| Inside the Fed: Monetary Policy and its Management, Martin through Greenspan to Bernanke |
| Stephen H Axilrod, MIT Press, 2009, 198 pages, £16.95. |
| "… [A]s a further complication, I suspect that future Fed chairmen will also need to take more direct account of international markets in making judgements about policy and its management." Well smoked out, Mr Axilrod! He provides us with an amiable, intelligent, and politically sophisticated history of the Fed from the early 1950s, when he joined it as an economist, to 1986, when he left (about the same time as Volcker retired as chairman). He then worked for several years as senior American in the US branch of Nikko Securities, and subsequently as a consultant. Unsurprisingly, Volcker is his favourite chairman, followed by Martin, then Greenspan, with Burns last (ignoring the transitory Miller and still-incumbent Bernanke). |
| This book runs up to mid-2008. The first part a reader today might turn to is the chapter on Greenspan, Bernanke, the germination of the crisis, and what the Fed was doing internally in the 2005-7 run-up to and subsequent bursting of the bubble. The conclusion is depressing: this author, who held high positions in the economics department of the Fed for so many years, and knew the key players well, does not understand what happened and why. |
| Mr Axilrod's analysis of the Greenspan years rightly focuses on the latter's drift into self-contradiction: excessive ease at the first whiff of financial or economic trouble, despite repeated claims that free markets are self-correcting. He is rightly hard on Greenspan. But the weakness of his viewpoint emerges in discussion of the Fed funds rate increase to 5¼% early in Bernanke's term (in June 2006). Axilrod says "… from the perspective of the economy and inflation …perhaps it was [a neutral rate, but] from the perspective of profound instabilities latent in the credit markets at the time, … it was way too high." |
| What this ignores is that pre-2007 US economic growth depended on unsustainable domestic debt growth: from 240% of GDP in 1997 to 340% in 2007. While half of this increase was financial sector debt - as the financial markets revolution went from maturity to grotesque excess - underlying this was a dangerous rise in non-financial business debt and, most importantly, a huge overshoot of household debt based on booming global liquidity that provoked wildly overvalued US house prices. As collapsing affordability reversed house-price gains from spring 2006 onwards, the growth of debt had to be stopped. At this level, the credit crunch was the start of the solution, not part of the problem. |
| Mr Axilrod refers only once to "a vast flow of funds into the United States from abroad to supplement our relatively low domestic saving." He does not mention Bernanke's analysis of this Eurasian 'savings glut' in March 2005 (six months after the same argument was published by this reviewer). The savings glut effectively 'crowded out' US domestic saving, via consistently low interest rates (also encouraged by low inflation helped by Asian-sourced cheap goods), the 'vast flow of funds' and the resulting booming liquidity and asset prices. (Martin Wolf of the Financial Times has made a similar point - his Fixing Global Finance was reviewed in this Journal in July 2009.) Under the savings-glut logic, Greenspan was right to adopt an easy policy in 2002-04, and from then on the US was on the horns of an ineluctable dilemma: either crush the growth and provoke unemployment despite only moderate inflation, or let growth continue and ensure a household-debt crisis, as the two streams - excessive mortgages and lunatic (mortgage-related) derivatives - came together. Not surprisingly, Greenspan and then Bernanke chose the latter. We now know the result. |
| China and Germany, the chief savings 'gluttons', hold the key to world recovery. Will they deliberately stimulate domestic consumption? Germany says firmly: No. China is boosting domestic demand, but nearly all in the form of fixed investment that, in a world of severely underutilised capacity, promises future deflation. Its savings rate remains over 50% of GDP. Both are as complacent as Mr Axilrod about the fundamental imbalances. The current recovery based on yet more (now deficit-country government) borrowing will not last long. The crisis has been deferred, not resolved. Unwittingly, this book illustrates why. |
Charles Dumas
Chairman, Lombard Street Research Ltd |
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