By Beat Balzli and Michaela Schiessl
Greenspan was long a member of the BIS board of directors and was effectively White's superior. As a fervent champion of the free market, he advocated the model of minimal intervention. In his view, the role of central banks was to control inflation and price stability, as well as to clean up after burst bubbles. Because no one can know when bubbles are about to burst, he argued, it would be impossible to intervene at the right moment.
In his eyes, the instrument of sharply raising interest rates to counteract market excesses routinely failed. Leaning "into the wind," he argued, was pointless. He could even cite historical proof for his thesis. Between the beginning of 1988 and the spring of 1989, the Fed raised the prime rate by three percentage points, the goal being to curtail lending by raising the cost of borrowing. The textbook conclusion was that this would be toxic to the markets, but precisely the opposite occurred: Prices continued to rise.
This supposed paradox repeated itself five years later. Once again, the Fed raised interest rates and, again, the market shot up.
These experiences only strengthened Greenspan's conviction that raising interest rates was an ineffective tool to counteract bubbles. However he never tried raising interest rates to a significantly greater degree than had previously been done, to see what would happen.
The question of who was right, Greenspan or White, didn't exactly lead to a power struggle in Basel. The forces were too unevenly distributed for that. On the one side was the admonishing chief economist, with his seemingly antiquated model that advocated the establishment of reserves, and on the other side was the glamorous central banker, under whose aegis the economy was booming -- the killjoy vs. the party animal.
The central bankers certainly discussed the competing models. But most of them were behind Greenspan, because his system was what they had studied at their elite universities. They refused to accept White's objections that the economy is not a science. There was no way of verifying his model, they said.
Besides, who was about to question success? Greenspan was their superstar, the inviolable master, a living legend. "Greenspan always demanded respect," White recalls, referring to the Maestro's appearances. Hardly anyone dared to contradict the oracular grand master.
And why should they have contradicted Greenspan? "When you are inside the bubble, everybody feels fine. Nobody wants to believe that it can burst," says White. "Nobody is asking the right questions."
He even defends his erstwhile rival. "Greenspan is not the only one to blame. We all played the same game. Japan as well as Europe followed the low interest policy, almost everybody did."
Meanwhile, White noted with concern what the central bankers were triggering as a result. Their policy of cheap money led to the Asian financial crisis in 1997. When the debt that banks had accumulated went into default, the International Monetary Fund (IMF) and other donors had to inject more than $100 billion (71 billion) to rescue the world economy.
In describing the failure of the markets as far back as 1998, White wrote that it is naïve to assume that markets behave in a disciplined way.
But Greenspan, the champion of free markets, remained impassive.
And what did Greenspan do? He lowered interest rates. Then the next bubble, the so-called New Economy, began to grow in Silicon Valley. It burst in the spring of 2000. What did Greenspan do? He lowered interest rates. This time the reduction was massive, with the benchmark rate dropping from 6 percent to 1 percent within three years. This, according to White, was the cardinal error. "After the 2001 crash, interest rates were lowered very aggressively and left too low for too long," he says.
While the economy was recovering from the demise of the dotcom sector and from the terrorist attacks of Sept. 11, 2001, cheap money was already on its way to triggering the next excess. This time it took place in the housing market, and this time it would be far more devastating.
White was losing his patience. Was there no other option than to regularly allow the economy to collapse? Didn't the policy of operating without a safety net border on stupidity? And wasn't it written, in both the Bible and the Koran, that it was important to provide for seven years of famine during seven good years?
This time, White didn't just want to discuss his views behind closed doors. This time, he decided to seek a broader audience.
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