Bursting the Greenspan bubble

IF A SHIP runs aground, Admiralty regulations hold the captain responsible. Federal Reserve chairman Alan Greenspan claims he is not responsible for America's economic woes. So just who does he think is running the good ship US?

Greenspan is in charge, so he is responsible, but he may not be to blame. It cannot be denied that the US economy is in trouble. Since this is due to the bursting of the Wall Street bubble, the issue is whether the central bank's chairman could or should have prevented the stock market's excesses.

There are three possible defences for such failure - that he could not know it was a bubble, that he could not stop it and that the results of stopping the bubble would have been worse than letting it run. Greenspan has pleaded all three. His defence is so poor that he would have been wiser to plead the Fifth (the amendment which allows American citizens to stay silent rather than incriminate themselves.)

The claim that he could not be sure it was a bubble fails on two grounds. First, he is on record as having recognised the bubble's existence in 1996, well before its worst excesses.

Secondly, economic information is never certain. The future is unknown and recent revisions to gross domestic product in the US have shown that we cannot even be sure about the past. It is nonetheless the job of a central banker to make sound judgments on the basis of dubious data.

The claim that he could not stop the bubble also conflicts with his recorded comments.

Greenspan said in 1996 that he could guarantee to get rid of a bubble by raising margin requirements.

The third defence is equally unconvincing. Stopping the bubble might have caused a recession, but the US had one anyway last year and is now threatened with another.

A well-managed economy will have periodic mild recessions, but will avoid rapid inflation and asset bubbles, because both of these are hard to cure without big or prolonged recessions. One reason for avoiding asset bubbles is that they go with an excessive build-up of debt.

There are then only two ways of cutting the debt and both are more damaging than a mild recession. One is widespread bankruptcy, which goes with a deep or prolonged recession, the other is inflation. Experience shows that inflation is hard to rein back without a serious loss of potential output.

Greenspan is to be awarded an honorary knighthood. Commenting on the news, John Plender referred in the Financial Times to the iron law of British public life. This holds that failure must never go unrewarded. Plender suggested that with Greenspan's award the law had gone global.

It is necessary to be hard on Greenspan for his errors because it is important that future Fed chairmen do not make them again. A refusal to recognise error is much worse than making mistakes.

Having failed to learn from Japan's bubble in the late 1980s, the US must at least learn from its own.

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