2012-10-23 13:14:50
If Alan Greenspan could stand in front of a TV camera today and say, "The economy is going down in a huge flaming pile just like the Hindenburg," the chances are good the economy would tank within the hour. This power is the result of the position he held for 19 years under four different presidents. Greenspan served as the chairman of the Federal Reserve Board from 1987 to 2006, a position he ceded to Ben Bernanke in February of that year. In all honesty, the former chairman of the United States Federal Reserve Board is not the most intimidating man in the world. In fact, he studied the clarinet and saxophone at New York's Juilliard School before getting an economics degree and a Ph.D. that he conferred without a dissertation. He certainly does not inspire awe when compared to an economic giant like Bill Gates or a leader like Sir Winston Churchill, but when Greenspan speaks the world trembles. Here we will show the highs and lows of one of the most memorable Fed chairmen and discuss how his actions
affected everyone from Presidents to the common man.
The Position of Power
Essentially, the chairman of the Federal Reserve Board is a bullfighter and a bear-baiter all in one. The chairman keeps balance by altering the benchmark interest rate. When the economy is growing too fast, resulting in inflation and a possible bubble, the chairman uses the blade of interest rate hikes to slow down the rampaging beast so no one gets hurt. When the economy is in a slump, the chairman can lull it out of hibernation with some choice morsels of low interest loans. In the most basic terms, the chairman makes money easy to borrow in hard times and harder to borrow in easy times. (For more information, see our The Federal Reserve tutorial and Formulating Monetary Policy.)
Although the role of the Fed may seem very clear cut, the job of chairman of the Federal Reserve Board is surrounded by a murky gray fog. For example, when does an economic slump require lower interest rates to recover? At what point is action preferable to patience? Should the economy be intentionally slowed down?
To Be a Hawk or a Dove?
As an investor, you probably want lower interest rates in order to maximize corporate profit and, therefore, your own returns. If a person holds a significant position in the market and is financially competent, all but the most extreme inflation is palatable. The ideal situation for investors is one where business is allowed as much room for growth as possible.
However, the chairman of the Federal Reserve serves the economy as a whole, transcending both the interests of Wall Street and the policies of any particular political administration. The chairman must also consider the unemployed and working poor for whom inflation equals fewer meals per month.
And so it is that you have two types of chairmen: hawks and doves. Doves are more accepting of inflation in order to spur the economy, whereas hawks are primarily concerned with limiting inflation rather than encouraging growth. Alan Greenspan was a hawk.
Thus, Wall Street and Greenspan often found themselves at odds. More often than not, business papers have painted Greenspan as being rabidly opposed to inflation - suggesting that if inflation were a person, Greenspan would attack it like a tornado of teeth, fingernails and tie clips. Although this is an exaggeration, Greenspan was criticized for pursuing a vendetta against inflation when he might have used his power to attain full employment or economic growth instead. (For more insight, see All About Inflation.)
Blunders Over Better Judgment
Despite presiding over one of the most prosperous periods in American history, Greenspan will be remembered as making two large errors. One occurred in the 1990s when the Federal Reserve put the brakes on the economy in response to inflation fears. This resulted in a downturn in the previously prosperous economy. Greenspan eventually reversed his actions, conceding that the "new economy" was not as susceptible to inflation as he had first thought.
In admitting his mistake, Greenspan actually strengthened his image as "the saintly Alan Greenspan". He was fallible, human and humble enough to repent in front of the Senate. In fact, Greenspan broke away from his hawk stance in 2000, when the dotcoms went burned out, and again in 2001, after the World Trade Center was attacked. Despite this, he will probably be remembered as a strict disciplinarian..
The second error Greenspan made was much more devastating. After setting the standard for an apolitical Federal Reserve, he compromised himself outside of his official duties.
Greenspan was famed for his ambiguous manner of speaking, largely due to keeping the markets from overreacting to his comments. As his prominence grew, the damage that his speeches could do also increased. If finance was a religion, Greenspan was the pope. And lo, he made a prophecy and it was false.
Greenspan's biggest mistake was not an interest hike or cut, but a comment he made when President George W. Bush took office. In a rare moment of comprehensible speech, Greenspan suggested that not only was there enough economic shoulder room for tax cuts, but there was a danger of the national debt being paid down too fast. (It is important to note that Greenspan did not specifically endorse the $1.6 trillion number Bush was looking to implement.)
When making his statement, Greenspan also noted that while there was room to make tax cuts, they should be conditional to the resurfacing of deficits, in that the appearance of deficits should lead to a reduction in the cuts. Greenspan condemned the same cuts later on, but the damage was already done. He could not have known that the tax cuts would precede a period of simultaneous wars and general upheaval, but he was roundly criticized for justifying them.
The End of an Era
Greenspan took the reins before one of the worst economic crises in history, the crash of 1987, and by boldly slashing interest rates he kept the economy from sinking into a depression period like the one in which he was born. The years that followed that only cemented his reputation as a pragmatist who did what was necessary for America - not necessarily for any group of Americans. Still, many believe that the Clinton-Greenspan-Robert Rubin economy was a golden age of American economic dominance.
Greenspan will always be remembered as the Captain of the American economy when it was the biggest ship on the sea. He was not always right, but with a combination of patience and adaptability he was able to keep the ship on an even keel. There is a chance that the current chairman, Ben Bernanke, and the people after him will be remembered as daring sailors who kept the economy afloat in a sea filled with ships equal to and larger than the American fleet. Perhaps Alan Greenspan's legacy will someday pale in comparison to those that follow him. But will any of them be able to finish a day of grilling questions in front of the Senate, and then go to a club and play swing music on the saxophone without missing a beat?
For further reading, check out Understanding Supply-Side Economics, Macroeconomic Analysis and What's the difference between macroeconomics and microeconomics?
by Andrew Beattie
Andrew Beattie has spent most of his career writing, editing and managing Web content in all its many forms. He is especially interested in the future of search and the application of analytics to the business world. In addition to being a long-time contributor to Investopedia.com, Andrew has been working on http://www.ForexDictionary.com.