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Exclusive Interview with Alan Greenspan

Riding the Financial Behemoth

The renowned economist reflects on the paradoxes and perplexities of global finance, and Taiwan?s true position in the international scheme of things.

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Riding the Financial Behemoth

By Isabella Wu
From CommonWealth Magazine (vol. 381 )

For 18 years, the words of Alan Greenspan, chairman of the Federal Reserve, received more trust from the American people and more attention from the world than those of any US president.

Having served through four presidential administrations and weathered two major financial crises, facilitating the United States’ decade-long economic boom, Greenspan won accolades from the likes of Nobel-laureate economist Milton Friedman. The market value of whole industries often shifted dramatically when the Fed unveiled its currency policy. His pronouncements literally moved the economies of the world.

Since stepping down from the Fed, he has been considerably more forthcoming with personal reflections in his new role as author. Recently in New York City, Alan Greenspan granted his first exclusive interview to a member of the print media in Asia, CommonWealth Magazine. Following are the perspectives he shared from his singularly historic vantage point.


Q: How could the U.S. sub-prime woes spiral into a global financial crisis?

A: The sub-prime in the United States became a problem in part because of the very significant decline of interest rates around the world for reasons that I have discussed at length in the book. That created a fairly dramatic increase in world liquidity. If you look at the market value of financial assets, or more specifically of the stocks and bonds of non-financial corporations, their value relative to global nominal GDP, it’s been rising very significantly in recent years.

And that is the primary source for international liquidity, because it’s those instruments, which all the financial institutions buy and intermediate, that create huge amounts of liquidity in the world. That excess liquidity has been increasingly looking for above-average rates of return. And it turns out that America’s sub-prime mortgage securitizers have had significantly higher rates of return and attracted very considerable investment around the world…That huge amount of liquidity looking for investments has increasingly been very strongly attracted to sub-prime securitized issues in the United States. That has created a very large demand for sub-prime mortgages, the fuel for these securitized types of instruments.

That has meant that the individual lenders, which are largely mortgage bankers and banks, who do not hold the mortgages but sell them to the securitizers, are demanding ever more in the way of mortgages, because they are getting the demand from the hedge funds and anybody else. So originations of sub-prime mortgages have risen very dramatically, largely because lenders trying to get as much a bargain as they can have basically created easy terms.

The consequence has been a dramatic rise in foreclosures and problems associated with them. And those lowered values have fed into a very surprising increase in the amount of securitized sub-primes held outside the United States and this is indeed were the initial cause of the whole problem has been. Consequently, were it not for the demand for the sub-prime mortgages to securitizers, the actual level of mortgages in the United States in the sub-prime would have been much less. They would never have gotten outside the United States, because there are no holders of sub-prime mortgages outside the United States, only in securitized form.

So it’s fundamentally a fascinating relationship of parsing the expansion of global finance and falling interest rates and a whole sequence of events which has led to an increased demand for mortgages, which would not have existed were it not for global forces.

But the unexpectedly rapid decline in the value of these mortgages has had extraordinary implications. In fact, the first real significant issue was the BNP Paribas in Paris, which had losses nobody anticipated. How could they have losses on sub-prime? That led to a sequence of a whole series of problems, which was triggered by sub-primes, but the financial markets were prone to an accident that was going to happen at some point.

It was going to happen, because the risks involved around the world were never fully priced – that is, yield spreads between, for example, developing world senior debt and U.S. Treasuries came down to a point far less than anytime ever. Human nature does not take that type of risk and eventually something would yield. If not sub-prime, it would have been something else. It was an accident ready to happen. But it was sub-prime, and that has spilled over into asset-backed commercial paper, which is a billion-dollar market, creating very serious problems. It stopped leverage buyouts. It forced 300 billion dollars onto the investment banks’ and commercial banks’ balance sheets. In short, the actual lawsuits that are involved here are far more than anything directly attributable to sub-prime, but it’s the sub-prime which triggered this reevaluation of the risks that were not adequately priced. So we are now seeing vast expansions of problems, essentially around the world. It’s not quite in Asia, but it’s obviously in Europe.

Q: How can this crisis be solved?

A: The markets will eventually price these corrections. This crisis is essentially a credit consumer crisis, meaning people are very untrusting of the credit standing of their counter partners, so banks are not lending, investors are not investing, and everything is coming to a halt in the financial markets, not fully, but to a very considerable extent. That will change only when, for technical reasons, the evaluation of all these exotic structured parts becomes clear. Once the big asset spreads on collateral debt obligations, for example, narrow so that everybody knows what it is, the fear comes down. This is a fear-driven phenomenon, but it will not come down, until it becomes fully clear what the international problems are.

I don’t know how long it’s going to take, but I know it will eventually get resolved. There is actually very little in terms of regulation to help this.

Indeed there is even an argument among central bankers that there is not a whole lot that central bankers can do, if this is indeed a credit concern problem, because if you have, say, 100 US dollars and somebody wants to borrow 10 dollars from you, but you think that they will never pay you back, if I give you another 100 dollars, you still won’t lend to that person. So increasing bank liquidity of itself may not actually do very much. But we don’t know and nobody knows. It’s going to take a number of weeks to solve this issue fully.

A more important question is where is the impact on the physical volume of production. And there we have the question of the market value of homes in the United States and the impact it will have on consumer expenditures. As you know, our consumer expenditures support a good deal of foreign trade, especially from East Asia. So if we run into problems, because housing prices are falling and that induces American consumers to restrict buying goods from China, we reimport about a fourth of Chinese exports, it’s a little less than that, but it’s a very big number.

Q: What would you do to address the problem?

A: If there is one single thing I would like to see happen, I don’t know how to do it, but I’d like to push the fear down, I don’t care what other statistics I have, but that’s all I need to know. Fear is something which human beings can’t get around. We can have a hundred threats to our lives, which induce fear and none of them materialize, you’d think we would learn something, that maybe we shouldn’t be fearful. But the 100th and first time, we are just as fearful. It’s not something we can learn – it’s built into our nature. The only thing that dissipates fear is declining uncertainty or more knowledge, so one understands fully where the risks are. It’s uncertainty which is the major problem – financial fear.

Q: Will inflation be the key issue in the years to come?

A: As I said in my book, the answer is, yes, I believe so – unless our political systems allow our central banks to constrain the inflation rate, and that can only be done by raising interest rates far more than they have recently. Politicians don’t like rising interest rates. So the reason for the inflation coming back is, as I am arguing, the huge changes that occurred since the end of the Cold War have fairly dramatically impacted on the world’s general price levels by suppressing them.

And as you look across the spectrum of developing countries and developed countries, they are all pretty well, but that is going to change, largely because the adjustment process that began at the end of the Cold War is coming to an end. The only way to avoid prices from rising is to have central banks become very stringent, but that requires the support of the political system. And in the United States I am a bit concerned about that.

Q: Who will suffer most from global inflation?

A: The people who will suffer are those with lower incomes, because they don’t have the wealth to meet the increased cost of foods, fuel prices... Food prices are a critical issue... Mostly, developing countries will suffer. Developing countries are called developing because they don’t have infrastructures, which enable markets to upgrade in the most effective manner. What that usually means is that their fiscal policies are not mature enough in the sense that they often allow inflation to take hold, more so than in developed countries, but we haven’t seen that for so many years, it’s going to be a very unusual sight. Between 1979 and 1989, before the end of the Cold War, inflation in developing countries was averaging almost 50 percent a year – Brazil a thousand percent. But still, it is a very important issue. Having developing countries with inflation rates in single digits is exceptional. It’s an extraordinary circumstance. It’s unusual, and I don’t think it will persist.

Q: Q: Do you think China is doing a good job at reining in inflation?

A: China is remarkable because by all various measures they shouldn’t be doing as well as they are doing. As you know, their inflation is quite low, although it is beginning to rise, especially for food. What happens to a lot of developing countries as they start to buy more expensive foods, and it tends to create problems in the economy, because they don’t have enough supply. Look at milk, which is a classic case that’s happening in societies, which rise.

But China is basically running all out, flat out and I don’t think that it’s controllable at this stage, because the central government doesn’t have all that much of a say across the provinces. There’s a great deal of individual independence in the party for province heads. That means that the type of suppression which they probably need to pull in their capital investment, which they have been trying to do, is thwarted, because most of the capital investment projects that should be pulled in are being initiated by provincial governors.

That is part of the problem which they are going to have to solve, because at the moment even though the Rmb is rising gradually, and the People’s Bank of China is buying very large quantities of U.S. dollars and euros to suppress the exchange rate, they won’t fully neutralize the inflationary effect of international currencies. The central bank, which buys international currencies, has created an inflationary base, which can be altered by selling debt against the central bank denominated in their domestic currency, which they are doing, but not enough, so that the money supply is growing at a more rapid pace than the nominal GDP.

For an economy like China, that is suggesting that inflation will start to take hold, and basically they are very concerned about inflation. Another reason they are concerned is that they came to power in 1949 because Chiang Kai-shek’s government had a huge inflation, and they (Mao’s communists) actually were able to take over, and that would not have happened were it not for inflation, they remember.

But we can’t explain why communist society would be so concerned about a capitalist thing like moving prices. Theoretically, you don’t even have moving prices in a communist society – prices are fixed. So it’s that they are more involved in creeping capitalism.

And the Shanghai and Shenzhen stock markets are very dangerous for them, because the prices continue to go up, because the earnings continue to rise, but a good part of the rising earnings is because the companies are buying stock and the capital gains are part of their income. So it’s an interaction of the stock market going up, companies investing in the stock market, they’re getting profits, the stock prices capitalized in capital gains, which is sort of a never-ending cycle. That can’t go on indefinitely. At some point it’s going to come down and create a fairly significant reaction in consumer demand, because a good deal of these securities have been bought by Chinese households.

Q: Will Taiwan be affected?

A: Taiwan will notice, but it's unclear when it will happen. First of all, it's not clear that it will happen, because the Chinese government will come in and try to support the prices and that will be part of the problem. But we can't count on China growing 11 percent a year. At some point it's going to come down. Growth rates are going to come down significantly. Your exports into China will be affected, but I'll leave it to Taiwanese economists to provide numbers.

Q: Do you think that Taiwan’s exclusion from regional trade pacts and groupings such as ASEAN-plus-three will affect our economy?

A: No. Actually, if you can maintain an open market and a flexible economic system, then you will essentially be gaining all the benefits from global trade, which is really the maximum force there is. When you have organizations that build up and have meetings in Singapore, Seoul, wherever, that doesn’t really matter that much. I have been to such meetings. I have been sitting across the table. You have nice conversations, but it’s not governments which regulate trade – it’s the business sector that does. So long as you keep your own property rights, so long as you maintain significant free flows of funds in and out of a country and people can invest... Foreign direct investors have got to know that when they invest in Taiwan, their money is safe. And a thing which is critically important from now on for nations is to have a good deal with that sort of investment coming, even if you then invest on the mainland. And these individual ASEAN groups, I mean they are very nice organizations, but they don’t do very much.

Q: In your book you mention countries losing ground to the emerging markets. What is your suggestion for the four little dragons of East Asia for the next stage?

A: I don’t have suggestions. I said what determines your future is innovation, new ideas, new products. By definition, innovation is not forecastable, because if it were, it wouldn’t be innovation. We can know all the problems, we can see them, but we cannot see all the good things that happen, because productivity is going to rise year by year.

It’s caused by new ideas, new investments, which we cannot anticipate. You can’t basically say what’s going to help us in the next ten or twenty years. The answer is, I don’t know. But there is no doubt in my mind that there will be something there before us. Centrally planned economies have to know what they think the future is going to be, because they are planned. They have demonstrated critically that they don’t know how to do it. The Soviet Union had just an awful experience indeed. So did Mao Zedong, for Christ’s sake.

The future will create itself if the incentives are there, and you need to know what type of new investments, new ideas and products you are going to produce. That will happen. It always has. We had this conversation ten years ago: How will Taiwan advance? Well, Taiwan has come a long way in the last ten years.

Q: What can governments do, given the growing influence of global finance?

A: Governments probably do best for their citizens to do less, because the markets are doing a remarkable job. Look at East Asia, the standards of living have risen so dramatically over the past ten years, and it had nothing to do with the governments.

The People’s Republic of China somehow convinced huge amounts of foreign investors that their money is safe in mainland China. And as a consequence, foreign direct investment has gone up 20 percent and more per year, which is essentially saying that foreign investors believe that the contracts they have in China are going to be maintained. The truth of the matter is, if they are not maintained, China will have considerable problems and the Party will suffer the consequences, that it’s very important for the future stability of China and the control of the Communist Party to see to it that the properties of individual investors are maintained.'

Q: What can governments do, given the growing influence of global finance?

A: If you don’t have material goods and services to distribute, then policies don’t help. What you really have to focus on is how much a society can produce, because it’s only a part of that that the government has available to engage in social programs. You don’t start with social programs, you start by making sure you have available real resources to do things. A thing that any government can do for its society is raise the average per capita GDP, which tends to change inequality, to spread wealth across the entire society. That’s the most formidable social program a government can institute.

Q: What about the widening wealth gap?

A: (There is) the need for ever increasingly skilled workers to basically deal with the complex structures and big assets that we have created – facilities and plants, and equipment. What we are learning is that our education systems are not going, at least in the United States, to produce the number of skilled people that are needed, and therefore, skilled people’s wages rise and that’s where most of the inequality comes from.

Q: What’s your view on sovereign wealth funds? China has just established a sovereign wealth fund, which is under direct supervision of the cabinet and run by a state-owned investment company.

A: I think that it’s difficult to do that through governments. That is, the types of risks that need to be taken are not the risks that governments should take.

Q: Are they aware of that?

A: Well, we will find out. If they make a lot of money, they’ll be fine, but some time they are going to lose, and then they are going to be very unhappy. It turned out that China has investedin a large American private equity firm and the stock price is going down. I don’t know what’s happened, but I know for certain that the financial people can’t be happy. It’s one thing when a private organization speculates and loses money, but it’s another when a government organization speculates and loses money. I don’t think that government has the tolerance to accept speculative losses – any government. This is not just true for China, Taiwan or the United States. So... the affluent Chinese people ought to be doing that, and not the government.

Q: What are your major concerns for the future?

A: The list is just too long to even start with. The list is long, and the reason is that you always know the problems, as I said before, but you never know the other side of it. The opportunities which will emerge.

So I have learned over the years not be too concerned about the list of problems, what goes on and what does not. There’s the other side. The possible events that we can’t forecast have over the years become more important to me than the problems.

Transcribed by Susanne Ganz

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Keywords:

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