The Bubble Meister

Martin Wolf reviews for The Economist a book by Sebastian Mallaby about the life and times of Alan Greenspan.

Paul Volcker was the brave man who crushed (goods and services) inflation. Alan Greenspan

once believed that regulating the financial system was a mistake. Much later he admitted to his own mistakes. One mistaken belief was that no-one could tell if a boom in asset inflation was a normal process of capitalism or a dangerous bubble. As a result he focussed on goods and services inflation and let asset inflation rip. The Fed will clean up afterwards he announced. As the painting suggests, it is hard to 'clean up' if the damage is too bad after a bubble bursts.

Martin Wolf concludes: 'If Mr Mallaby faults Mr Greenspan for inertia on regulation, he is no less critical of the [goods and services] inflation-targeting that Mr Greenspan ultimately adopted, albeit without proclaiming this objective at all clearly. The advantage of inflation-targeting was that it provided an anchor for monetary policy, which had been lost with the collapse of the dollar’s link to gold in 1971 followed by that of monetary targeting. Yet experience has since shown that monetary policy is as likely to lead to instability with such an anchor as without one. Stable inflation does not guarantee economic stability and, quite possibly, the opposite. [This is a highly relevant comment - developed in the article linked below.]

'Perhaps the biggest lesson of Mr Greenspan’s slide from being the “maestro” of the 1990s to the scapegoat of today is that the forces generating monetary and financial instability are immensely powerful. That is partly because we do not really know how to control them. It is also because we do not really want to control them. Readers of this book will surely conclude that it is only a matter of time before similar mistakes occur.'

Australia's new RBA chief when much younger wrote persuasively about the issues surrounding control of asset inflation. But his mandate focuses on goods and services inflation. Low rates of interest to tame the Aussie dollar have largely failed to do so but in the process have encouraged asset inflation, most dangerously in Australia's house price inflation. Global share price inflation also due to mistakenly low - often zero, or even negative - rates of interest in the USA (and elsewhere) is a global source of future asset destruction. As with the physical universe, what goes up eventually goes down. The higher it goes, the bigger the fall.

Philip Lowe, you are in charge of overseeing 'the forces generating monetary and financial instability' that, as Martin Wolf points out 'are immensely powerful'. And, as you know better than most, are far from fully understood. Confusion about forces creating financial and therefore economic instability puts the capitalist system at risk of deep depression.

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For 150 odd years analysis of US asset and goods inflation ...

Readers please look under the heading below in the economics section of the new Henry Thornton site, www.henrythornton.com. A formal link will be available shortly.

Beyond Friedman; Adding Asset Inflation and 52 Extra Years