Are Alan Greenspan's first two months in office a sign of things to come? I hope not. Bond prices have fallen sharply since the new Federal Reserve Board chairman was sworn in in early August, this weeks' bond market rally notwithstanding. Mortgage rates have started to rise, as has installment credit and automobile financing, not to mention the one-half percent rise in the prime rate, which affects business borrowing and long-term capital investment.
In my opinion, this has happened for three major reasons. First is his very traditional approach, which has frightened the markets. This manifests itself in the hands-off non-interventionist free market approach. This is fine, but it is in sharp contrast to Paul Volcker, who had a hands-on management style that was consistent and pleased the markets worldwide. The markets felt a high degree of confidence in his judgment.The second reason is his lack of a policy. He must tell the markets what he is going to do. Then let the marketplace decide, good or bad. He must be clear, concise, and consistent. This can be in the form of money supply targets, a move to the gold standard, public statements and a stable dollar policy.
The third reason is his failure to use the markets for an objective. For example, he speaks of long-term low interest rates. Yet when he was sworn in, the dollar went from 140 yen to 153 and 180 deutsche marks to 190. At this time he had the opportunity to lower the discount rate and strengthen our somewhat sluggish economy. Since rates were so much lower in Japan and Germany, there would be no need to have a run on the dollar, particularly with added growth in our economy. Instead, the rise in the discount rate has slowed housing and auto sales and has not yet stabilized the dollar.
Mr. Greenspan must set clear policy guidelines that the central banks feel is consistent and must set a stable policy that is understandable and will further economic growth. This policy should include Federal Reserve Board leadership in defending our currency and not depending on others.
The recent flight from the dollar has taken the form of a flight to
financial assets, as stock prices have shown around the world. In the meantime, our currency has grown shakier in the hands of those who are using it as a weapon in the trade war. In a sense we have joined the cutthroat currency competition by undervaluing our currency as a means of reducing the trade deficit and using it as a cure for other world ills. This, of course, has set in motion protectionist forces here and abroad.
We are seeing the twin deficit problems in the financial markets. The Japanese and West Germans buy newly created Fed dollars to protect their export industries and to ensure the value of their own dollar holdings at the core of their monetary base.
The newly issued marks and yen, which are supposed to hold up the dollar, are not yet sterilized because of domestic money tightness in Japan and Germany. They just add liquidity in the yen and mark area and tend to lift
financial markets abroad. Then the central banks buy up the dollars and invest them short term in New York. This holds down short-term U.S. interest rates, depreciates the currency and makes equities more attractive so our long-term interest rates stay high and hurt corporate investment.
To end this financial disorder the Federal Reserve Board should consider a currency stability plan based on gold or some reference of commodity pricing. Whatever the new system is, it should neither be inflationary nor deflationary, because over the long run history shows that there is no effective alternative to unrestricted domestic and international convertibility at fixed rates into gold.