Alan Greenspan: The Fed Can't Prevent Market Bubbles
Friday, 25 Jul 2014 07:05 AM
In a MarketWatch interview, the former central bank chief said bubbles are the result of human nature, and suggested there may be limits to what monetary policy can accomplish.
“When bubbles emerge, they take on a life of their own. It is very difficult to stop them, short of a debilitating crunch in the marketplace …," he said. “I do believe that central banks that believe they can quell bubbles are living in a state of unrealism.”
When he was chairman in 1994, Greenspan said the Fed tried to defuse a financial markets bubble with a 300-basis point hike in the federal funds rate, but it did not help for long. “The dot-com boom resumed,” he recalled.
Greenspan said the biggest challenge facing the Fed now and its current chair Janet Yellen is how to unwind the enormous increase in its balance sheet — i.e. the amount of debt sitting on the nation’s books.
“It is not going to be easy, and it is not obvious exactly how to do it.” He said here is a possibility current economic recovery efforts may turn into yet another “false dawn.”
In Greenspan’s opinion, declines in domestic savings and capital investment — i.e. what Americans put in the bank and what businesses spend — are the reason for corrosion in productivity growth and standards of living.
“At root, the problem is government deficits suppressing the national savings rate. Until we come to grips with that, it is going to be difficult to get the economy moving in a sustainable way.”
According to his thinking, there is probably little Wall Street — and the individual investor — can do when the Fed finally tightens on rates except duck for cover.
“Look what happened when the first indication of tapering occurred,” he said, referring to first two times in 2013 when the Fed warned of tapering its massive $80 billion monthly asset purchases. The Dow fell 4.9 percent in May and June, then 5.6 percent in August. The declines were dubbed "Taper Tantrum 1" and "Taper Tantrum 2."
“Markets have always been sensitive. They reflect animal spirits,” said Greenspan.
“One area I was always doubtful about during my tenure is how much we could effectively communicate to markets, because they were always second guessing the Fed.”
The dot-com bubble popped in 2000, sending stocks tumbling, but Greenspan said the Oct. 17, 1987 meltdown, when stocks lost 23 percent in a day “was the scariest experience I had during my 18 years at the Fed.”
When Yellen spoke out this month, warning of “stretched valuations” in social media and biotech stocks, some observers compared it to Greenspan’s similar 1996 warning of “irrational exuberance” about stocks in the dot-com era.
Perhaps those kinds of remarks coming from a Fed chair could be construed as bullish, in an unintentional way.
The New York Times noted recently an investor who ignored Greenspan’s advice and bought into the Standard & Poor’s 500-stock index the morning after his speech has earned a 268 percent return since then, including reinvested dividends.
Related Stories:
- Greenspan: Fed Didn't Cause the Financial Crisis
- Fortune: Greenspan Can't Be Faulted for Keeping Rates Too Low
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