[This column describes the unusual monetary problems caused by the long economic boom of the 1990s in the US. It appeared in Business Standard of 28 February 2000.]
Who is afraid of Alan Greenspan?
The oil crisis of 1973 ushered in a series of bad years in America, culminating in the second oil crisis of 1979. It was also a period of frequent droughts, which harmed US agriculture. As a result, revenues again fell short of expenditure. The deficits worsened in the 1980s with the coming of Ronald Reagan. Reagan was a firm believer in supply-side economics, and cut taxes to stimulate growth. The economy certainly recovered, but the fisc did not.
In the 1990s, however, the US entered a prolonged boom which is now 9 years long and still continuing. The boom has again accelerated revenue growth and brought down deficits. The last year was the first one in which the deficit disappeared. In his testimony to Congress in the middle of February, Lawrence Summers, Treasury Secretary, predicted that by 2013, the entire Treasury debt held by the public – currently $3.6 trillion – will have been repaid.
Last year the surplus was modest, of the order of $200 billion. But it has had unsettling effects already. Summers naturally wanted to eliminate the more expensive long-term debt first. So he did not issue any 30-year bonds at all, and tried to retire some. As a result, long-term bond rates slumped, and came down below short-term rates. The market felt that this could not last; but the market did not know how the rates would change. As a result, the offers were poor in the auction of Treasury bonds held at the beginning of February. Summers is a canny economist, and it will be fascinating to see how he uses the surplus to play with the market.
The surplus has also given new choices to the politicians. Basically there are three. The first is to raise expenditure. Clinton has proposed a rise in some of the social expenditures; and Democrats in general would like to see more spending on anti-poverty and environment-friendly programmes. The Republicans, on the other hand, are traditionally against taxation, and would like to cut taxes. And then there are economists, Summers included, who would like to use the surplus to reduce the public debt. As he said in his testimony, he would prefer to bring down the debt, and use the savings on interest arising out of the lower debt for other purposes like tax reduction and social services. Amongst Republicans themselves, George W Bush, the frontrunning Presidential candidate, would like to follow in Reagan’s footsteps and reduce taxes; McCain has, on the other hand, favoured reducing the debt, and thus taken a more responsible stance.
But there are some people whom debt reduction would terribly upset. Foremost amongst them are old people and the pension funds that cater to them. They need safe investments which would yield high and stable returns. Since the government can never go bankrupt – it can only send others into bankruptcy – its bonds are best suited for pensioners. Already the supply of long government bonds has begun to fall short of demand, and pension funds are suffering. The same problem has arisen in Britain, where too the government is running a surplus.
The other person whom the falling supply of government bonds should upset is Alan Greenspan. He would not say it; in fact, in his testimony to the House Committee on Monetary Policy in the middle of February, he said that debt reduction was the best use to which the surplus could be put. But if there is a shortage of government securities, interest rates would fall, whereas Greenspan may well be of the opinion that the economy is overheating and may want to raise interest rates. In fact, that is just what he believes, and he has been raising the Treasury Bill rate – the rate the government pays on newly issued Bills – over the last year the rate has gone up by 1 per cent. And Greenspan fully intends to keep raising it. He said in his testimony that share prices should rise no faster than income – whereas in the 1990s they have been in the habit of rising much faster. Within minutes after he began his testimony on 17 February, the Dow Jones fell a hundred points. It ended the day 47 points lower, and it is 4 per cent lower than it was in the middle of 1999.
The Nasdaq index, on the other hand, did not bat an eyelid. It shot up 2.7 per cent, and Nasdaq’s turnover exceeded 2 billion shares for the first time. The reason is that all the traditional stocks are listed on New York Stock Exchange, and the high-technology stocks on Nasdaq. High-tech companies are so profitable that they have hardly any debt. Some of them do not even pay any dividends. But because investors think that the companies are going to do ever better, they continue to buy the companies’ shares, and to fuel the boom.
Which is as it should be in a free enterprise economy, and Greenspan would be the last person to decry it. What upsets him, however, the effect these capital gains are having on Americans. The capital gains are not a part of their regular income; they could any day be turned into losses. But in the meanwhile, they are as real to the people as earnings, and they are saving less out of income because they count the capital gains as their savings. Americans’ personal savings have fallen to 4 per cent of their income; and that is simply too low for Greenspan. He wags his finger at Americans and tells them they cannot go on like this. He tells them that they have not hurtled into a crisis only because imports have augmented supply and prevented the economy from overheating. He keeps raising the Bill rate by a quarter percentage point whenever he gets a chance. But the exuberant economy is no longer listening to him.