From the WSJ Opinion Archives
THINKING THINGS OVER
The Moral-Hazard Bubble
This slowdown stems from Clinton's mismanagement of the international economy.
The current economic slowdown is not all that severe. The real sector is flat, not meeting the recession benchmark of two down quarters. In the financial sector, technology stocks have plunged, but the Dow Jones Industrial Average has not yet met the bear-market rule of thumb, closing down 20% from its peak.
We've survived real recessions and real bear markets before, yet somehow the current pause has been particularly frightening to a lot of people. For one thing, it came off years of uninterrupted progress and spectacular growth from mid-1999 to mid-2000, and it also hit rather by surprise. But the most important reason the downturn is scary, I suspect, is that its cause remains a mystery.
Lay aside the canard that the Bush campaign and administration "talked down" the economy. In fact, the Nasdaq started to tank in March of 2000; GDP growth fell to 2.2% in the third quarter from 5.6% in the second; earnings warnings spread in October; and by December the slowdown was evident in unemployment, consumer sentiment surveys and Fed warnings of "economic weakness."
Clearly, tech companies were overextended and OPEC managed to raise oil prices, but these have the feel of merely contributing factors. So in the absence of any other good explanation, eyes have turned to monetary policy. "Maestro" Alan Greenspan has even come in for some carping.
Some of my best friends argue he was too tight for too long. I find this view at best problematic. Yes, a strong dollar in forex markets and a falling price of gold are signs of monetary tightness. But the consumer price index is showing inflation around 3.5% a year, which seems to me high. (The gold price, while not an eternal verity, has sometimes been a good advance indicator of the CPI. This isn't working just now.) In any event, I am opposed to the Fed targeting the real economy as opposed to the price level; GDP growth does not depend on quarter-point changes in the Fed Funds rate a quarter later or a quarter earlier.
Arthur Laffer has argued in The Wall Street Journal, for example, that the Fed pumped out a lot of liquidity to avert a Y2K bank run, then suddenly withdrew it when the fear proved groundless. The first caused the 1999-2000 boom and the second the 2000-2001 slowdown. Time, he suggests, will cure everything.
Mr. Laffer bases the Y2K scenario on movements in the monetary base, a statistic embracing currency and bank deposits at the Fed. He makes a good case that the Fed mostly follows rather than leads market interest rates. Maybe, but I stopped following such statistics in 1981, partly at the urging of a brash young economist named Arthur B. Laffer.
So I decided to take a look at what was going on when the Fed changed its Fed Funds target, which at least is what it says it changes when it wants to affect things. The result is that a different roller-coaster explanation leaps out at you:
The Fed's big easing came in late 1998, in the context of a spreading world financial crisis. The Thai baht collapsed in July 1997, followed by crises all over Asia, followed by the Russian default in August 1998. In July, Mr. Greenspan had warned Congress that the Fed might need to move "promptly and forcefully" should inflation appear. With the Russian debacle starting to spread into the U.S. markets, the Fed governors came back from their annual Jackson Hole retreat to do the opposite, aggressively provide liquidity.
If we had a "bubble," this was its origin. This liquidity found its way into dot-com stocks and also provided the monetary accommodation necessary to OPEC price boosts. With price increases starting to spread, the Fed tightened, giving us the downturn we're currently experiencing. After a lag, we'll see the effects of the more recent easing.
Mr. Greenspan's easing in late 1998 was a classic lender-of-last-resort action, providing enough liquidity to prevent a cascade of failing financial institutions. In my view it averted a much more serious collapse than anything we're now experiencing. When you inject emergency liquidity, though, you're likely to pay for it in inflation that has to be wrung out later.
Mr. Greenspan, it seems to me, is relatively innocent. Yes, going back even further, he might have recognized that he was creating liquidity that went into Thai skyscrapers. And the Fed-sponsored bailout of Long-Term Capital Management added to moral hazard. But the emergency was created by mismanagement of the international economy, the responsibility of the International Monetary Fund and the U.S. Treasury. With a formula of devaluations, high taxes and investor bailouts, they built the climate of moral hazard that has come back to haunt the economy with yesterday's boom and today's slowdown.
We are paying a price, that is, for the mistakes of Bill Clinton, Robert Rubin and Lawrence Summers. Treasury Secretary Paul O'Neill, a professed admirer of their stewardship, please take note.
Mr. Bartley is editor of The Wall Street Journal. His column appears Mondays in the Journal and on OpinionJournal.com.
