enough that even partisanship was no longer an impediment to the necessary judgement. Published on February 28, 1980, the JEC report thundered in its introduction:
The Majority and Minority Members of the Joint Economic Committee have risen above political partisanship in this election year to once again issue a unified annual report. We have done so because we believe that our Committee has developed an innovative and effective strategy to help reverse our country’s declining economic fortunes and raise the standard of living for all Americans during the 1980’s and beyond.
The 1980 annual report signals the start of a new era of economic thinking. The past has been dominated by economists who focused almost exclusively on the demand side of the economy and who, as a result, were trapped into believing that there is an inevitable trade-off between unemployment and inflation.
Thirty five years later, here we are once again focused solely upon the “demand” side and achieving nothing for it. Friedman was right about economists if utterly mistaken about economy. Those that branched into Nixon’s version of the quote were repudiated by the 1970’s, leaving those Keynesians in “language and apparatus” to follow Freidman to Chicago and the monetarist “school”; eventually forming the activist Federal Reserve.
Thus, Keynes’ interventionist core could escape its thorough debunking by laying dormant in the mathematics of central bank econometrics. Free market economics is boring and back burner; saving the world through monetary policy is thrilling (to an economist) and elevates the entirety of the profession to something of grave, international importance and standing. It is no coincidence that the Federal Reserve, in particular, saw emergency in every single financial event from that point forward. From the 1987 crash to the S&L crisis to LTCM and the dot-coms, Greenspan’s Fed reacted as if each were a threat on par with 1929 without ever bothering to figure out if that were actually true (and why it might not be).
The dominant monetary setting, then, was one of lack of restraint for which the Fed and the mainstream confused with prosperity. It was commonplace in the 1920’s for the ancestors of interventionist economists to declare that decade a “plateau of permanently high prosperity.” Irving Fisher used those words to infamously describe the stock market in October 1929, but others were sure they also applied to the US economy as if the activity then were the only baseline for the future – no matter how many cracks appeared in the foundation.
EHH Simmons, head of the New York Stock Exchange, said in January 1928, “I cannot help but raise a dissenting voice to statements that we are living in a fool’s paradise, and that prosperity in this country must necessarily diminish and recede in the near future.” By that quote alone we know that there were not just warning signs but that they had achieved a level of concern necessary for optimists (politically and otherwise) to deny. It is, again, human nature especially when confronted with the emotional prospect that “my way” might not work or, worse, might actually be dangerous.
It is amazing in retrospect, but in the late 1990’s Alan Greenspan and his Chicago Keynesianism was given a level of respect that might properly be catalogued as cultish devotion. This was not, however, a narrow demographic; it was widespread throughout the world. For those that did not live through the dot-com bubble or may have forgotten its more extreme edges, the St. Louis Fed in its Fall 2000 Magazine published an article that should be preserved throughout economic history as just this kind of further warning:
The Federal Reserve is famous for being tight-lipped about its potential monetary policy moves. In desperate attempts to predict what Fed policy-makers are thinking, market-watchers occasionally resort to rather odd measures. For example, on mornings when the Federal Open Market Committee (FOMC) meets to discuss the economy and make decisions regarding monetary policy, the media often focus on the image of Fed Chairman Alan Greenspan carrying his briefcase into the front door of the Federal Reserve Board building. In fact, www.CNNfn.com updates its “Eyes on the Fed” section with commentary and pictures of the chairman’s briefcase on the mornings of FOMC meetings at www.cnnfn.com/news/specials/eyes_on_fed. If the briefcase is bulging, so the speculation goes, it is full of evidence that has been gathered by Greenspan to persuade other members of the FOMC to vote for a higher interest rate target. If the briefcase is thin, so the theory goes, then markets can relax because no change is likely.
The briefcase analogy tells us nothing about the Fed and everything about the world that wanted to believe in the mystique, the myth that Plato’s enlightened philosopher kings were not just real but right at that moment at work. Popular perception had turned a systemic lack of restraint into King Arthur and financial Camelot. Alan Greenspan relished the role (and the attention) and economists swore him undying allegiance for what it did in bringing up the whole discipline in political and popular opinion.
In August 2012, he told BusinessWeek:
As Fed chairman, every time I expressed a view, I added or subtracted 10 basis points from the credit market. That was not helpful. But I nonetheless had to testify before Congress. On questions that were too market-sensitive to answer, “no comment” was indeed an answer. And so you construct what we used to call Fed-speak. I would hypothetically think of a little plate in front of my eyes, which was the Washington Post, the following morning’s headline, and I would catch myself in the middle of a sentence. Then, instead of just stopping, I would continue on resolving the sentence in some obscure way which made it incomprehensible. But nobody was quite sure I wasn’t saying something profound when I wasn’t.
He had other options, of course, but those would betray interventionism. He could have said, as he did internally in June 2003, something to the effect “we are not at all sure we can actually do what we say we can do.” Despite his mediocre attempt at modesty a decade later, it is clear from his quote as well as his actions that he believed the myth as much as the public did. He claims well afterward to be disquieted, but he still holds to the premise that it was his utterances that moved markets. Again, it says more about human nature and the legends of “easy money” than anything else.
It is in sharp contrast to Janet Yellen, a woman who should be given the same regard ceteris paribus. After all, Greenspan’s “power” came from words; Yellen’s come from Bernanke’s trillions. Where the “maestro” moved the federal funds rate target around in precise, so he says, quarter point moves here and there, up and down, Bernanke exploded the Fed’s balance sheet. Yet, it is the former who was regarded as a genius while the latter left with serious questions; both leaving it to Yellen to appear the fool.
As Bloomberg wrote on June 10:
The challenge with that approach is that it seems to be making it harder to understand the U.S. central bank’s plans. Their intentions are signaled in statements issued after each rate-setting Federal Open Market Committee meeting, as well as subsequent comments by its 17 policy makers that don’t necessarily add up to a coherent explanation of Fed action.
Greenspan admits to putting out a purposefully lack of “coherent explanation” and was celebrated and lauded to the point his briefcase became a Wall Street icon. Janet Yellen’s Fed does the same and is roundly criticized as not providing near enough. What changed?
The answer is simple – Keynes is showing again. The philosophy functions only as a myth and a legend. When exposed to actual and explicit effort, it wilts. When Greenspan was in office, everyone just assumed the Great “Moderation” was his doing. Since August 2007, the Fed was instead tasked to prove that it really was; and it has only failed time and again, starting with the panic and Great Recession itself. Where was the “Greenspan put” in September 2008? What in the US or global economy in 2015 and 2016 is left of four QE’s?
It is a shocking realization for so many let alone economists. History is replete with such warnings, including the common cliché of “too good to be true.” The Federal Reserve was and is Mighty Casey of Ernest Lawyer Thayer’s celebrated poem.
The sneer is gone from Casey’s lip, his teeth are clenched in hate,
He pounds with cruel violence his bat upon the plate;
And now the pitcher holds the ball, and now he lets it go,
And now the air is shattered by the force of Casey’s blow.
Oh, somewhere in this favoured land the sun is shining bright,
The band is playing somewhere, and somewhere hearts are light;
And somewhere men are laughing, and somewhere children
But there is no joy in Mudville—mighty Casey has struck out.