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DOW JONES     Chairman Alan Greenspan, A Fiat Mind for a Fiat Age (Christina)

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Christina     posted : 29/05/10   11:50 am

A speech delivered at the Ludwig von Mises Institute Conference: "Austrian Economics and the Financial Markets," held at the University Club in New York City, May 22, 2010. Comments in brackets and italics were cut from talk due to time constraints. The speech can be heard in the "Interviews" section of the website, and, on the Ludwig von Mises website along with those of other conference speakers.

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Part 1: Introduction

Alan Greenspan was the right Federal Reserve chairman for his times. His reputation was a creation of inflation and this was a century of inflation. His knowledge was superficial, when America tended towards superficiality. He was a creation of publicity in an age that craved celebrities. He was inarticulate, at a time when minds were growing more confused. He took short cuts to the top, when Americans more readily took the easy route.

Money has been degraded over the past century. It takes at least $20 to buy what cost $1 in 1913. Inflation of money was integrated into the twentieth century inflation of words, constant distractions and media promotion. Thus, the worship of celebrities simply because they are celebrities and the success of one pandering politician and clever opportunist: Alan Greenspan.

The short cuts taken in the 1950s set the course to the present. We bargained for wages and benefits that could not be paid in constant dollars. Americans worked fewer hours. We were buying more from abroad than we were selling. The government was spending more than its revenues by the 1960s.

In 1971, we stopped settling our balances in gold. Governments - and this was true around the world - found deficit financing an opium to the masses. Government programs abounded. The masses grew accustomed to inflation and borrowing in currencies that tended towards depreciation. Thus, debtors paid back less real money than they had borrowed. Bankers could lend more after the link to gold was severed since no final settlement of claims existed.

For this subterfuge of honesty and common sense, the United States employed celebrity economists who would make up new theories on the fly. This was dishonest. It follows that our dealings in dollars became dishonest. The corruption by the government, by economists who satisfied their interests, was matched by the corruption of those who trafficked in money. Since honesty was the enemy of our dealings, dishonesty held an advantage. In the end, credit and government policy have gravitated to fewer hands, those willing to participate in a swindle of the public's savings and of its trust.

At the center is an institution, the Federal Reserve System, which has been a willing accomplice. It employs dishonest economists. In 1987, it elected as its chairman a man of no merit but who could be counted upon to cut whatever corner was necessary to maintain the façade of national solvency. That imposter was Alan Greenspan.
Part 2: Alan Greenspan


When Alan Greenspan was 26 years old, he made a far-sighted and characteristic decision. He started smoking a pipe.

This was in 1950.

He had just entered Columbia University where he was studying for a doctorate in economics. He signed up for a class under Professor Arthur Burns. Burns was a well-known figure. He was co-author of a well regarded book: Measuring Business Cycles.

Whatever he learned in Burns's class, Greenspan did the important thing: he took up the pipe. This was Burn's trademark, as some will remember when Federal Reserve Chairman Arthur Burns sat before Senate committees and reinvented economics in the 1970s.

For instance, when inflation raged in the 1970s, it was Burns who removed food and energy from the Consumer Price Index.

In 1953, Burns left Columbia to head President Eisenhower's Council of Economic Advisers - the CEA. Greenspan left Columbia at the same time, without receiving his doctorate.

In 1977, he would receive his doctorate degree in economics, from NYU. It is a collection of articles and some economic journal pieces stapled together.

Alan Greenspan made a habit of choosing the easy route.

The media drones on about Greenspan's "ideology." Or, sometimes it's his "libertarianism." Or, it might be his "free-market beliefs." Whatever the case, these are simple labels, and simple labels are about all we will get from the media.

Alan Greenspan has cared about one - and only one - thing. Every nerve ending in his body at every moment in his life has been devoted to the promotion of Alan Greenspan.

Greenspan never had an ideology. He probably never understood what Ayn Rand was talking about. Nathaniel Branden, Rand's number one acolyte in the 1950s and also the Randian closest to Greenspan, wrote years later:

"Now, looking at [Alan], I wondered to what extent he was aware of Ayn's opinions."

Branden continued: Complimenting Ayn on some [paper she had written and read to the group], Greenspan might say, "On reading tends to feel...exhilarated."

Platitudes and assurances also mesmerized the nation 50 years later. By then, that's about all we could get from any public figure. Of course, as a nation we did not demand more.

Ayn Rand seems to have understood why Alan clung to her apron strings, if she wore an apron.

She asked Branden: "Do you think Alan might basically be a social climber?"

She hit the nail on the head.

Alan knew what he was doing. Around that time, a young writer asked Gore Vidal if he had any advice: Vidal replied: "Yes, get on TV as often as possible."
Part 3: Slichter-Martin

At this time, there was a blazing debate in Washington about inflation. Some were for it and some were against it.

In the mid-1950s, academic economists were angling their presence into the media. One was Harvard University Professor Sumner Slichter. Fortune magazine named him the "father of inflation." That might not sound complimentary, but it was publicity.

Slichter told the Senate that the Fed would have to accept inflation to generate sufficient jobs. Slichter argued that costs for materials and labor were rising because "unions [were pushing up] wages and fringe benefits faster than the gains from productivity of labor. The result is a continuation of the slow rise in prices".

Slichter was correct, but ignored the traditional solution to either work harder or reduce benefits. America was not in the mood for either.

Slichter stands at the front of a long list of economists who decided they could abandon common sense in our road to ruin. In my book, I quoted Alfred Jay Nock:

"It is an economic axiom that goods and services can only be paid for with goods and services."

In the opposite corner to Slichter was William McChesney Martin Jr. Martin was chairman of the Federal Reserve board from 1951 to 1970.

After Slichter gave the senators the good news, Martin lashed back. [This was in early 1957:

"I refuse to raise the flag of defeatism in the battle of inflation. If you take [Schlicter's] view, then another bust will surely come."]

Refusing to raise the white flag, Martin gave one of the finest speeches ever delivered by a central banker. He might not have much competition. It was on August 13, 1957, that he spoke before the U.S. Senate Committee on Finance.

He told the assembled: "There is no validity whatever in the idea that any inflation, once accepted, can be confined to moderate proportions." Martin responded to "some segments of the community" - probably economists - who were arguing for "a gradual rise in prices...perhaps 2 per cent a year," Martin warned that such a prospect would work incalculable hardship." "Losses would be... inflicted upon millions of people..."

[These included: "pensioners...people who have their assets in savings accounts and long-term bonds...."]

Chairman Ben Bernanke has stated the economy should have a minimum inflation rate of 2% per year. There is not necessarily a contradiction here. Simple Ben doesn't seem to care if he inflicts hardship upon hundreds of millions, if he knows what he's doing at all.

Martin believed, fears of inflation would "cause people to spend more and more of their incomes and save less...."

Martin told the politicians that the composition of savings would change. It would "tend towards speculative commitments...and the pattern of investments and other spending - the decisions on what kinds of things to buy - will change in a way that threatens balanced growth."

Martin warned that "a spiral of mounting prices and wages seeks more and more financing" with a "considerable volume of the expenditure...financed at all times out of borrowed funds."

Martin was not an economist. This may be obvious. He had studied Latin at Yale.

"Finally" Martin said, "we should not overlook the way that inflation could damage our social and political structure....Those who would turn out to have savings in their old age would tend to be the slick and the clever rather than the hard-working and the thrifty. Fundamental faith in the fairness of our institutions and our Government would tend to deteriorate."

We know who won that battle.
Part 4: Greenspan's Rise

Speaking of the slick and the clever, by 1970, Alan Greenspan was a millionaire. By then, he owned an apartment at United Nations Plaza, a new and fashionable address where Walter Cronkite, Truman Capote and Johnny Carson also lived.

But what had he done - that is - as an economist to live among such company? It really isn't clear. He was a minor figure. Those who respected him said he was a whiz with numbers. A far larger group remembers, yes, he was full of numbers, but he was always wrong.

In the words of biographer Justin Martin: "[T]he general impression among people who knew Greenspan in those days was that he wasn't exactly marked for real greatness.... His old friends were destined to watch his career unfold - Nixon adviser, Ford adviser, [five]-term Fed chief-in stunned amazement."

Another to witness the curious elevation of Alan Greenspan was Marc Faber, who joined the Wall Street firm of White, Weld in 1970. Shortly after, [White Weld] hired Alan Greenspan, then as a consulting economist.

Part of Marc's job was to attend the monthly economic presentations by Greenspan and interpret his comments for the overseas offices.

Quoting Marc:

"Looking back....I... had no idea what Mr. Greenspan was talking about, but I may not have been the exception. When Mr. Greenspan first came on board at White, Weld as a consultant, 30 or 40 people from the firm's various departments would attend the meetings. Within a few months, however, attendance had dropped to just a handful.... By then I had also learned that the easiest way for me to communicate the (to me) incomprehensible remarks... was simply to summarize the previous day's news from the front page of the Wall Street Journal..."

Marc noted that one of the best investment decisions White, Weld ever made was to "get rid of Mr. Greenspan in late 1972 and hire instead the economist Gary Shilling."

Martin Mayer, who has written several books about Wall Street, first met Alan Greenspan in the 1960s. The millionaire economist was making a specialty of "statistical espionage" - that was Greenspan's description. Mayer later wrote: "the book on him in that capacity was that you could order the opinion you needed."

Greenspan's girlfriend Barbara Walters, wrote in her recent autobiography: "How Alan Greenspan, a man who believed in the philosophy of little government interference and few rules or regulations, could end up becoming chairman of the greatest regulatory agency in the country is beyond me."

This was the road to his success: he would do anything and he would say anything. He worked on his relations with the press much harder than he worked as an economist for his clients. He went one step further than other fast-track economic consultants - he even dated the press, then finally married it.

Even though he was a minor figure during the 1960s, he was getting his name in the New York Times, making market predictions. The funny thing is, he was almost always the voice of doom in those days. That was the 'sixties, so he was always wrong. In the seventies he was always wrong too, since he was always bullish.
Part 5: Back to the 1950s

William Martin's insight - that "a spiral of mounting prices and wages seeks more and more financing" and a "considerable volume of the expenditure...financed at all times out of borrowed funds." was a feature of the 1960s. That was the decade of the conglomerate.

Some who built mountains from molehills in the 1950s and 1960s were Meshulam Riklis, Carl Lindner and Saul Steinberg. They used paper instead of cash to buy out companies.

It ended in a baleful scrapheap of waste with such absurdities as Mary Carter Paint [relabeled Resorts International] attempting to swallow Pan American Airways. (It was unsuccessful.)

It is not a coincidence that American living standards probably plateued around 1970, since capital was so badly mishandled.
Part 6: The 1970s

By 1974, price inflation was in double digits: "incalculable hardship" was suffered by millions. [Capital was again mishandled, one reason being there were so many distractions from running a business. In 1973, Time magazine reported: American businessmen [could] accomplish much [by] "speculation." A U.S. executive "may enclose a check with his order rather than wait until the steel is delivered and the dollar's value may have fallen."]

On June 28, 1978, Federal Reserve Board Member Henry C. Wallich addressed the graduating class at Fordham University. "Inflation," he informed the graduates, "is a means by which the strong can more effectively exploit the weak. The strategically positioned and well-organized can gain at the expense of the unorganized and aged."

At this moment every graduating member of the Fordham class of '78 ran out of the stadium to the closest Goldman, Sachs recruiting booth. [Wallich spoke from first-hand experience. He was born in Germany in 1914, so had lived through the Weimer hyperinflation as a child.]

Wallich explained inflation "is technically an economic problem. I mean the breakdown of our standards of measuring economic values, as a consequence of inflation." The strong are smart enough to understand that inflation "introduces an element of deceit into our economic dealings." Contracts are no longer made to "be kept in terms of constant values" but, one party understands this better than the other.

Wallich went on to emphasize "the increasing uncertainty in providing privately for the future pushes people who are seeking security toward the government."
Part 7: The 1980s

Moving forward - to the 1980s, we had the savings and loan free-for-all. We also were adding mounds of debt that would have been inconceivable when Martin spoke in 1957.

In 1980, we - the United States, borrowed $1.40 for every $1 we added to GNP. By 1985, we were adding $4.00 for every $1 increment in GNP.

Savings and loans were perfectly designed for clever operators. S&L deposits were insured by the government and they had been deregulated. In the wrong hands, the S&Ls were sponges for questionable investments.

Meshulam Riklis, Carl Lindner, Saul Steinberg used their conglomerate platforms to swap paper.

Barrie Wigmore, then at Goldman, Sachs, wrote an excellent book, Securities Markets in the 1980s.

Wigmore wrote, of Riklis, Lindner and Steinberg: "it is tempting to conclude they... represented a cabal.... [They] cooperated and invested with each other extensively and were old hands in the market aspect of "Chinese paper" from the merger wave of the 1960s." .... Their "activities illustrate the combination of native cunning and access to leverage that made them effective."

Wigmore wrote, they [Riklis, Lindner and Steinberg] had a common involvement with Michael Milken's group at Drexel Burnham that probably helped to create enough liquidity for their junk bond securities..."

William Seidman, who headed the Resolution Trust Corporation, the body that cleaned up the savings and loan mess, wrote later that Michael Milken had "rigged the market by operating a sort of daisy chain among the S&Ls to trade the bonds back and forth across his famous X-shaped trading desk in Los Angeles. By manipulating the market, he maintained the façade that the bonds were trading at genuine market prices... When... [Milken] was brought down, and his trading operation with him, so were the S&Ls that depended on the value of his bonds to stay afloat."]

In 1984, Alan Greenspan was hired by the most notorious criminal in the savings and loan racket: Charles Keating. Keating laundered money through Lincoln Savings and Loan. He needed someone to write a letter to his regulator, [the Federal Home Loan Bank of San Francisco] that stated Lincoln Savings and Loan's investments were sound.

In 1985, Greenspan wrote to the Federal Home Bank that Lincoln's management "is seasoned and expert in selecting and making direct investments." By that time, Lincoln was not only loaded up with deals through Milken, it was swapping them at a profit with its holding company, American Continental Corporation. American Continental Corporation - and Charles Keating - had been spun out of Carl Lindner's American Financial Corporation. Keating was known as Lindner's hatchet man. [In 1978, Keating had offered no defense when the SEC charged him - in the words of Martin Mayer - with: "arranging fraudulent loans to himself... from a bank owned by his friend and employer Carl Lindner."]

Greenspan surely knew who he was dealing with. He had been on Wall Street in the 1960s. He trafficked in knowing who he should be schmoozing. In the 1980s, he must have known Lincoln was part of the Riklis, Steinberg, Lindner, Boesky, Milken crowd.

[Lindner had been in the news when he extorted greenmail from Combined Communications (1979), and Gannett (1981). "Greenmail" - was a neologism for the word "blackmail," - when a "corporate raider" acquired shares in a company and the company then bought the shares back at a premium to rid itself of the raider. Steinberg's most publicized success was also his most profitable - when he extorted $60 million from Walt Disney in 1984.

Lindner used Keating when greenmail efforts went awry and he wanted to dump shares. An example was Gulf Broadcast - Keating's first big investment, in 1984. Keating paid $132 million to Lindner's American Financial. This was 30% above that day's market price. The $132 million was also twice Lincoln's net worth - a violation of California regulations. All of this was before Greenspan's 1985 high praise for Lincoln Savings and Loan's "expert[ise] in selecting and making direct investments.".

I should note that Riklis and company had not introduced some fractured ethos of their own. Wall Street was financing greenmail and corporate raiders; investment bankers led raids on their own clients. This conduct was nurtured in the 1970s and bloomed in the 1980s. The rise in debt financing, and leverage, was one reason.]

This was just the man to inherit the Federal Reserve chairmanship in 1987. Four years before, in 1983, a poll of Wall Street executives found that 31% of them had a special confidence in Alan Greenspan, should he be named chairman. He was second in that poll, behind Paul Volcker.
Part 8: Proxmire

Greenspan's hearing for Federal Reserve chairman was in August, 1987. Senator William Proxmire, a Democrat from Wisconsin, was the chairman. He did not like Greenspan. He had voted against Greenspan's confirmation as chairman of the Council of Economic Advisers in 1974 because he thought Greenspan would pass information back to the companies with whom he had consulted.

I don't know why he thought that, but it is an odd suspicion of a candidate for a senior government post. [At least it was in 1974.] He may have known about Greenspan's reputation: "the book on him was that you could order the opinion you needed."

Proxmire opened the hearing by chastising Greenspan for his abysmal forecasting record.

More than Greenspan's habit of always being wrong - and by such a wide margin - Proxmire was probably more concerned by Greenspan's less-than-honest "full disclosure" statement he had submitted to the White House and the Senate.

He had not revealed services rendered to [Sears and] Lincoln Savings & Loan. Greenspan distinguished the two by slipping them in the side pocket of "advocacy projects."

Proxmire was a foe of bank deregulation. He feared big banks would squash smaller banks. He feared Alan Greenspan would to be only too happy to squash them.

The senator lectured the candidate for the Fed chairmanship:

"As chairman of the Federal Reserve you play the key role in approval or disapproval of these massive bank mergers.... I would feel much better about this appointment if there was somewhere in your record an indication of your awareness of the dangers to our economy of excessive financial concentration."

Well, there was no such indication, and oddly for Greenspan, he didn't try to spin some preposterous middle path.
Part 9: Greenspan's Chairmanship

After becoming Federal Reserve chairman, Alan Greenspan could not fulfill Senator Proxmire's fears fast enough. (Proxmire had retired.)

In 1989, the Federal Reserve permitted J.P. Morgan, of which Greenspan had been director before becoming Fed chairman, to underwrite Xerox debt. This was the first such debt issue from a commercial bank since 1933, the year of the Glass-Steagall Act.

In 1990, the Federal Reserve permitted J.P. Morgan to underwrite stock. Time magazine called this "the widest breach of Glass-Steagall yet."

Greenspan was as permissive when it came to money printing as he was on mega-banking. He had to be. Americans were impatient and Greenspan did not want to disappoint: He loved to be liked. He would not wait for a proper recovery after the recession of 1990. He reduced the fed funds rate from 9-3/4% in 1989 to 3% in 1992. Banks and hedge funds leveraged up and refloated the economy.

This was the first time a recovery in the U.S. was driven by finance rather than production. Money and credit was concentrated more and more in the hands of "the slick and the clever" who had nearly unlimited access to "more and more financing." By now, the middle class was getting trounced.

From that point forward, every time the economy coughed, Greenspan cut rates and pumped up a bubble. Loose money attracts characters who should never deal in money.

The economy had become badly unbalanced. Federal Reserve Governor Larry Lindsey warned the Federal Reserve Open Market Committee (FOMC) of the growing income disparity, in every FOMC meeting from 1993 to 1996. The other Fed governors did not understand what he was talking about. For example, Lindsey spoke and Janet Yellen worried that Americans were saving too much, which would reduce the GDP. Not only was the underclass getting crushed, it was borrowing in a desperate attempt to keep up.

In what might be called his farewell address, Lindsey spoke at the September 1996 FOMC meeting:

MR. LINDSEY. Our luck is about to run out in the financial markets because of what I would consider a gambler's curse: We have won this long, let us keep the money on the table.... But the long-term costs of a bubble to the economy and society are potentially great. They include a reduction in the long-term saving rate, a seemingly random redistribution of wealth, and the diversion of scarce financial [and] human capital into the acquisition of wealth.... I think it is far better that we [burst the stock-market bubble] while the bubble still resembles surface froth and before the bubble carries the economy to stratospheric heights. Whenever we do it, it is going to be painful however.... If the optimists are wrong, then indeed not only our luck but that of the markets and of the economy has run out. Thank you.

CHAIRMAN GREENSPAN. On that note, we all can go for coffee.

Greenspan sat there and drank coffee for the next 10 years. He blew up the stock market, then the mortgage and credit markets while the sorts of characters who were reaching the top on Wall Street were of a persuasion that you wouldn't allow to fill your gas tank.
Part 10: Standards Keep Eroding

In 2001, David Tice testified before the House Financial Services Committee: "The most reckless fund managers, the most reckless auditors, the most reckless investment bankers, the most reckless corporate officers made the most money. So you had greater and greater incentives to promote the most reckless guys." Meanwhile "the most reckless CEOs hired the most reckless [chief financial officers.]"

That was in 2001 - a generation of CEOs before those who were promoted and reached the top ran us off the cliff, as such types could be expected to do.

But, the worst racketeers in the country have gravitated to the Federal Reserve Board. To prevent the economy from collapsing they rigged more markets than the Politburo.

The 2004 transcripts from the Federal Reserve Open Market committee - the FOMC - were just released.

At the March, 2004 meeting, Federal Reserve Governor Donald Kohn stated the FOMC's mission: "Policy accommodation - and the expectation that it will persist - is distorting asset prices. Most of the distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices...."

In other words, Federal Reserve policy was to distort asset prices. Kohn also said this was deliberate and desirable. In other words, distorted asset prices were not an unfortunate consequence of such-and-such Fed policy. The Fed's goal was to distort asset prices.

Kohn went on: "It's hard to escape the suspicion that at least around the margin some prices and price relationships have gone beyond an economically justified response to easy policy. House prices fall into this category".

So note: the Fed was deliberately driving up the prices of houses.

I wrote about the 2004 transcripts last week on my blog. Having read all the transcripts from 1994, I can say this latest batch was of a different character. The Fed was now - in 2004 - holding long-term Treasury rates within a narrow band - for the benefit of the carry trade. The FOMC was now managing the size of the carry trade, and Greenspan was now asking whether hedge fund managers were properly delta hedging the extension of mortgage security duration due to changes in interest rates.

That was in 2004 - and we know how badly this central planning effort failed. Now in 2010, what in the world is the FOMC trying to manage to prevent an even larger blow up? [Those who own stocks: take note.

In retirement, Alan Greenspan claimed that he really didn't get it about subprime housing until late 2005.

He can be a particularly incurious fellow.

The center of the subprime universe was Irvine, California. Lincoln Savings and Loan was in Irvine, California. This was not a coincidence. Some of the same characters who had used their "combination of native cunning and access to leverage" in the 1980s were back.

In 2005, New Century ($35 billion), Option One ($29 billion) and Ameriquest ($19 billion) - all of Irvine - sold $83 billion of subprime loans in 2005. That is just subprime. In a single year.

All of America bought $161 billion worth of mortgages in 1992.]

And what is Fed policy today?

This policy was stated by Donald Kohn in the fall of 2009:

"Recently the improvement, in risk appetites and financial conditions, in part responding to actions by the Federal Reserve and other authorities, has been a critical factor in allowing the economy to begin to move higher after a very deep recession.... Low market interest rates should continue to induce savers to diversify into riskier assets, which would contribute to a further reversal in the flight to liquidity and safety that has characterized the past few years."

So, we have it:

One reason for the Fed's zero percent interest-rate policy, in the words of former Federal Reserve Board member Henry C. Wallich: "is [as] a means by which the strong can more effectively exploit the weak. The strategically positioned and well-organized can gain at the expense of the unorganized and aged."

The old can not live on zero percent, so the Fed has been able to chase them into riskier assets.
Part 11: Conclusion

In conclusion, Chairman Greenspan was a fiat chairman for a fiat age. His credentials were inflated to serve in a position of responsibility where he would justify that "special confidence" Wall Street executives had vouched for in 1983.

Americans were beguiled by this fixture on television, who gained more credibility simply because he was the central attraction on television. Americans were also taken in by corrupt economists, who were advertised as experts. They propelled a system that needed constant infusions of propaganda, convincing Americans they were getting richer even though they were getting poorer. By 2001, the "slick and the clever" had to be "the most reckless auditors [and] the most reckless investment bankers" since their dealings were divorced from any real, economic function. Thus "fundamental faith in the fairness of our institutions and our Government has deteriorated."

Hear Frederick Sheehan interviewed by Lisa Chase, "The Political Chick," on May 24, 2010, in "Interviews" on

See his blog at
I\'m happy to receive any constructive criticism about my trades. I\'m always ready to learn more.
mart.j     posted : 20/06/11   05:35 pm


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betandbetter Trader     posted : 04/11/11   07:43 am

Greenspan Was Worried that the U.S. Would Pay Off It’s Debt, Causing the Fed to “Lose Control of Monetary Policy” … So He Suggested Tax Cuts for the Wealthy to INCREASE the Debt

As I noted in 2009:

Paul Krugman [believes] that debt is a “phantom menace”. But this is not because Krugman is a liberal. Government economists in the Reagan, Bush and Obama administrations have all believed pretty much the same thing: deficits don’t matter.

Indeed, as Steve Keen documents in his must-read book, Debunking Economics: The Naked Emperor Dethroned, mainstream (i.e. neo-classical) economists don’t even take debt into consideration in their models of what makes for healthy economies.

As Keen noted in September:

The vast majority of economists were taken completely by surprise by this crisis—including not just … the ubiquitous “market economists” that pepper the evening news, but the big fish of academic, professional and regulatory economics as well.


Why did conventional economists not see this crisis coming, while I and a handful of non-orthodox economists did [?] Because we focus upon the role of private debt, while they, for three main reasons, ignore it:


They believed that the level of private debt—and therefore also its rate of change—had no major macroeconomic significance:


Finally, the most remarkable reason of all is that debt, money and the financial system itself play no role in conventional neoclassical economic models. Many non-economists expect economists to be experts on money, but the belief that money is merely a “veil over barter”—and that therefore the economy can be modeled without taking into account money and how it is created—is fundamental to neoclassical economics. Only economic dissidents from other schools of thought, like Post Keynesians and Austrians, take money seriously, and only a handful of them—including myself (Steve Keen, 2010;—formally model money creation in their macroeconomics.

Even the most “avant-garde” of neoclassical economists, like Paul Krugman, have only just begun to consider the role that debt might play in the economy:

Given both the prominence of debt in popular discussion of our current economic difficulties and the long tradition of invoking debt as a key factor in major economic contractions, one might have expected debt to be at the heart of most mainstream macroeconomic models—especially the analysis of monetary and fiscal policy. Perhaps somewhat surprisingly, however, it is quite common to abstract altogether from this feature of the economy. (Paul Krugman and Gauti B. Eggertsson, 2010, p. 2)

Even when he attempted to break from this mould, Krugman did so from the same point of view as Bernanke above—that the level of debt doesn’t matter, only its distribution, and that one can abstract completely from how money is created:

Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person’s liability is another person’s asset ….

So most economists think that debt – and our money system – don’t matter.

Debt is the Essence of Our Money System

But as the following two quotes show, debt is the very essence of our current money system:

That is what our money system is. If there were no debts in our money system, there wouldn’t be any money.
- Chairman of the Federal Reserve Mariner S. Eccles, September 30, 1941 hearing before the House Committee on Banking and Currency

If all the bank loans were paid, no one could have a bank deposit, and there would not be a dollar of coin or currency in circulation. This is a staggering thought. We are completely dependent on the commercial Banks. Someone has to borrow every dollar we have in circulation, cash or credit. If the Banks create ample synthetic money we are prosperous; if not, we starve. We are absolutely without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is. It is the most important subject intelligent persons can investigate and reflect upon. It is so important that our present civilization may collapse unless it becomes widely understood and the defects remedied very soon.
-Robert H. Hemphill, FORMER Credit Manager of the Federal Reserve Bank of Atlanta

(This must-see 47 minute video provides details).

Greenspan Worried that We’d Pay Off Debt … So He Suggested Cutting Taxes on the Wealthy, to Increase the Debt

Indeed, despite the harms that too much debt can cause, some in government have worried that paying off our debt would be harmful for our country.

As NPR reported last month:

[NPR] has obtained a secret government report outlining what once looked like a potential crisis: The possibility that the U.S. government might pay off its entire debt.

It sounds ridiculous today. But not so long ago, the prospect of a debt-free U.S. was seen as a real possibility with the potential to upset the global financial system.

We recently obtained the report through a Freedom of Information Act Request. You can read the whole thing here. (It’s a PDF.)


If the U.S. paid off its debt there would be no more U.S. Treasury bonds in the world.


The U.S. borrows money by selling bonds. So the end of debt would mean the end of Treasury bonds.

But the U.S. has been issuing bonds for so long, and the bonds are seen as so safe, that much of the world has come to depend on them. The U.S. Treasury bond is a pillar of the global economy.

Banks buy hundreds of billions of dollars’ worth, because they’re a safe place to park money.

Mortgage rates are tied to the interest rate on U.S. treasury bonds.

The Federal Reserve — our central bank — buys and sells Treasury bonds all the time, in an effort to keep the economy on track.

If Treasury bonds disappeared, would the world unravel? Would it adjust somehow?


What do you do with the money that comes out of people’s paychecks for Social Security? Now, a lot of that money gets invested in –- you guessed it — Treasury bonds. If there are no Treasury bonds, what do you invest it in? Stocks? Which stocks? Who picks?


The danger that we would pay off our debt by 2012 has clearly passed. There are plenty of Treasury bonds around these days. U.S. debt held by the public is now over $10 trillion.

And in talk last a week and a half ago before the United Nations, Nobel prize winning economist Joseph Stiglitz said that -10 years ago, when the U.S. had a surplus – Federal Reserve chairman Alan Greenspan was worried that if we didn’t do something, we would end up paying down all of our debt, and then the Fed “wouldn’t be able to conduct monetary policy”.

So Greenspan pushed for a tax break for the wealthy, to increase the debt.

Debt In the Real World

In the real world – and not even taking into account the debt downgrades to the U.S. – economists have shown that too much debt creates a drag on the economy which stifles growth.

Nouriel Roubini points out:

Ultimately, deleveraging requires the writing down of debt as reflationary policies are not a free lunch and won’t solve the debt overhang problem (Dr. Roubini). Important case study: Japan back into deflationary territory despite huge public debt and QE (Chinn).

Steve Keen says:

[We’ll have] a never-ending depression unless we repudiate the debt, which never should have been extended in the first place.

As I noted in July:

PhD economist Michael Hudson says (starting around 4:00 into video):

If the problem that is grinding the economy to a halt is too much debt, and if no one in the government – in either party – is looking at solving the debt problem, then … we’re going to go into a depression as far as the eye can see.

Yet the U.S. hasn’t reined in its profligate spending. While modern economic theory shows that debts do matter (and see this), the U.S. is spending on guns and butter.

As PhD economist Dean Baker points out, the IMF is cracking down on the once-proud America like a naughty third world developing country. (As I’ve repeatedly noted, the IMF performed a complete audit of the whole US financial system during Bush’s last term in office – something which they have only previously done to broke third world nations.)

Indeed, economics professor and former Senior Economist for the President’s Council of Economic Advisers Laurence Kotlikoff wrote yesterday:

Let’s get real. The U.S. is bankrupt.


Last month, the International Monetary Fund released its annual review of U.S. economic policy…. The IMF has effectively pronounced the U.S. bankrupt.


Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt.


This is what happens when you run a massive Ponzi scheme for six decades straight….


Bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.

On the other hand, as I also pointed out last month, the government isn’t even stimulating in an effective way:

“Deficit doves” – i.e. Keynesians like Paul Krugman – say that unless we spend much more on stimulus, we’ll slide into a depression. And yet the government isn’t spending money on the types of stimulus that will have the most bang for the buck: like giving money to the states, extending unemployment benefits or buying more food stamps – let alone rebuilding America’s manufacturing base. See this, this and this.

(Yes, Congress has just thrown twenty billion dollars at jobs and the states, but it is a tiny drop in the bucket compared to the many tens of trillions of dollars in handouts to the giant banks.)

Keynes implemented his policies in an era of much less debt than we have today. We’re now bankrupt, with debt levels so high that they are dragging down the economy.

Even if Keynesian stimulus could help in our climate of all-pervading debt, Washington has already shot America’s wad in propping up the big banks and other oligarchs.

More important still, Keynes implemented his New Deal stimulus at the same time that Glass-Steagall and many other measures were implemented to plug the holes in a corrupt financial system. The gaming of the financial system was decreased somewhat, the amount of funny business which the powers-that-be could engage in was reined in to some extent.

As such, the economy had a chance to recover (even with the massive stimulus of World War II, unless some basic level of trust had been restored in the economy, the economy would not have recovered).

Today, however, [politicians] haven’t fixed any of the major structural defects in the economy [update]. So even if Keynesianism were the answer, it cannot work without the implementation of structural reforms to the financial system.

Luck i m your father     posted : 17/11/12   11:19 am

Greenspan Warns Finanical Markets Will Crash if US Can't Solve Fiscal Cliff Problem

Former Federal Reserve Chairman Alan Greenspan told Bloomberg Television's Betty Liu on "In the Loop" this morning that "markets will crater if we run into any evidence that we can't solve this [fiscal cliff] problem."

Greenspan said, "If we get out of this with a moderate recession, I would say that the price is very cheap."

"We have to recognize that this is going to be extraordinarily difficult to solve. All of the simple low hanging fruits have been picked and the presumption that we are going to resolve the big issue on spending by making a few little twitches here and there I think is a little naive. If we get out of this with a moderate recession, I would say that the price is very cheap. The presumption that we will solve this problem without paying I think is grossly inappropriate."

"I think it is not only Simpson-Bowles. I think the markets are getting very shaky. And they are getting shaky because I think fiscal policy is out of control. And I think the markets will crater if we run into any evidence that we cannot solve this problem. And I think the notion that the issue of the impact on the economy is strictly the spending tax issue, is also the market. I think we underestimate the extent to which the market value of assets has a very important impact on real GDP."

"Not necessarily. I am just saying that we may get a deal, which will take us for next year or so. But the question isn't that. I think the question is essentially how are we going to stop what is a critical problem here, an extraordinarily rapid rise in what the department of commerce calls government social benefits to persons, which has been rising very rapidly bipartisanly in the sense that it has been rising even faster under Republican administrations than Democratic administrations. And they are all very closely involved in these new benefits, the only problem is that it is eating into the savings of the society and our long-term growth. And yes, we can continue for the next year or so without any really serious problems emerging. But I think it is a highly risky endeavor. The problem is, if we are going to come to grips with this thing, we are going to have to recognize that even if we have got to pay the cost of a significant rise in taxes to get a significant slowing and then decline in social benefits, that is a very cheap price in the sense that a large increase in taxes required to fund what is currently on the books is going to cause a recession. But I think that if we can get away with that is the only cost to this whole problem, I think that is a pretty good deal."

On tax policy:

"The problem basically is that we have tried for decades to somehow manage our budget in such a way that, yes we can run deficits of this or that size, and we use it sophisticatedly for fiscal policy. It turns out we cannot do that well. It gets out of hand and this is not an accident. There is no question that raising taxes will turn the economy downward. Ideally I would like to just cut spending. I do not think politically that is feasible because the problem, no matter how you look at it, is fundamentally this extraordinary rise in social benefits to persons. That is the core of the problem. But the issue is, if we can solve it the way I would want to solve it, if we go back to where we were earlier at a much lower level of those benefits because I think what is then going on in recent years, we have not been able to afford."
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