“Historians may well lay the real blame for current distress at the door of Alan Greenspan, who pioneered the use of morphine to dull economic pain, but they will probably also credit him with a certain level of discretion in its prescription. During Greenspan’s tenure at the Fed, economic leaders became convinced that the solution to market distress was to ensure that the financial system had access to easy money.”
“When the dot com bubble burst, Greenspan kept the financial system energised by lowering rates so far that they were, for a substantial period, at negative levels.
A negative real interest rate means we are effectively paid to take out loans. That might sound good, but how would you feel if I used the words “paid to take a few more hits of crack cocaine”? The underlying problem was that people had become accustomed to high rates of return and did not want to accept that real rates of return in the US were moving down. They had become accustomed to easy money, and Greenspan’s policy ensured that money remained accessible at a time when people had demonstrated a low ability to invest that easy money well.”
“Now, with hindsight, it appears that the real reason for the absence of inflation was that the Chinese were increasing their productivity dramatically, and that US consumers were spending so much on Chinese goods that Chinese productivity growth, not US productivity growth, was keeping US prices low.
When tech came off the boil and people should have been using the pause to clean up their affairs, Greenspan made it easy for people to get themselves into a worse position. Easy money made stock market prices artificially high, so stock market investors felt rich. Worse, easy money made house prices artificially high (by about 45%), so everybody felt wealthier than they had planned or expected to.
To make matters worse, a series of financial innovations created a whole industry designed to help people go back into debt on their houses. I remember trying to watch TV in the US and being amazed at the number of advertisements for “home equity withdrawals”. They made it sound like turning your major personal financial asset – your paid-off house – into an ATM machine was a good thing.”