Oracles

Feeling a little bit like Claudia and Jamie from the Mixed up Files of Mrs. Basil E. Frankweiler, I headed to the audience hall of Ashurnasirpal II in the Sackler Gallery of the Metropolitan Museum last night. Allan Greenspan, our modern day oracle spoke. He gave what I imagine is his stump speech, a modest review of his achievements and an optimistic outlook for the US and world economy.

History

The economic implications of political events are often not understood until later. Greenspan stated that the fall of the Berlin Wall, which led to the abandonment of the concept of command economies was the most significant contributor to growth.

Current State of Economy
The current situation is good driven by positive demand, capital investment and exports. Homebuilding and inventories are keeping a lid on the economy.

There are two imbalances; the current account imbalance and the deficit. The current account balance is an economic number. Despite years of deficits, the last quarter was the first quarter where US paid out more interest than it received on foreign investments. The rates of return on foreign investments are higher than we are paying foreigners. So why do foreigners keep investing here? The stability and the protections provided by the constitution. The current account deficit has been occurring for years. Division of labor means that there is a constant growth in the deficit. Think of the deficit across other entity boundaries; cities, counties and states and it will become clear that the division of labor is an irresistible force. It only becomes noticeable when national boundaries are breached. The only risk is protectionism.

The Fed did a lot of research using much more information than available to private investors to try to forecast exchange rates. His conclusion was that "long term rates cannot be predicted better than a coin toss". The way that banks and financial institutions make money in fx is by taking the other side of the trade of the "garment business".

The other imbalance is the budget deficit. Excepting for Medicare this is a political problem. We can forecast the number of recipients of Medicare but not the outlay per recipient. It seems that the current promises cannot be fulfilled. The program will end up paying for only those in need.

On Bubbles
He was modest about the powers of his office. "It don't work" he says about attempts to address asset prices. There was much talk in the Fed about how to defuse bubbles. Bubbles can only be crushed, not slowly deflated. Maybe 1000 bps of fed funds increases might have worked to end the 90's bubble. Rather than attempt to end things this way, Greenspan felt it would be easier to deal with the stock market bubble's aftermath and address the downside. But even this might not be a lesson for future bubbles.

The housing bubble primarily impacts consumption thru the wealth effect. Even the amount of this on the upside and the downside is not clear. Mortgage equity withdrawals have been cut in half and consumption is still level. At any rate, most of the worst of the housing slump might be over. The stock market is a more potent force by its impact on capital, goods and people.

The commodity bubble in base metals is a passing one. As China develops it will follow the path of the US and move from a real to a conceptual economy. Use of steel and commodities per GDP will decline. The energy problem is more serious.