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The Ron Paul/Alan Greenspan
Congressional Exchanges

Transcripts of the historic hearings before the U.S. House of Representatives' Committee on Financial Services during question & answer sessions, 1997-2005


2000

2/17/2000

Dr. PAUL. Thank you, Mr. Chairman.

Good morning, Mr. Greenspan. I understand that you did not take my friendly advice last fall. I thought maybe you should look for other employment, but I see you have kept your job.

I am pleased to see you back, because at least you remember the days of sound money, and you have some respect for it. Even though you do describe it as nostalgia, you do remember the days of sound money. So I am pleased to have you here.

Of course, my concern for your welfare is that you might have to withstand some pummeling this coming year or two when the correction comes, because of all the inflation that we have undergone here in the last several years.

But I, too, like another Member of this committee, believe there is some unfairness in the system, that some benefit and others suffer. Of course, his solutions would be a lot different than mine, but I think a characteristic of paper money, of fiat money, is that some benefit and others lose.

A good example of this is how Wall Street benefits. Certainly Wall Street is doing very well. Just the other day, I had one of my shrimpers in my district call me and say he is tying up his boat. His oil prices have more than doubled and he cannot afford it, so for now he will have to close down shop. So he suffers more than the person on Wall Street. So it is an unfair system.

This unfairness is not unusual. This characteristic is well-known, that when you destroy and debase a currency, some people will suffer more than others. We have concentrated here a lot today on prices. You talk a lot about the price of labor. Yet, that is not the inflation, according to sound money economics.

The concern the sound money economist has is for the supply of money. If you increase the supply of money, you have inflation. Just because you are able to maintain a price level of a certain level, because of technology or for some other reason, this should not be reassurance, because we still can have our mal-investment, our excessive debt and borrowing. It might contribute even to the margin debt and these various things.

So I think we should concentrate, especially since we are dealing with monetary policy, more on monetary policy and what we are doing with the money.

It was suggested here that maybe you are running a policy that is too tight. Well, I would have to take exception to that, because it has been far from tight. I think that we have had tremendous growth in money. The last three months of last year might be historic highs for the increase of Federal Reserve credit. In the last three months, the Federal Reserve credit was increasing at a rate of 74 percent at an annual rate.

It is true, a lot of that has been withdrawn already, but this credit that was created at that time also influenced M3, and M3 during that period of time grew significantly, not quite as fast as the credit itself, but M3 was rising at a 17 percent annual rate.

Now, since that time, a lot of the credit has been withdrawn, but I have not seen any significant decrease in M3. I wanted to refer to this chart that the Federal Reserve prepared on M3 for the past three years. It sets the targets. For three years, you have never been once in the target range.

If I set my targets and performed like that as a physician, my patient would die. This would be big trouble in medicine, but here it does not seem to bother anybody. And if you extrapolate and look at the targets set in 1997 and carry that set of targets all the way out, you only missed M3 by $690 billion, just a small amount of extra money that came into circulation. But I think it is harmful. I know Wall Street likes it and the economy likes it when the bubble is getting bigger, but my concern is what is going to happen when this bubble bursts? I think it will, unless you can reassure me.

But the one specific question I have is will M3 shrink? Is that a goal of yours, to shrink M3, or is it only to withdraw some of that credit that you injected through the noncrisis of Y2K?

Mr. GREENSPAN. Let me suggest to you that the monetary aggregates as we measure them are getting increasingly complex and difficult to integrate into a set of forecasts.

The problem we have is not that money is unimportant, but how we define it. By definition, all prices are indeed the ratio of exchange of a good for money. And what we seek is what that is. Our problem is, we used M1 at one point as the proxy for money, and it turned out to be very difficult as an indicator of any financial state. We then went to M2 and had a similar problem. We have never done it with M3 per se, because it largely reflects the extent of the expansion of the banking industry, and when, in effect, banks expand, in and of itself it doesn't tell you terribly much about what the real money is.

So our problem is not that we do not believe in sound money; we do. We very much believe that if you have a debased currency that you will have a debased economy. The difficulty is in defining what part of our liquidity structure is truly money. We have had trouble ferreting out proxies for that for a number of years. And the standard we employ is whether it gives us a good forward indicator of the direction of finance and the economy. Regrettably none of those that we have been able to develop, including MZM, have done that. That does not mean that we think that money is irrelevant; it means that we think that our measures of money have been inadequate and as a consequence of that we, as I have mentioned previously, have downgraded the use of the monetary aggregates for monetary policy purposes until we are able to find a more stable proxy for what we believe is the underlying money in the economy.

Dr. PAUL. So it is hard to manage something you can't define.

Mr. GREENSPAN. It is not possible to manage something you cannot define.

7/25/2000

Dr. PAUL. Thank you, Mr. Chairman.

Mr. Greenspan, I have a couple of questions today. One is a general question. I want to get a comment from you dealing with the Austrian free market explanation of the business cycle. I will lead into that, as well as a question about the productivity statistics that are being challenged in a few places.

But first off, I would like to lead off with a quote that I think is important that we should not forget about our past history. ''Every new era in our history''-and we have had several-''has been based upon the exaggerated enthusiasm and the inflationary forces set in motion by some single new industry or industrial activity.'' This was written by Businessweek in 1930, a couple of days after the crash.

Also, I would like to remind my colleagues about surpluses, and I know we look forward to all the surpluses. First, that portion of the national debt we pay the interest on is still going up. So there is a question about if we have true surpluses. But even if we did, I would like to remind my colleagues that we were, as a country and as money managers, reassured in the 1920's that our surpluses in the 1920's would serve us well, and it did not predict what was happening in the 1930's.

Basically, the way I understand the Austrian free market explanation of a business cycle is once we embark on inflation, the creation of new money, we distort interest rates and we cause people to do dumb things. They overinvest, there is malinvestment, there is overcapacity and there has to be a correction, and the many good members or well-known members of the Austrian school, I am sure you are well aware of them, Mises, Hayek and Rothbord, as well as Henry Hazlitt, have written about this, and really did a pretty good job on predicting. It was the reason I was attracted to their writing, because certainly, Mises understood clearly that the Soviet system wouldn't work.

In the 1920's, the Austrian economic policy explained what would probably come in the 1930's. None of the Austrian economists were surprised about the bursting of the bubble in Japan in 1989, and Japan, by the way, had surpluses. And of course, the best prediction of the Austrian economists was the breakdown of the Brettan Woods agreement, and that certainly told us something about what to expect in the 1970's.

But the concerns from that school of thought would be that we still are inflating. Between 1995 and 1999, our M 3 money supply went up 41 percent. It increased during that period of time twice as fast as the GDP, contributing to this condition that we have. We have had benefits as a reserve currency of the world, which allows us to perpetuate the bubble, the financial bubble. Because of our huge current account deficit, we are now borrowing more than a billion dollars a day to finance, you know, our prosperity, and most economists, whether they are from the Austrian school or not, would accept the notion that this is unsustainable and something would have to happen.

Even recently I saw a statistic that showed total bank credit out of the realm of day-to-day activity in control of the Fed is increasing at the rate of 22 percent. We are now the biggest debtor in the world. We have $1.5 trillion foreign debt, and that now is 20 percent of the GDP, and these statistics concern many of the economists as a foreboding of things to come.

And my question dealing with this is, where do the Austrian economists go wrong? And where do you criticize them and say that we can't accept anything that they say?

My second question deals with productivity. There are various groups that have said that our statistics are off. Estevao and Lach claim, and this was written up in the St. Louis Fed pamphlet, that the temps aren't considered and that distorts the views. Stephen Roach at Morgan Stanley said we don't take into consideration overtime. Robert Gordon of Northwestern University says that 99 percent of the productivity benefits were in the computer industry and had very little to do with the general economy, and therefore, we should not be anxious to reassure ourselves that the productive increases will protect us from future corrections that could be rather serious.

Mr. GREENSPAN. Well, I will be glad to give you a long academic discussion on the Austrian school and its implications with respect to modern views of how the economy works having actually attended a seminar of Ludwig Mises, when he was probably 90, and I was a very small fraction of that. So I was aware of a great deal of what those teachings were, and a lot of them still are right. There is no question that they have been absorbed into the general view of the academic profession in many different ways, and you can see a goodly part of the teachings of the Austrian school in many of the academic materials that come out in today's various journals, even though they are rarely, if ever, discussed in those terms.

We have an extraordinary economy with which we have to deal both in the United States and the rest of the world. What we find over the generations is that the underlying forces which engender economic change themselves are changing all the time, human nature being the sole apparent constant throughout the whole process. I think it is safe to say that economists generally continuously struggle to understand which particular structure is essentially defining what makes the economy likely to move in one direction or another in the period immediately ahead, and I will venture to say that that view continuously changes from one decade to the next. We had views about inflation in the 1960's, and in fact, the desirability of a little inflation, which we no longer hold any more, at least the vast majority no longer hold as being desirable.

The general elements which contribute to stability in a market economy change from period to period as we observe that certain hypotheses about how the system works do not square with reality. So all I can say is that the long tentacles, you might say, of the Austrian school have reached far into the future from when most of them practiced and have had a profound and, in my judgment, probably an irreversible effect on how most mainstream economists think in this country.

Dr. PAUL. You don't have time to answer the one on productivity, but in some ways, I am sort of hoping you would say don't worry about these Austrian economists, because if you worry too much about them, and these predictions they paint in the past came true, in some ways we should be concerned, and I would like you to reassure me that they are absolutely wrong.

Mr. GREENSPAN. Let me distinguish between analyses of the way economies work and forecasts people make as a consequence of those analyses. The remarkable thing about the behavior of economies is they rarely square with forecasts as much as one should hope they did. I know there is a big dispute on the issue of productivity data. I don't want to get into that. We would be here for the rest of the month. I think the evidence, in my judgment, is increasingly persuasive that there has been an indeed underlying structural change in productivity in this country.

(4)

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