Testimony of Chairman Alan Greenspan before the Joint Economic Committee, U.S. Congress, October 29, 1997
Greenspan: "it is quite conceivable that a few years hence we will look back at this episode, as we now look back at the 1987 crash, as a salutary event in terms of its implications for the macroeconomy."
On February 27, 1998, Greenspan remarked on management in the global financial system, before the Annual Financial Markets Conference of the Federal Reserve Bank of Atlanta, Miami Beach, Florida:
"Defaults and restructuring will not always be avoidable. Indeed "creative destruction," as Joseph Schumpeter put it, is often an important element of renewal in a dynamic market economy.
Greenspan testified on the crisis in emerging market economies, before the Committee on the Budget, U.S. Senate, September 23, 1998:
"As I indicated several weeks ago to a university (Berkeley) audience, it is just not credible that the United States, or for that matter Europe, can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress. With few signs that the financial crisis that started in Asia last year has subsided, or is about to do so, policymakers around the world have to be especially sensitive to the deepening signs of global distress, which can impact their own economies"
Greenspan went on in the same testimony to make an erroneous diagnosis:
"The situation in many emerging market economies is illustrative. Under stress, fixed exchange rate arrangements have failed from time to time. Consequently, domestic currency interest rates, reflecting devaluation probability premiums, are almost always higher in emerging market economies with fixed exchange rates than in the economy of the major currency to which the emerging economy has chosen to peg. That currency is often the dollar." Greespan went on: "This phenomenon, and its risky exploitation, is one important element in the current crisis and a symptom of what has gone wrong generally. What appeared to be a successful locking of currencies onto the dollar over a period of years in East Asia and elsewhere, led, perhaps inevitably, to large borrowings of cheaper dollars to lend at elevated domestic interest rates, with the intermediary pocketing the devaluation risk premium. When the amount of unhedged dollar borrowings finally became excessive, as was almost inevitable, the exchange rate broke. Incidentally, it also broke in Sweden in 1992 when large borrowings of DM to lend in krona at higher interest rates met the same fate. Such episodes are not uncommon, suggesting that investors, even sophisticated ones, are prone to this type of gambling."
Yet he continued to encourage Hong Kong and China to hang on to the fixed exchange rate. Even in hindsight, Greenspan totally missed the systemic nature of the causes and impact of the crisis.
Two weeks later, in Testimony of Chairman Alan Greenspan on Private-sector refinancing of the large hedge fund, Long-Term Capital Management, before the Committee on Banking and Financial Services, U.S. House of Representatives, October 1, 1998:
"It was the judgment of officials at the Federal Reserve Bank of New York, who were monitoring the situation on an ongoing basis (Henry's note: in reality FRBNY was alerted only two days earlier), that the act of unwinding LTCM's portfolio in a forced liquidation would not only have a significant distorting impact on market prices but also in the process could produce large losses, or worse, for a number of creditors and counterparties, and for other market participants who were not directly involved with LTCM. In that environment, it was the FRBNY's judgment that it was to the advantage of all parties--including the creditors and other market participants--to engender if at all possible an orderly resolution rather than let the firm go into disorderly fire-sale liquidation following a set of cascading cross defaults."
The doctrines of "creative destruction" and moral harzard were conveniently thrown out of Greenspan's ideological window. Still, Greenspan was forced to concede: "Of course, any time that there is public involvement that softens the blow of private-sector losses--even as obliquely as in this episode--the issue of moral hazard arises. Any action by the government that prevents some of the negative consequences to the private sector of the mistakes it makes raises the threshold of risks market participants will presumably subsequently choose to take. Over time, economic efficiency will be impaired as some uneconomic investments are
undertaken under the implicit assumption that possible losses may be borne by the government."
Greenspan concluded by turning Keynesian (in the long run, we are all dead):
" Conclusion:
For so long as there have been financial markets, participants have had on occasion to weigh the costs and, especially, the externalities associated with fire-sale liquidations of troubled entities against short-term assistance to tide the firms over for a time. It was such a balancing of near-term costs and longer-term benefits that presumably led J.P. Morgan to convene the leading bankers of his age--both commercial and investment--in his library in 1907 to address the severe panic of that year. Such episodes were recognized as among those rare occasions when otherwise highly effective markets seize up and temporary ad hoc responses were required. The convening of LTCM investors and lenders last week at the Federal Reserve Bank of New York could be viewed in that long tradition. It should similarly be viewed as a rare occasion, warranted because of the potential for serious disruptions to markets. We must also remain mindful where to draw the line at which public-sector involvement ends."
So, there had never really been free markets after all. And "the line at which public-sector involvement ends" is when only Asian, Russian and Brazilian assets are being "creatively destroyed" for the protection of American capital. Amazing for someone who poses as a firm believer of globalization. This weekend at the G-7 meeting in Bonn, Rubin/Greenspan continue to argue against capital control and exchange rate stabilization on a global basis.
It is real pied piper leadership.
Henry