I Am John Galt (34 page)

After that, Greenspan kept rates where he raised them in early 1997. Gold continued to fall, which under the stealth gold standard should have signaled to Greenspan that deflationary pressures were building, and that rates should be lowered to relieve them.

By 1998, those deflationary pressures started to weigh on the world's most fragile debtors: the fast-growing Asian nations that had borrowed vast sums of dollars to build out their commodity-based economies. In the deflation Greenspan had triggered, the prices of commodities fell along with the price of gold, and at the same time debt service in dollars became intolerable. It was much like what happened to debtors around the world in the deflation of the Great Depression of the 1930s. The result was the so-called Asian flu, a contagion of currency devaluations and debt defaults that swept Asia from Thailand to Russia.

In the United States, the highly leveraged hedge fund Long-Term Capital Management (LTCM) got caught in the undertow of Asian and Russian defaults and devaluations. With all the top Wall Street firms exposed to LTCM, it was a systemic crisis. In response, Greenspan finally lowered interest rates—which his stealth gold standard would have had him do years before—and the pressure was relieved.

At the same time, the Fed organized a rescue of Long-Term Capital Management. We say “organized,” because that's all the Fed did; it didn't spend a dime of its own money bailing out LTCM. All it did was get all of LTCM's shareholders in one room at the New York branch of the Federal Reserve, and convince them that the only way to save Wall Street was to have all of them kick in extra money to LTCM. It was the opposite of a bailout—it was a bail-in.

When the smoke cleared, Greenspan got credit for expertly averting a global crisis—yes, the same one he himself caused by going off his own stealth gold standard. Greenspan was featured on the cover of
Time
as the chairman of the Committee to Save the World, and people started calling him the maestro.

And the legend of the Greenspan put grew. Ask anyone on Wall Street how the LTCM crisis was resolved, and chances are good you'll be told—wrongly—that the Greenspan Fed bailed it out.

With his laurels polished to the point of gleaming, Greenspan didn't learn from his mistake. As irrational exuberance kicked into high gear and the dot-com stock market went hyperbolic at the end of the decade, Greenspan started raising rates again, taking them to new highs—even as gold kept falling.

He spoke of the “new economy,” yet he kept raising rates. It was as though he was now on a stealth Nasdaq standard instead of a stealth gold standard. But try as he might, he couldn't burst the bubble. He says now, in frustration, that he had “raised the spectre of ‘irrational exuberance' in 1996—only to watch the dot-com boom, after a one-day stumble, continue to inflate for four more years, unrestrained by a cumulative increase of 350 basis points in the federal funds rate from 1994 to 2000.”
37

From Bust to Bubble

After the dot-com bubble burst in early 2000 (probably more from its own unsustainable silliness than anything Greenspan had done to burst it), the deflationary consequences of abandoning the stealth gold standard took on deadly new dimensions.

Coming out of the brief recession of 2001, inflation fell to the lowest levels in 40 years. It had dipped in mid-1998, and Greenspan had seen the consequences in Asia, Russia, and Wall Street. Now it was lower still. It was not negative—not actual outright deflation. But for Greenspan, knowing in his heart of hearts that he'd been erring versus his own stealth gold standard on the side of deflation, it was scary.

So Greenspan panicked. He went from keeping rates too high for too long to keeping rates too low for too long. He lowered interest rates to a mere 1 percent in mid-2003, a level not seen since the Depression. And he kept them there for an entire year, what the Fed kept announcing to the market, all the while, would be a “considerable period.” Then when the Fed finally started raising rates, it announced that its rate-hiking regime would be “measured.” Starting in mid-2004, the Fed began a series of regular, timid, 0.25 percent rate hikes at every Federal Open Market Committee (FOMC) meeting. Rates didn't even get back up to a mere 3 percent until mid-2005.

Greenspan denies this,
38
but many scholars now believe that keeping rates so low for so long was what triggered the boom in excessive mortgage lending in the United States and around the world—the boom that became a bubble, the bubble that became a bust, and the bust that became a global banking crisis and the Great Recession.

Among Greenspan's sharpest critics on this is John Taylor, the Stanford University economics professor famed in monetary policy circles for positing the Taylor rule for setting interest rates. Taylor delivered his critique in the summer of 2007, just when the first tremors of the mortgage bust were beginning to be felt—when no one had any idea it would lead to a global crisis. At the Fed's prestigious annual Jackson Hole research symposium, Taylor argued:

During the period from 2003 to 2006 the federal funds rate was well below what experience during the previous two decades of good economic macroeconomic performance . . . would have predicted. Policy rule guidelines showed this clearly. There have been other periods . . . where the federal funds rate veered off the typical policy rule responses . . . but this was the biggest deviation. . . .

With low money market rates, housing finance was very cheap and attractive—especially variable rate mortgages with the teasers that many lenders offered. Housing starts jumped to a 25 year high by the end of 2003 and remained high until the sharp decline began in early 2006. . . .

As the short term interest rate returned to normal levels, housing demand rapidly fell bringing down both construction and housing price inflation. Delinquency and foreclosure rates then rose sharply, ultimately leading to the meltdown in the subprime market. . . .
39

While the Fed's too-low rates fueled the mortgage and housing bubbles, the Fed as banking regulator did little to rein in abusive lending practices or excessively leveraged capital commitments by banks. It's not like Greenspan didn't know there were bad guys out there—and perhaps stupid guys, too. In the wake of Enron and other financial scandals in the early 2000s, he had spoken of “infectious greed”
40
—a phrase that became almost as canonical as “irrational exuberance.”

Why did corporate governance checks and balances that served us reasonably well in the past break down? . . . An infectious greed seemed to grip much of our business community. Our historical guardians of financial information were overwhelmed.

And it's not like he couldn't see housing prices get out of control. As Greenspan now protests, “I expressed my concerns before the Federal Open Market Committee that ‘. . . our extraordinary housing boom . . . financed by very large increases in mortgage debt—cannot continue indefinitely.'”
41

Furthermore, it's not like he didn't know that the quasi-government lending agencies Fannie Mae and Freddie Mac were overleveraged and corrupt. He used his bully pulpit as Fed chair to attack them repeatedly and call for sweeping reform.

So when he says now that he is “shocked” by the failure of self-interest to rein in the banks all by itself, one thinks of the police captain in
Casablanca
who was “shocked—shocked!—to find that gambling is going on in here.” Yet the Greenspan Fed essentially did nothing about it.

Even if Greenspan were playing the Randian double-agent hero, trying to minimize the Fed's regulatory footprint, there is one huge practical problem that such an idealistic strategy lethally overlooks. Greenspan forgot that the market expects the Fed to regulate the banking system, whether or not in Rand's moral universe it ought to—especially the Greenspan Fed, in the hands of the maestro, the chairman of the Committee to Save the World, the man who always knows the right thing to do.

So why shouldn't banks take highly leveraged off-balance-sheet risks based on mortgages that nobody in his or her right mind could have expected the borrower to repay? Greenspan's not objecting—and he's regulating this casino, isn't he? Isn't he?

So what's a Randian hero double agent supposed to do? Well, as Dr. Robert Stadler asked in
Atlas Shrugged
, “But what can you do when you deal with people?”

The Maestro's Final Bow

Alan Greenspan politely refused our requests to be interviewed for this book, but he did agree to meet with us.

When we saw him in his Washington, D.C., office, we were struck by how terribly old and small and frail he is, this giant who bestrode the global economy for two decades. His large eyes still bloomed with intelligence at age 84, and his rapid-fire repartee revealed a mind still operating with enormous power. Yet when we grasped his hand to greet him, it seemed for a moment that his whole arm would come off at the shoulder.

It was more than just the physical exhaustion of age. There was also something about him that spoke of resignation, disappointment, even shame. And why not? What must it cost a man, after a record 18-year run as chairman of the Federal Reserve, seeing nearly two decades of unprecedented global growth, able to master every crisis along the way, celebrated as the greatest central banker of all time, and on the cover of
Time
as the chairman of the Committee to Save the World, to be blamed for the banking crisis that triggered the greatest global recession since the 1930s.

For Greenspan, it's more than just having presided over the greatest global boom/bust cycle in history, having gone from adulation as the man who saved the world to vilification as the man who destroyed it. For Greenspan, this titanic fall from grace is all the more humiliating because it takes place squarely in the long shadow of Ayn Rand.

As Greenspan proudly told us when we met, he spent 30 years as a close friend of Rand, right up until the day she died in 1982. When we asked him whether in his confrontation with Henry Waxman he'd intended to recant his Randian beliefs in the supremacy of free markets, he told us absolutely not.

His despair, he told us, is not that his and Rand's ideas turned out to be wrong. Rather, it's that the world has abandoned them. Coming out of the Great Recession, he sees the United States having crossed a fateful threshold, a point of no return, at which we've taken on too great a government debt, and at the same time made too great a commitment to government control of the economy. He told us that we won't recognize America 20 years from now, and that we won't like what we see.

We asked him to inscribe our copy of Rand's anthology
Capitalism: The Unknown Ideal
(a first edition already bearing Rand's signature), in which is reprinted his article on gold and economic freedom. He told us that he thinks every idea in the book—his own and Rand's—has stood the test of time.

We left feeling that Alan Greenspan is no villain. In his own way, he is indeed a hero—not a Randian hero, but rather a tragic one.

Chapter 9

The Economist of Liberty

Milton Friedman as Hugh Akston, the academic who showed the world the connection between capitalism and freedom

“We never make assertions, Miss Taggart,” said Hugh Akston. “That is the moral crime peculiar to our enemies. We do not tell—we show. We do not claim—we prove. It is not your obedience that we seek to win, but your rational conviction. You have seen all the elements of our secret. The conclusion is now yours to draw—we can help you to name it, but not to accept it—the sight, the knowledge and the acceptance, must be yours.”

—Atlas Shrugged

As Milton Friedman stepped up to the podium in Stockholm, Sweden, on December 10, 1976, he may have felt a mix of emotions. On one hand, it was a great honor to be just the twelfth recipient of the prestigious Prize in Economic Sciences in Memory of Alfred Nobel. On the other hand, perhaps he couldn't help but feel the irony.

Just six years earlier, the very same prize had been awarded to his professional opponent Paul Samuelson, who represented the antithesis of Friedman's ideas. Whereas Friedman was a fervent advocate of the efficiency of free markets, Samuelson argued just as fervently that markets if left to their own devices would invariably spin out of control without preemptive intervention by the government. Their opposing views symbolized the twentieth-century struggle between the forces of collectivism under far-reaching government and individual liberty represented by unhindered free markets. Whereas Samuelson believed government was the solution to a vast array of socioeconomic problems, Friedman's own factual investigations led him to the conclusion that the government itself was the problem.

Friedman wrote in 1962 in his seminal
Capitalism and Freedom
, “The Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by any inherent instability of the private economy.”
1
This was no mere political slogan. Friedman and his colleague Anna Schwartz had spent countless years painstakingly assembling data on money, banking, and the economy—ultimately published as the epochal bible of macroeconomic research,
A Monetary History of the United States.
This work had proved beyond doubt that the Federal Reserve's mismanagement of the money supply and the banking system led to the Depression. Revolutionary at the time, this is now so completely accepted that on the occasion of Friedman's 90th birthday, Federal Reserve governor (later chairman) Ben Bernanke publicly apologized on behalf of the Fed. “Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.”
2

After
Capitalism and Freedom
, Friedman's intellectual rival and fellow Nobelist Samuelson countered in his best-selling textbook
Economics: An Introductory Analysis
, defending the economic benefits of Soviet-style command-and-control economics. In the 1976 10th edition Samuelson wrote that it was a “vulgar mistake to think that most people in Eastern Europe are miserable.”
3
In the 1980 11th edition he removed the word “vulgar.”
4
Then in the 1989 13th edition, just before the collapse of the Berlin Wall, he wrote, “The Soviet economy is proof that, contrary to what many skeptics had earlier believed, a socialist command economy can function and thrive.”
5
Not only did the global collapse of communism—prompted by all those people who weren't miserable, one supposes—prove Samuelson spectacularly wrong, but what followed proved Friedman spectacularly right. As the formerly communist world embraced capitalism, there was an unprecedented surge in global wealth made possible by an unprecedented surge in global economic freedom.

For Friedman,
this
, not the Nobel, was the prize: being right—using economics to make a prediction and see the prediction come true. This was Friedman's way. Start with real-world research. Adduce an economic theory from it that results in a prediction. Then see if the prediction comes true. While this would seem to be little more than the application of the scientific method to economics, Friedman's method stands in stark contrast to that of most economists, which is simply to theorize.

Friedman called his approach “positive economics.” Ayn Rand might have simply called it “reason.”

In
Atlas Shrugged
Rand symbolized the primacy of reason in the character of Hugh Akston. Milton Friedman was, in many important ways, Hugh Akston come to life. Both were eminent academics—Akston a professor of philosophy, Friedman a professor of economics. Both were influential mentors—Akston to John Galt, and Friedman to a generation of advocates of economic liberty, from Ronald Reagan (who called Friedman's television series
Free to Choose
“a survival kit for you, for the nation, and for freedom”
6
) to Margaret Thatcher (who said Friedman “revived the economics of liberty when it had been all but forgotten”
7
). And both contested with powerful intellectual adversaries representing the dark forces of collectivism—Akston with philosophical imposters who taught students that the mind is impotent, and Friedman with economists like Samuelson who taught students that the government is omnipotent.

Akston's philosophy of reason leads directly to Friedman's positive economics. Akston said, “We never make assertions. . . . That is the moral crime peculiar to our enemies. We do not tell—we show. We do not claim—we prove. It is not your obedience that we seek to win, but your rational conviction.”

Former Secretary of State George Shultz put it this way: “I wish I were as sure of anything as Milton is of everything.”
8
Such is the power of reason.

There is one very large difference between Friedman and Akston. In
Atlas Shrugged
, Akston walked away from his professional battles, becoming the first recruit to John Galt's strike of the mind. Of his intellectual rivals Akston said, “[M]odern thinkers considered it unnecessary to perceive reality. . . . I could not share my profession with men who claim that the qualification of an intellectual consists of denying the existence of the intellect.”

Friedman, in contrast, never gave up his battles on behalf of reason in economics right up to the day he died. And he was great at it. Economist and Reagan intimate Martin Anderson recalls Friedman's technique: “At first he listens quietly, intensely. As long as he totally agrees he listens, but that usually isn't for long. At the first sign of the slightest break in your logic, or your facts, he pounces with a bewildering array of questions, statements, and relentless logic. And it's all done in such a friendly, earnest way that even the intellectually shredded thoroughly enjoy the encounter.”
9

For Friedman, it was always the facts that mattered, not external accolades. So the Nobel Prize was not only ironic, but also faintly absurd, bestowing upon him in the collective mind of society an omniscience that no one deserves. “It is a tribute to the worldwide repute of the Nobel awards that the announcement of an award converts its recipient into an instant expert on all and sundry, and unleashes hordes of ravenous newsmen and photographers from journals and TV stations around the world,” he quipped with his characteristic mirthful grin to the crowd at his awards banquet. “I myself have been asked my opinion on everything from a cure for the common cold to the market value of a letter signed by John F. Kennedy.”

And then, as if sending forth a cautionary message to the likes of Linus Pauling and Paul Krugman (Samuelson's student at Massachusetts Institute of Technology, by the way, whom we met in Chapter 2, “The Mad Collectivist”), who would later use the imprimatur of their Nobel awards as license to toss around unfounded opinions on everything from the health benefits of Vitamin C to wildly inaccurate predictions on the direction of the stock market, Friedman concluded, “Needless to say, the attention is flattering, but also corrupting. Somehow, we badly need an antidote for both the inflated attention granted a Nobel laureate in areas outside his competence and the inflated ego each of us is in so much danger of acquiring.”
10

Milton Friedman was both a serious academic and a masterful public communicator. During the latter half of the twentieth century he grew to become a well-known and popular voice of reason in an increasingly irrational world. According to George Shultz, “His achievements in professional terms were his work on monetary policy, his work on consumption, and his general impact in terms of professional ideas . . . but then his impact was far greater on the general population and thinking around the world because he was such a good teacher.”
11

Like Hugh Akston, Friedman became a virtual father to legions of student acolytes and, through his work, created a new branch of economic science that came to be called the Chicago school—named for the University of Chicago, where Friedman taught. Friedman's students would eventually fan out across the globe, spreading his economics of reason both as teachers and as technocrats. Dubbed “the Chicago Boys,” many of them earned positions of considerable power within the economic policy elites of developing nations, putting to work for the first time Friedman's potent philosophical brew of capitalism and freedom.

In the academic sphere, Friedman wrote many influential treatises, pamphlets, papers, and books, including the magisterial
Monetary History.
In the nonacademic sphere,
Capitalism and Freedom
is his most definitive philosophical statement. But he was best able to reach—and teach—the general public in two other forums. For many years he wrote a column for
Newsweek
, alternating on the magazine's pages with his rival Paul Samuelson. And in 1980, he and his wife Rose produced a 10-part miniseries for public television called
Free to Choose.

Whether in academia or before the public, his message was unwaveringly in favor of free-market capitalism. But it wasn't political dogma; it was reasoned research discovering the best available system, the one that had proven successful through hard evidence. Or as he told Phil Donohue on television in 1979, “There is no alternative way, so far discovered, of improving the lot of ordinary people that can hold a candle to the productive activities that are unleashed by a free enterprise system.”
12

Friedman was firmly principled, but also pragmatic. He believed that government had a critically important role to play in human affairs—albeit one strictly limited to only those activities that could not be effectively accomplished by the private sector. Referring John F. Kennedy's famous epigram, Friedman wrote, “The free man will ask neither what his country can do for him nor what he can do for his country. He will ask rather ‘What can I and my compatriots do through government' to help us discharge our individual responsibilities, to achieve our several goals and purposes, and above all, to protect our freedom?”
13

Freedom, he believed, was a “rare and delicate plant.” So while he was willing to participate in political processes to advance his economic ideas, he always took care to not let himself be used to advance politicians. He once wrote, “The role of the economist in discussions of public policy seems to me to be to prescribe what should be done in the light of what can be done, politics aside, and not to predict what is ‘politically feasible' and then to recommend it.”
14

A Young Mind in Training

Milton Friedman was born in 1912, in Brooklyn, the fourth child of immigrants from Austro-Hungary. His mother ran a small retail dry goods store, and his father did odd jobs. “The family income was small and highly uncertain,” Milton remembers. “Financial crisis was a constant companion.”
15

Milton was a fast learner from an early age, graduating from Rahway High School in 1928 when he was just 15. His father died during his senior year, leaving his mother and two older sisters supporting the family. He was awarded a scholarship to Rutgers University. He noted that a “class of competitive scholarships for financially needy students which [now] go not to those who score highest in the exams but to underachievers is a nice illustration of how our standards have been corrupted over the years.”
16