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Mr. Greenspan's Sleight of Hand

By Curtis Lang on Sep 21, 1993

Originally published in WORTH magazine

Depending on how money is defined, the nation's supply is either flat or running out of control.  The confusion may be intentional.

(First published in the September 1993 issue of Worth

Does money matter?  Well of course it does, as anybody who's ever been a nickel short at the
bus stop knows.  But we don't mean that kind of money.  We mean the kind the Federal Reserve Board worries about, the kind that's measured in billions and that includes the dollars in the consumer's wallet, the money deposited in checking accounts, and the balances in mutual funds. Economists believe that the supply of this kind of money is directly linked to the health of the economy.

Expand the supply of money too fast and inflation results, according to monetary theorists like
Milton Friedman.  Shrink it too much and the economy spirals into recession.

That seems simple enough.  Unfortunately, many economists, politicians, and money managers
believe the Fed has lost track of what money is.  The truth may be even worse: The Fed's uncertainty is a smokescreen, a way to avoid political flak that virtually guarantees economic upheaval in the future.

Here are the facts, or at least those that the Fed carefully doles out.  Every year the Fed sets
its goals for the growth of the money supply, measured by a touchstone indicator called M2, which includes cash, checking accounts, savings accounts, time deposits, and money-market mutual funds.  In 1992, the Fed wanted M2 to grow by 2.5 percent to 6.5 percent; it grew by only 1.9 percent.  For 1993, the central bankers lowered their target for M2 to 2 percent to 6 percent, and still they missed. During the first quarter of 1993, as the fragile Clinton recovery sputtered along, M2 posted its first quarterly decline since 1959, in sharp contrast to previous recoveries, during which the Fed's aggressive easing of monetary policy has typically resulted in M2 expansion of 6 percent to 14 percent.


Congress, which has to face voters who believe the country is still in a recession despite the
rosy scenarios pushed by pundits, hasn't been pleased, to say the least.  House Banking Committee Chairman Henry Gonzalez and others in Congress say that Greenspan's failure to meet his own monetary targets undermines public faith in the Fed's ability to manage the economy.

Nobel Prize-winning MIT economist Paul Samuelson told Congress late last year that
Greenspan's 24 rate cuts from 1989 to 1992 were too little, too late to offset the bursting of the '80s bubble economy--and unhappy Bushies, who remember Greenspan's glowing forecasts of a no-recession "soft landing" from the boom, might agree.  Samuelson says that Greenspan's lowered M2 targets for 1993 are an extension of Bush-era Fed policy that will result in continued stagnation unless someone provides a fiscal stimulus.  Clinton and Congress, struggling to cut the budget, know there isn't any such stimulus around.  They see the money supply as the only rabbit in town, with the Fed stubbornly refusing to pull it out of Greenspan's hat.

Greenspan's defense has amounted to a "did not"/"did too" argument couched in technocratic
jargon.  He told Congress that the feeble growth of M2 "does not pose a threat to the economic expansion," and added that M2 doesn't function well as a leading indicator of economic activity anymore.  Look instead at M1, he urged.  M1, a stricter definition of money that counts just cash, traveler's checks, and checking and NOW accounts, has been soaring for the last 13 months.  And besides, yield-hungry investors have moved their cash out of CDs and money-market funds and into bond and equity mutual funds, which aren't included in M2.  By Greenspan's new measures, the economy is actually--whaddaya know--expanding.

Inflation hawks within the Fed, like Vice Chairman David W. Mullins Jr., Wayne Angell,
Lawrence Lindsey, and members of the Shadow Open Market Committee, a group of hard-money monetarists led by Carnegie Mellon's Allan Meltzer, disagree.  The debate about M2 is beside the point, they say.  They argue that with M1 soaring--up 12.3 percent in the year ending June 28--and Fed reserves ballooning while the central bank lets banks borrow at low cost and then sells them treasury bonds, Greenspan's monetary policy is already far too loose.  Since the economy clearly hasn't picked up much speed, the hawks see stagflation resulting.

The view from Europe is even less sanguine.  Dr. Kurt Richebacher, an economist and
historian, says that the schizophrenic U.S. money-supply numbers reflect a two-tier economy, with Wall Street soaring and Main Street shrinking.  "The M1 surge, while inflating the financial markets, completely fails to impact the real economy," Richebacher says.  "Although the Fed talks tough, its action betrays continuing aggressive ease.  But instead of stimulating the economy, it stokes a financial mania.  Surging M1 is a sign of [a kind of] inflation that has nothing to do with the real economy. It's a most disastrous kind: financial inflation.  Big financial bubbles, sooner or later, must end in a bust. The experiences of 1929, 1937, and 1987 are undeniable evidence."

Even if Greenspan's monetary theories are total hogwash, as political tactics they are priceless.
Congress and the economic community are wrapped up in arguing such arcane mysteries as what defines M2, how to measure velocity, and the like.  The uproar has drowned out all significant public debate about the potential for impending stagflation, deflation, or inflation.

"I think the winners are the central bankers, who can gather...and congratulate each other on
what a wonderful job they're doing, and be tough and stern and all the other good words," legendary Republican economist Paul McCracken snarls.  "The losers are clearly those without a job and trying to get employed."