Greenspan's Dark Cloud

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In an interview at the Council on Foreign Relations (Sept. 15), Greenspan called for higher taxes. This got headlines. But he said a lot more than this.

When a high-level national figure speaks on the record at the CFR, he usually says nothing radical. He is brought there to speak to the members, but he is also speaking to the media. There are rarely any big surprises at one of these meetings.

These meetings are important for this reason. The CFR sets boundaries on what constitutes the climate of Establishment opinion. Remember: when anyone says something for the record at a CFR meeting, he has been screened. He is part of the decision-making class. He minds his P’s and Q’s. He wants to be invited back.

I have long used the CFR as an indicator of what the Establishment sees as the possibilities of the Next Big Thing. The CFR’s magazine, Foreign Affairs, is deadly dull. It will have several what-if articles by academic wanna-be’s. Nobody pays any attention. They are mostly blah-blah-blah. Nothing is going to change because of any of these filler pieces. They rarely offer a specific program that the government must implement to solve the problem. And nothing gets implemented. Drift is the way of life for all bureaucracies most of the time.

The magazine may run a piece by a big-name figure. But, on the whole, it does not tell readers much that they had not heard elsewhere.

However, when someone famous shows up to give a speech for the record, I pay attention. He may say something significant. He may set forth bad news: the Next Big Problem.

Greenspan mentioned this one: the deficit. In a subtle, garbled way, he sounded ominously like the Mogambo Guru. “We’re all freaking doomed!”

No one argued with him.


Mort Zuckerman of the CFR and U.S. News asked the questions. Since he is in the top 150 of America’s richest people, I appreciated his first question: Why no recovery?

Greenspan began with an observation: the stimulus of 2008 and then 2009 did not have much effect. He said that the government’s money that went into the financial sector has not gone from there into fixed capital investment by businesses, meaning bricks and mortar. Businessmen want liquidity. They are afraid of making long-term illiquid investments.

Then he got to his main theme: the Federal deficit is too large. The economy needs to “heal.” Zuckerman then asked: What about residential real estate? Greenspan said that home construction today barely matches the normal demolition of old houses. The owners of empty houses are not selling these foreclosed homes. There is a “big overhang of unsold homes on the market.” There will be no solution to this sector of the market until this overhang goes away. It will take a year, he said.

Zuckerman did not buy this. A year is not long enough to clear this market, he suggested. He is the multibillionaire real estate mogul. I will trust his judgment over Greenspan’s.

Greenspan really had nothing to say to support his one-year prediction. He waffled. “If prices can hold,” he said, “we will gradually eliminate the shadow inventory.” But he was not sure if prices would hold. Zuckerman offered no optimism here.

Greenspan said that in 2005—6, 8 million homes were purchased with 20% down. That equity is gone. These owners don’t default quickly. But they will if prices fall further.

Zuckerman said there must come a moment of truth for lenders, when non-mortgage-paying owners must be evicted. Sooner or later, there will be movement here. Quite true. He also said that a house falls in value 5% to 10% as soon as the owner is evicted. So, lenders are not evicting. Also quite true.

Zuckerman’s point was this: nothing is moving. He kept saying that owners are living rent-free. This has gone on for years. But few get evicted. He offered no scenario about what will cause this to change. Neither did Greenspan.

He asked: What about jobs? There has been no response to the stimulus in the job market. What can we do?

Greenspan thinks the critical problem is productivity. It has been growing. Businesses are not hiring. There is not much new investment in fixed capital. Liquid assets are being accumulated in the corporate sector. The business community is risk-averse to fixed capital investment. There is little construction. This loss is the #1 cause of the loss of employment.

“We must lift this pall.” He meant the absence of fixed capital investment. Liquidity rises, but there is not enough rise to counteract lost investment.


Greenspan wants the Federal government to do less rather than more. This is a minority view, he said. This is another way of saying that Keynesianism is the dominant outlook among economists.

Large Federal deficits do crowd out capital investment, he said. He thinks the stimulus is losing a third to a half of the money that should be going into fixed capital investment.

Basically, this is Keynesianism lite. He thinks the stimulus should have done more. He has accepted the Keynesian prescription: more deficits, more fiat money. But it’s not working well this time.

The whole concept is wrong. The Federal deficit always shifts money from private markets to the government. It reduces productivity. It reduces wealth.

Zuckerman then said that the government is running out of tools. He is correct. Greenspan did not object.

The sense I got from this was that the Establishment is finally worrying that the Federal government has shot its wad. If this economy turns down, they don’t know what to do for an encore. Meanwhile, it is not only not turning up, it is sliding into slower growth.

What’s a Keynesian to do?


Greenspan wants Congress to “close the deficit.” He thinks the government must raise taxes. The deficit is too large. “We are fooling ourselves about how much time we have.” He wants the Bush tax cuts to expire on January 1. After that, we must cut back on spending.

“We”? He means Congress.

This man lives in a fantasy world. Congress will spend every dime of any extra money that is collected. This is obvious to taxpayers. It is not obvious to Greenspan.

A tax increase risks causing a recession in 2011. He knows this. A tax increase would then generate fewer revenues. He knows this. Still, we must take that risk, he said. He said it repeatedly.

Zuckerman asked: What of business confidence? Greenspan thinks Obama can restore confidence. One way is to give a green card to foreign graduates of American universities’ graduate programs.

Will anything change here? Of course not.

He had no other suggestion as to how Obama can restore confidence. Greenspan was tossing pixie dust in front of Zuckerman, who was not buying it. He was polite, but it was clear that he did not think Greenspan had much of a case for a restoration of business confidence. Greenspan made no case.

Zuckerman: Will there be more stimulus programs? Keynesians want more. Greenspan did not answer.

Greenspan said he would avoid all discussion of monetary policy.

Then Zuckerman turned over the questions to the floor.

A LIQUIDITY TRAP“What about money velocity?” asked one member. Greenspan replied: excess reserves are a trillion dollars. Low-risk commercial loans are paying 150 basis points (1.5 percentage points) higher than what the FED is paying.

This is a very high risk premium, Greenspan said. There is a “heavy weight of uncertainty on the system.” The bankers are not willing to lend. “There is a clogging up of the system.” This is international. The money goes into the financial system. It does not come out. It is a “liquidity trap.” He said Keynes described it well in 1936.

Once the lending system starts moving, the money will flow into the private markets, he said. But the financial system today is “disabled.”

What he of course did not mention is this: with $1.3 trillion in new reserves (October 2008), any reduction in the amount of money held as excess reserves will increase price inflation. The monetary base will be converted into M1. If all the banks’ excess reserves go into the economy, this will be wildly inflationary. No one in high places ever talks about this. Yet they have to know.

We are not in a depression, he said. He said the likelihood of a double-dip recession is low. Why? Because nothing is going down. There is no liquidation of inventories. Housing and autos are at the bottom. In short, “Been down so long, it looks like up to me.”

But if housing prices fall, “all bets are off.” He meant bets favoring the recovery.

Zuckerman said that another 5% to 10% drop in housing prices could transform the economy. Greenspan said he thinks this is a greater risk than a double-dip.


One woman asked: “What about gold?” Greenspan was harder core than I had thought he would be. “Gold is still the ultimate means of payment.” We do not understand why, he said. If multiple currencies fall in value, but move down together, what do we mean, “fall”? “Relative to what?” Gold. Human beings go to gold. We do not know why, but they do. It’s the canary in the coal mine.

He was implicitly admitting that gold’s rise in price is an indicator that something is wrong with the world’s currencies.

Then he said: “Our financial institutions are partially disabled.” Lenders do not feel secure. This is obvious, of course. But at least he said it.

The recent Basel Committee agreement allows 8 years to bring up capital ratios of banks. Greenspan thinks there will not be a rush by banks to raise money. There will be no credit crunch. This is a small sector of the economy. We must build it back up: sooner is better than later.

He said we will not get another crisis like 2008 in the next 8 years. There is no irrational exuberance.

Again, “Been down so long, it looks like up to me.”


Demographics expert and multibillionaire Pete Peterson asked: What about other nations beside Greece? (He is Greek.) The debt-to-GDP ratios are rising everywhere. What will be the effect of this? Will there be a global debt crisis?

Greenspan replied: “It’s a real serious problem.” It is risky to delay considering this. He compared today’s America with 1979. There was confidence in the summer that there would be no crisis. Then, in just two months, the optimistic psychology broke with respect to interest rate premiums. They rose by 400 basis points (4 percentage points). The same could happen again: the deficit. “We’re in trouble.”

Then he said: “Our choice is not between good and bad. It’s between terrible and worse.” This was picked up by the media. Here is the issue: the risk of a larger deficit. He does not see how we will get through next February’s budget program.

The U.S. economy cannot meet the requirements of real resources: physical resources.

What about Medicare? Capital will move to medicine. Real resources will shift. We know the outer limits of our production system. “We are running out of real resources.”

We are running out of this cushion: the Federal debt held by the public as a share of the capacity to borrow. The gap is closing . . . fast. It happened in World War II, but people knew it would end. “That’s not the case today.”

He really is worried about the American deficit. He does not think we can go on for many years by kicking the can. He thinks there will be trouble as soon as February. He did not say what.

I think of the recent speeches by Harvard’s Niall Ferguson. He has said much the same. The confidence in the financial system could disappear rapidly. Business as usual could turn into a frantic increase in interest rates. But it will not be solvable by traditional methods.

What I am hearing — from Ferguson, from Zuckerman, from Greenspan, from Peterson — is that nothing is working. The old Keynesian magic is not working. The economy is not recovering.

There are no reserves. Greenspan called it a cushion.

There was a question about the yen. He said that the demand for yen in Japan is still strong. This keeps rates low. The Japanese problem is demographics. Savings will fall. Then they will borrow internationally at high rates. But he said this was in the future. He did not see anything major happening with the yen. Neither do I.

Zuckerman went back to his first question. There is no momentum. What is our lesson?

Greenspan’s answer: big government did the right thing in 2008.

He said that central bankers (meaning Greenspan) knew for years that the crisis might lead to this kind of situation. (He never said this in public.) In 2008, there had to be a substitution of sovereign credit for private credit. He said that TARP worked. The government did the right thing. It was a once in a 100-year flood. “It worked.”


What I got out of this interview was this: the Establishment is losing confidence. The trends are against the long-term solvency of governments. The bills are coming due, and there are no visible solutions.

There was not a trace of optimism during this session: not from Zuckerman, Greenspan, or people asking questions. Yet these people are the heavy hitters. They are the Establishment.

The economy must heal, Greenspan said. He did not say how, other than having the government do less. But he said that the commitments have already been made. He did not say how they can be met.

These people are beginning to sound like hard-money e-letter writers.

September 18, 2010

Gary North [send him mail] is the author of Mises on Money. Visit He is also the author of a free 20-volume series, An Economic Commentary on the Bible.

Copyright © 2010 Gary North