Positive Economic Commentary
Labor Dazed by Greenspan
August 31, 2001
This Labor Day weekend, Fed Chairman Greenspan will probably be feasting on prime beef grilled to perfection when he is not on the tennis court, taking a dip in the pool with Andrea and, if time permits, pondering the weighty issues of conducting policy in an information economy. Yes, it's time for the Kansas City Fed's annual end-of-summer barbecue bash in Jackson Hole. Meanwhile, working stiffs, who are indirectly footing the bill for Greenspan's and his best buds' fun in the sun, will spend the long weekend eating charred hotdogs and pondering weighty issues of their own, such as how many extra years they will now have to work now that their 401(k)s have bitten the dust. And that's what the optimistic ones will be pondering. The more pessimistic ones will be pondering when they will show up in the weekly new jobless claims. The most pessimistic will be pondering when the unemployment benefits they currently are receiving will run out. Labor's trying to figure out what Greenspan dazed them with in the space of a year.
I wonder what novel ideas Chairman Greenspan will come up with after conferring with the best and brightest this weekend. Are we in a new "new era"? What happened to Greenspan's last new era? It turned out to be not a miracle but a mirage. How so? Let's check out some compound annualized rates of productivity over peak-to-peak periods of industrial production. The advantage of looking at productivity growth over complete industrial production cycles is that the cyclically sluggish periods of productivity growth get folded in with cyclically sprightly periods. Productivity in the period from 1990:Q3 to 2000:Q3 grew at an annualized rate of 2.0%. That looks pretty good compared to the previous cycle's (1979:Q2 to 1990:Q3) growth of 1.3%. But before we declare the most recent cycle of productivity a new era, let's look at some other cycles. From 1973:Q3 to 1979:Q2, productivity grew at an annualized rate of 2.0%. And from 1959:Q2 to 1969:Q3, productivity grew at an annualized rate of 2.7%. What do you think was the annualized growth in productivity for the 20-year period from the industrial production peak in 1959:Q2 to the peak in 1979:Q2? It was 2.4%. So, Greenspan's much ballyhooed new era of productivity appears to be nothing of the kind, but merely a move back toward trend, with a ways still to go.
Let's look at the ratio of market value of equities to book net worth for nonfinancial corporations over some of these same cycles. In the most recent cycle, 1990:Q3 to 2000:Q3, this ratio averaged 117.8. In this same period, economic profits of nonfinancial corporations as a percent of their book net worth averaged 7.2%. In the period from 1959:Q2 to 1969:Q3, profits as a percent of net worth averaged 9.7%. Despite the fact that the return on net worth was 2.5 percentage points higher in the 1960s than in the 1990s, market cap to net worth averaged only 83.0 in the 1960s, or about 30% less.
So, productivity growth in the past decade was not of new-era proportions. Return on net worth was not of new era proportions. Yet the market capitalization of equities relative to net worth was of new era proportions. Does this suggest that perhaps a bubble had formed in the stock market, especially in the late 1990s? I think it would certainly cause prudent folks, the kind of folks who are supposed to be running the most powerful central bank in the world, to suspect a bubble. But Chairman Greenspan on numerous occasions said that he could not tell before the fact whether we were experiencing a stock market bubble. Who was he to second-guess the millions of investors(?) who were bidding up the prices of Amazon.com and Lucent to astronomical levels. After all, said Chairman Greenspan, stock market analysts were projecting new-era earnings growth for corporations. Chairman Greenspan has been more than willing to express his opinions on trade policy, fiscal policy, energy policy and just about anything else we need an expert witness on. But when it came to expressing his opinion on whether a bubble had formed in the stock market, he fell silent after the bad reviews he got for his "irrational exuberance" speech of 1996. But even if it was a bubble, not to worry. Greenspan told us he had learned from history how to manage the negative economic effects of a burst bubble through the deft use of monetary policy. I’m sure that relieves the 937,000 extra folks now receiving state unemployment benefits vs. a year ago.
But whether or not Chairman Greenspan was a cheerleader for the new-era notion and, implicitly, a cheerleader for the high stock market valuations is small potatoes compared to his aiding and abetting the creation of the bubble through his monetary policy actions, or in-actions, as the case may be. He could have done all the sideline cheering he wanted and there would not have been a bubble had he not created all of the cheap credit that is a necessary condition for the inflation of an asset bubble.
Anytime Chairman Greenspan started to waver from the straight and narrow new-era line, the editorial page managers of The Wall Street Journal were quick to call on one of their shills to write an op-ed piece chastising him. Let the good times roll. Phillips Curve, Schmillips Curve. Supply curves are infinitely elastic in a new-era world, including the supply curve for labor. The unemployment rate can be pushed lower and lower without putting upward pressure on unit labor costs or consumer inflation. That's what the shills wrote each time Chairman Greenspan might get worried about tight labor markets. Well, the shills were wrong. Check out Chart 1 below. Notice that as the unemployment fell through 5% (the solid horizontal line), unit labor cost growth increased. And in Chart 2, notice that after unit labor cost growth had been rising for awhile, non-energy consumer inflation started trending higher too. So, Fed Chairman Greenspan then had no choice but to cease supplying cheap credit to feed the bubble. The bubble burst, as it inevitably had to. Workers, who were duped by the shills to throw caution to winds and join the bidding frenzy for stocks are now being duped by these same shills into criticizing Chairman Greenspan for cutting back on his creation of cheap credit in 1999 and 2000. Chairman Greenspan should be criticized by the workers not for his monetary tightening in 1999 and 2000 but rather for his failure to tighten in 1997 and his easing late in 1998.
On this Labor Day weekend, younger workers must be pondering how much their standard of living will be cut due to the higher payroll taxes that they might have to pay in a few years in order to provide for their predecessors’ Social Security benefits. Older workers must be pondering this weekend whether there will be a Medicare prescription benefit available when they retire in a few years. Here, again, Chairman Greenspan comes to mind. In the last few years prior to George Bush, Jr. being elected president, Chairman Greenspan recommended that any federal budget surpluses that might evolve first be used to pay down the publicly-held national debt rather than be used to fund a tax cut. Chairman Greenspan urged caution in accepting long-run projections showing federal budget surpluses in that these projections had a history of missing the mark by a wide margin. But, after the Bush Jr.'s election, it was though Chairman Greenspan had an epiphany. Suddenly, the long-run budget surplus projections had more credibility. Given the huge surpluses that almost assuredly would be realized over the next ten years, we would soon run out of national debt to redeem. Other than have the federal government accumulate private financial assets with the ever-growing projected budget surpluses, the only feasible alternative was to grant a tax cut, which, coincidentally, was one of the platforms that Bush Jr. ran on. When Fed Chairman Greenspan put his seal of approval on a tax cut, the political momentum for one became overwhelming. I guess it never occurred to Chairman Greenspan to recommend that these projected surpluses be used to “buy out” current contributors to the Social Security program so that a Ponzi scheme could be converted to a fully funded pension plan. But now we come to find out that the near-term budget surpluses are not likely to be as big as projected just six months ago. And given the mounting evidence that the new era was a mirage, the size of the longer-term budget surpluses are questionable in that the economy's potential growth rate appears to be considerably lower than thought six months ago. So, maybe we’re not in danger of running out of Treasury debt to redeem after all. And maybe the federal government’s balance sheet won’t look as clean as otherwise when it has to borrow in order to make good on its Social Security promise to my generation. What about the Medicare prescription benefit? What do you think your tax cut was for?
Chairman Greenspan, a maestro? Workers this Labor Day weekend must think him more a music man, like the one in River City, than a maestro.
Paul "Ahab" Kasriel The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
Director of Economic Research