* By Polar Bear
Alan Greenspan was a prime model of opaque verbiage during his term as Federal Reserve Chief, but his memoirs, THE AGE OF TURBULENCE: Adventures In A New World, published in 2007, provide crisp entertaining reading. I strongly recommend his book as an important background to the current contraction under way in the United States.
The end of the "Tech Boom" inaugurated a sharp fall in the equity markets, especially the Nasdaq Index. There was a sharp downturn in business investment and industrial production. There seemed every prospect of a sharp economic contraction. Yet as Greenspan recounted on page 225:
....I was puzzled by the course the 2001 recession was taking--it was like nothing I'd ever seen. Following December's sharp break in confidence and the significant decline in stock prices through the summer, I'd steeled myself for a marked downturn in GDP. Industrial production was off 5 percent during the year. GDP, however, held steady. Instead of being in a deep valley, we were on a plateau. (Indeed, it would turn out that the economy actually eked out a slight expansion for the year.)
The shallowness of the recession looked to be a consequence of global economic forces that had driven long-term interest rates lower and ignited a sharp rise in home prices in many parts of the world. In the United States, homes had increased in value so much that households, feeling flush, seemed more willing to spend. That, coupled with underlying productivity growth, appeared to have endowed the American economy with a whole new degree of buoyancy.
Again on page 229:
Consumer spending carried the economy through the post - 9/11 malaise, and what carried consumer spending was housing. In many parts of the United States, residential real estate, energized by the fall in mortgage interest rates, began to see values surge. The market price of existing homes rose 7.5 percent a year in 2000, 2001, and 2002, more than double the rate of just a few years before.
Credit expansion can only be sustained by rising asset values. Housing provided the ballast for the US recovery after 2002. If asset prices continue to fall, thereby weakening the capacity to borrow and service debt, neither Discount and Federal Fund rate reductions, nor short term pumping of liquidity into the banking system will avert a broader credit contraction.
Alan Greenspan was fortunate. We cannot say the same for his successor, Ben Bernanke.