Alan Greenspan at the Mountain Top

Long Waves, Stagnation and the First ‘Falling Rate of Profit Crisis’:

Alan Greenspan at the Mountain Top

February 10, 2003

R L Norman

Our main theme [i.e, the Friedmans main theme] was that the effect of whatever economic forces produced the contraction was magnified by the unprecedented decline in the quantity of money resulting from the banking crises. Our ancilliary judgement was that the Federal Reserve System could have prevented the monetary consequences of the banking crises, but failed to do so.

Anna Schwartz, 'Understanding 1929-1933', The Great Depression Revisited, Karl Brunner, Boston: Martinus Nijhoff Publishing, 1981.

2003: A New Stagnation ?

Despite sporadic criticism of Fed Chairman Alan Greenspan, most businessmen and mainstream economists give him credit for one of the longest booms in modern capitalist history. This credit does not go far enough, in that it does not truly understand the almost mountainous problems which Greenspan has faced since 1987 and worse yet, the final challenge of his career, how to permanently deal with the end of 200 years of 'Long Waves' in capitalist growth and the arrival of the first ‘Falling Rate of Profit Crisis’. More will be said shortly about these two problems, but what the present crisis appears to be, is a bout of ‘Secular Stagnation’ as defined by John Maynard Keynes. It is the ‘appearance’ of stagnation which is now occurring almost daily in the business news, which the business columnists such as Louis Uchitelle of The New York Times and Gregg Ip and David Wessel of The Wall Street Journal may shortly proclaim. The problem will be, that the normal solution to stagnation, of federal deficits, may not work this time; as it has twice since 1940, once for Franklin Roosevelt between 1940 and 1945 and next for Ronald Reagan between 1981 and 1987.

Stagnation was Keynes’s term for the lack of job creation in the 1930s which began after the Great Crash of 1929, a shocking blow to an almost decade-long market rise. During the entire 1930s, job creation remained far below the needs of the available work force and this underemployment level was not resolved in the advanced industrial countries until after war-time spending began, thus partially confirming an old Leninist theory, that of imperialism.

Deficits and World War ll Recovery from the Depression

Keynes’s ideas of using federal debt to buy war material (actually material of any variety), was used by the Americans to refloat the economy and by about 1943, morning was truly in America. The stock market took a while longer to return to mid-1929 levels, but the working class was in clover by 1943. So powerful were Keynes’s ideas while he was alive, that the U.S. government ran up the debt-to-GDP ratio from about 30% in 1940 to almost 150 % in 1945, the end of war. Yet after war ended, the U S economy suffered only a mild recession, resuming good growth off and on until the mid-1960s, when the economy again faltered. This faltering was attributed at the time to the ‘guns and butter’ policy of Pres. Lyndon B. Johnson, which implied that the ‘Great Society’ social spending could continue even as the Vietnam War escalated.

However, it is just as possible that the primary problem was that the mid-1960s simply marked the end of the almost 20-year stimulis which the 1940 to 1945 federal debt explosion had provided to the American economy. This 20-year period of good growth corresponded with a ‘Long Wave’ upswing, as defined by the Russian economist Nicholai Kondratieff around 1925. And the most prominent exponent of left-wing Long Wave theory, Ernest Mandel, claimed as such. For the Trotskyite, the 20-year growth phase after World War ll corresponded to the ‘normal’ 20-year upswing cycle of a Kondratieff Long Wave. In fact, such a Long Wave probably had not occurred, certainly not of the type of labor-based innovation long wave cycle as defined by Kondratieff. More accurately the 20 years of good growth were almost certainly the result of the huge amount of debt which had been purchased by the American working class during World War ll, being ‘recycled’ back into personal consumption after the war ended and the soldiers had returned home to establish families and join the peacetime economy.

Milton Friedman versus Keynes: Supply Side or Demand Side Federal Deficits ?

Partially because of Keynes’ tragic death around 1946 and because the post-1945 economy did not require much more of a Kenyesian debt-boost, an alternative explanation of the causes of the Great Depression became popularized by hardline monetarist Milton Friedman. Friedman and his wife Rose, basically revised the actual causes of the Great Depression from that of an almost insurmountable crisis of advanced capitalism, into a more academically ‘managable’ problem associated with some incorrect Federal Reserve actions during the period shortly after the 1929 market crash. This simple explanation does not do justice to Friedman’s full theory and subsequent revisions, but as a one-sentence statement and the above quote from Anna Schwartz is fairly close.

Keynesian Fiscal Deficits versus Friedmanite Monetary 'Deficits'

Friedman’s views over the years have tended to substitute traditional Keynesian ‘pump-priming’ deficit spending by the Congress during recessions, into interest rate decreases by the Fed instead during downturns. In the abstract, $100 billion dollars in stimulis provided by Congressional deficit spending should be roughly equal to a one point decrease in the Fed rate, which again in the abstract is supposed to worth about $100 billion in stimulis. Thus $100 billion in stimulis to the economy during a downturn should have approximately the same effect, regardless of whether the Fed injected the money into the U S banks, or the Congress appropriates $100 billion in deficit spending. Another way of seeing this, is to say that Keynes's deficit spending tended to beef up 'demand-side' weakness, while Friedmanite deficits might be seen as supporting the 'supply-side' problems. While to refer to the current proposed deficits by George Bush as 'Friedmanite' might seem as unfair to Friedman, I believe that this is as fair a term as any.

While seemingly theoretically economically correct, in the real world there are often very different results from the Fed's use of monetary policy. Thus between 1990 and 1992, Greenspan himself lowered the Fed rate from about 10 % to almost 3%, a drop of almost 7 full points, worth almost $700 billion in stimulis to the economy. However, since this $700 billion was channeled into the economy through the banking system, its ‘normal’ lag time of between 6 and 12 months, was delayed almost one year longer, until the last quarter of 1992, just in time to help the new President Bill Clinton, but about 3 months too late to help the first George Bush get reelected. In 1990 the banks were continuing to suffer from the after shocks of the October 1987 market crash, and after Greenspan began lowering the banks’ cost of money, the banks simply failed to lower their ‘prime rate’ as fast as the Fed was lowering its rate. This additional spread between the dropping Fed rate and the stable prime rate, was simply treated as ‘found money’ by the banking system for about 6 quarters, long enough to restore a good level of profitability to the banks and long enough to dash Bush’s reelection prospects in 1992.

So, the banks are not always the best way to restore an economy in trouble, even for a Republican president. Congressional deficit spending usually works better, since usually the reason that an economy is in trouble, is that it is producing more than can be consumed by the working and middle class and as the government steps in, this surplus can often be reduced sufficiently and sufficiently rapidly, that the economy can resume growing. Thus the speed at which the Congress can act, compared with the often six to twelve months required for Fed actions, known as ‘open market operations’ or OMOs here; make Congressional action often superior to Fed actions in stimulating a sinking economy.

Keynesian Fiscal Deficits plus Friedmanite Monetary 'Deficits': The Hope for 2004 ?

Yet whatever the comparative effects during relatively ‘normal’ downturns, during severe crashes, there is no way for the Federal Reserve to revive the economy on its own, for one simple reason. It is not possible for the Fed to drop its rate below zero percent. Thus while the Fed, can easily run out of room to further stimulate the economy, once it has dropped its own rate below about 2 %- where it is now by the way; in theory Congress could appropriate deficits for years, as occurred both during Ronald Reagan’s years during the 1980s, as well as during Franklin Roosevelt’s war-time years, of 1940 to 1945. And the Congress continued to run large deficits during the entire time when Greenspan was lowering the Fed rate from 1990 to 1992. Thus even the combined affects of both a rapidly falling Fed rate and a rapidly increasing federal deficit from 1990 to 1992, were not enough to get the American economy going until fourth quarter 1992. Again, this was too little and too late for then President George H. W. Bush.

Can Forced Inflation beat Deflation: Japan and America ?

It is true that some monetarists, including Paul Krugman of the New York Times are attempting to overcome this limitation, by trying to ‘force-feed’ consumption into a deflating economy by creating a low level inflation, through normal 'open market operations'. This is being tried in Japan presently, but seems to be having minimal effects. In a recent year, it seems that the Bank of Japan created a 30% increase in Japanese yen value, but scarcely moved the GDP upwards. Still this policy may have prevented the Japanese economy from crashing far lower. It is hard to be sure whether this policy of trying to restart private consumption in a deflating economy will actually work. Again, Japan is a test case for the theory. If deflation contiues in the American economy, we may get to see another test of this theory.

Greenspan's Legacy: Falling Rate of Profit Crisis or More 'Creative Destruction' ?

Yet as Alan Greenspan begins to consider his very successful 15 years as the Fed Chairman, his biggest challenge may be looming. For it the underlying structural problem in the American economy is the final ending of Long Waves or their post-Keynesian surrogates, Debt Long Waves, then stagnation may not be the real problem. If the real problem is a combination of the end of Long Wave action and the arrival of Karl Marx’s long-delayed ‘Falling Rate of Profit Crisis’, then economic solutions geared for ‘stagnation’ and deflation, as those being used in Japan, may well fail. I’m pulling for Greenspan personally, but theoretically, I believe that he will fail in this final confrontation with the Falling Rate of Profit Crisis.