A hired gun

Alan Greenspan, former Chairman of the US Federal Reserve, and the man everybody blames for the current financial crisis – the “housing bubble” that was a “result” of his loose monetary policy in the first half of this decade, was a close friend of Ayn Rand. In 1966, he wrote an essay – “Gold and Economic Freedom”

A fully free banking system and fully consistent gold standard have not as yet been achieved. But prior to World War I, the banking system in the United States (and in most of the world) was based on gold and even though governments intervened occasionally, banking was more free than controlled. Periodically, as a result of overly rapid credit expansion, banks became loaned up to the limit of their gold reserves, interest rates rose sharply, new credit was cut off, and the economy went into a sharp, but short-lived recession. (Compared with the depressions of 1920 and 1932, the pre-World War I business declines were mild indeed.) It was limited gold reserves that stopped the unbalanced expansions of business activity, before they could develop into the post-World Was I type of disaster. The readjustment periods were short and the economies quickly reestablished a sound basis to resume expansion.

But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline-argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913. It consisted of twelve regional Federal Reserve banks nominally owned by private bankers, but in fact government sponsored, controlled, and supported. Credit extended by these banks is in practice (though not legally) backed by the taxing power of the federal government. Technically, we remained on the gold standard; individuals were still free to own gold, and gold continued to be used as bank reserves. But now, in addition to gold, credit extended by the Federal Reserve banks (“paper reserves”) could serve as legal tender to pay depositors.

When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage. More disastrous, however, was the Federal Reserve’s attempt to assist Great Britain who had been losing gold to us because the Bank of England refused to allow interest rates to rise when market forces dictated (it was politically unpalatable). The reasoning of the authorities involved was as follows: if the Federal Reserve pumped excessive paper reserves into American banks, interest rates in the United States would fall to a level comparable with those in Great Britain; this would act to stop Britain’s gold loss and avoid the political embarrassment of having to raise interest rates. The “Fed” succeeded; it stopped the gold loss, but it nearly destroyed the economies of the world, in the process. The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed.

In 1961, he spoke about “Antitrust”

“Competition” is an active, not a passive, noun. It applies to the entire sphere of economic activity, not merely to production, but also to trade; it implies the necessity of taking action to affect the conditions of the market in one’s own favor. The error of the nineteenth-century observers was that they restricted a wide abstraction — competition — to a narrow set of particulars, to the “passive” competition projected by their own interpretation of classical economics. As a result, they concluded that the alleged “failure” of this fictitious “passive competition” negated the entire theoretical structure of classical economics, including the demonstration of the fact that laissez-faire is the most efficient and productive of all possible economic systems. They concluded that a free market, by its nature, leads to its own destruction — and they came to the grotesque contradiction of attempting to preserve the freedom of the market by government controls, i.e., to preserve the benefits of laissez-faire by abrogating it.

The crucial question which they failed to ask is whether “active” competition does inevitably lead to the establishment of coercive monopolies, as they supposed — or whether a laissez-faire economy of “active” competition has a built-in regulator that protects and preserves it. That is the question which we must now examine.
[…]
The churning of a nation’s capital, in a fully free economy, would be continuously pushing capital into profitable areas — and this would effectively control the competitive price and production policies of business firms, making a coercive monopoly impossible to maintain. It is only in a so-called mixed economy that a coercive monopoly can flourish, protected from the discipline of the capital markets by franchises, subsidies, and special privileges from governmental regulators.

To sum up: The entire structure of antitrust statutes in this country is a jumble of economic irrationality and ignorance. It is the product: (a) of a gross misinterpretation of history, and (b) of rather naive, and certainly unrealistic, economic theories.

As a last resort, some people argue that at least the antitrust laws haven’t done any harm. They assert that even though the competitive process itself inhibits coercive monopolies, there is no harm in making doubly sure by declaring certain economic actions to be illegal.

But the very existence of those undefinable statutes and contradictory case law inhibits businessmen from undertaking what would otherwise be sound productive ventures. No one will ever know what new products, processes, machines, and cost-saving mergers failed to come into existence, killed by the Sherman Act before they were born. No one can ever compute the price that all of us have paid for that Act which, by inducing less effective use of capital, has kept our standard of living lower than would otherwise have been possible.

In 1963, he wrote about “The Assault on Integrity”-

Protection of the consumer against “dishonest and unscrupulous business practices” has become a cardinal ingredient of welfare statism. Left to their own devices, it is alleged, businessmen would attempt to sell unsafe food and drugs, fraudulent securities, and shoddy buildings. Thus, it is argued, the Pure Food and Drug Administration, the Securities and Exchange Commission and the numerous building regulatory agencies are indispensable if the consumer is to be protected from the “greed” of the businessman.

But it is precisely the “greed” of the businessman or, more appropriately, his profit-seeking, which is the unexcelled protector of the consumer.

What collectivists refuse to recognize is that it is in the self-interest of every businessman to have a reputation for honest dealings and a quality product. Since the market value of a going business is measured by its money-making potential, reputation or “good will” is as much an asset as its physical plant and equipment.
[…]
It requires years of consistently excellent performance to acquire a reputation and to establish it as a financial asset[…] Thus the incentive to scrupulous performance operates on all levels of a given field of production. It is a built-in safeguard of a free enterprise system and the only real protection of consumers against business dishonesty.
[…]
To paraphrase Gresham’s Law: bad “protection” drives out good. The attempt to protect the consumer by force undercuts the protection he gets from incentive. First, it undercuts the value of reputation by placing the reputable company on the same basis as the unknown, the newcomer, or the fly-by-nighter. It declares, in effect, that all are equally suspect and that years of evidence to the contrary do not free a man from that suspicion. Second it grants an automatic (though, in fact, unachievable) guarantee of safety to the products of any company that complies with its arbitrarily set minimum standards.
[…]
Government regulations do not eliminate potentially dishonest individuals, but merely make their activities harder to detect or easier to hush up. Furthermore, the possibility of individual dishonesty applies to government employees fully as much as to any other group of men. There is nothing to guarantee the superior judgment, knowledge, and integrity of an inspector or a bureaucract—and the deadly consequences of entrusting him with arbitrary power are obvious.
[…]
Capitalism is based on self-interest and self-esteem; it holds integrity and trustworthiness as cardinal virtues and makes them pay off in the marketplace, thus demanding that men survive by means of virtues, not of vices. It is this superlatively moral system that the welfare statists propose to improve upon by means of preventative law, snooping bureaucrats, and the chronic goad of fear.

(All three essays are available in the book – Capitalism: The Unknown Ideal)

Here was a man who was absolutely against regulation – at least he wrote and spoke about the issues involved like he was. And then he went ahead and joined the very Federal Reserve, the very Regulator that printed paper and called it money, and controlled competition among banks, and sanctioned fraud under the guise of “fractional reserve banking.” But he has an out. He is supposed to have told a colleague “to distinguish carefully between what he believes personally and how he acts as chairman of the Fed.”

To the present, according to Greenspan, in March of this year, he said – “Those of us who have looked to the self-interest of lending institutions to protect shareholder’s equity (myself especially) are in a state of shocked disbelief.” In a NYT article that “takes a hard new look at a Greenspan legacy”, he is quoted as saying-

“In a market system based on trust, reputation has a significant economic value. I am therefore distressed at how far we have let concerns for reputation slip in recent years.”

and

“Risks in financial markets, including derivatives markets, are being regulated by private parties.”

and

“There is nothing involved in federal regulation per se which makes it superior to market regulation.”

He is right most of the time, except for when he is in a state of “shocked disbelief.” He shouldn’t be in such a state because he should know that under the system he was working, institutions could palm off doubtful loans to Mae and Mac and earn “commissions” for their services, banks no longer needed to have any reputation or manage risk like they would have had to, if they were on their own – the Fed allowed them to “create credit”, they were “too big to fail” – government rules had replaced the need for reputation. Now all that the businessmen had to do was to make money without bothering to create trust in the market – the government had done the dirty work for them. As Andrew West writes in the aftermath of the Enron-Arthur Anderson fiasco-

I suggest that Alan Greenspan, forty years ago, identified the most fundamental cause of auditors’ current moral and professional grayness. Government regulation has diminished the value of establishing one’s reputation on the free market, and thus reduced the benefits of differentiation. Why compete to be the “best” governmental-form-filler-outer? When standards are seen as government-authorized, there is little reward but great risk in deviating from or going beyond those standards. Of what value are notes one makes on the margins of one’s IRS Form 1040?

Greenspan is responsible for the mess because he accepted the job of Fed Chairman, because he chose a job that necessarily meant an intervention in the market – distorting the market. Once he does that, he has no business being shocked at the different ways in which such intervention influences people’s behavior. However, placing the entire blame on him is unfair. Intervention in the market is bad – it is a statist idea. But Greenspan was simply a hired gun, one among many; it was the government that hired him.

“[Atlas Shrugged was written] to glorify the real kind of productive, free-enterprise businessman in a way he has never been glorified before. [But] I make mincemeat out of the kind of businessman…that runs to government for assistance, subsidies, legislation and regulation,” Greenspan’s close friend Rand is supposed to have said about her magnum opus. Sadly, those are the only ones that are left. A system of government intervention can never make people virtuous. But there are two things it can do better than no other system can – strip some of them of their virtues – break them, and make beggars out of the rest. Greenspan is an example of the former.

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Comments

  • Mike Aspen  On November 11, 2008 at 9:44 am

    Could not possibly have said it better myself. I’ve been re-reading “Capitalism: The Unknown Ideal” by Rand and wondered if some of his previous statements were on the web.

    I’m certain Alan Greenspan has had an interesting life. I suppose many people thought he could make Fed decisions that imitated the gold standard and we could make it work somehow.

    Alan Grenspan, still a good and gifted man, broke my heart.

    Mike Aspen
    Omaha, NE

  • Pramod Biligiri  On December 12, 2008 at 12:44 pm

    Well said. Perhaps he thought having a deep awareness of the free market can shield him from the harmful effects of government. He was badly mistaken.

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