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What Is Greenspan Up To?

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It is singularly odd (one might even say out of line) for a former Fed chairman to intrude on the turf of the current Fed chief. So why is Greenspan making predictions about the US economy, ones that seem to be at odds (at least in tone) with Bernanke’s?

You may recall that the week before last, Bernanke appeared before the House banking committee and gave such a reassuring performance that the Dow went to new highs. He said he wasn’t very worried about inflation, and if anything strengthened that message this week, indicating he was more interested in lowering unemployment (when it is already at what is considered to be a low level) than in preventing inflation.

In Hong Kong, by contrast, this week we have Greenspan signaling that this cycle may be coming to its close and we may have a recession before the year end. Now technically that may not contradict Bernanke’s posture (Bernanke has said he is biased towards stimulus), but Bernanke most certainly did not say that the economy might need more stimulus.

So what gives? We have one theory from Dean Baker, “Greenspan Warns of Recession Risk“:

Apparently, former Federal Reserve Board Chairman Alan Greenspan has gone to the other side of the world to issue his first warnings about a potential recession later this year. In a speech in Hong Kong, he warned that the recovery is getting old and that weakening profit margins could be the first sign of an imminent recession. He also assured his audience that the housing market posed no problem for the economy, with a soft landing producing no spillover effects.

Greenspan’s comments should warrant some serious media scrutiny. If there is a housing crash driven recession, as some people have predicted, then Greenspan’s fingerprints are all over it. He let the housing bubble expand to dangerous levels and ignored the rapid growth in questionable mortgage lending practices. On the other hand, if the business cycle expansion runs its natural course, then no one can blame the former Fed chairman.

As far as this latter view, the current recovery is less than five and a half years old, the 90s expansion lasted for ten full years. The 80s cycle lasted for seven and a half years. It seems a bit pre-mature to claim that the recovery is about to die from old age. The profit margin story can’t hold water either. The profit peak in the 90s was in 1997, the economy continued to sustain strong growth for 4 more years.

With mortgage default rates soaring, the sub-prime segment of the mortgage market tightening rapidly, and inventories of unsold homes at near record levels, it is easy to tell a recession story based on the collapse of the housing bubble. It is not clear that Mr. Greenspan can produce a credible alternative story, but his efforts in this direction deserve serious attention nonetheless.

I don’t disagree that this is plausible. Greenspan’s biggest flaw as a Fed chairman was his need to be liked, so delivering a message to shore up his reputation certainly fits his pattern. And I believe corporate profits are vulnerable (they’ve been running on cost cuts and overleveraged consumers, neither of which are sustainable). And even though the powers that be tout every scrap of positive news about the housing market, there is still tons of inventory overhang, and things could well get worse before they get better.

But let me offer another thought. It really is unprecedented for a former Fed chairman to speak out like this. Volcker never never did so. Which to me says this is in fact a sanctioned comment. Bernanke may well want to take a bit of the frothiness out of the markets (we’ve commented many times on complacency towards risk and signs of excessive speculation). When Greenspan himself spoke out against speculation, in his famous “irrational exuberance” comment, the Dow took a 145 point dive. Perhaps he and Bernanke are now trying a good cop, bad cop act to instill a little, but not too much, fear into the markets.

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