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Monday, October 24, 2005

Is Greenspan Responsible for China's Asset Bubble?

In criticizing Greenspan and Snow over their recent trip to Japan, Bloomberg's William Pesek Jr. revives the global excess liquidity argument and says one of Greenspan's biggest blunders is his role in creating China's asset bubble:

Greenspan Visits Scene of Fed's China Crime, William Pesek Jr., Bloomberg: To show he means business on China opening its economy, U.S. Treasury Secretary John Snow recently had a powerful prop on hand: Alan Greenspan. While the Federal Reserve chairman retains an almost godlike aura in Asia... Greenspan's presence in China last week didn't help the White House... In fact, Snow seemed to retreat from his campaign to force China to let the yuan rise. ... The trip did offer the Fed chairman a chance to visit the scene of what history may show to be one of his biggest blunders: China's asset bubble. ... It may seem a reach to blame Greenspan and the Fed for irrational exuberance in markets like Shanghai real estate. Yet globalization has globalized the Fed. While it has 12 districts in the U.S., its influence has never been greater. Think of Latin America as the 13th district, Southeast Asia the 14th, Russia the 15th, China the 16th, and so on. The Fed's policy of keeping interest rates low in the first half of this decade fueled ... a cheap capital-fueled investment boom in China.  ... The trend has manifested itself in a variety of ways, including fueling a surge in the use of derivatives. ... The upshot may be untold amounts of leverage and risk in a global financial system... And for that, Greenspan's easy-money policies bear some blame. ... Greenspan probably isn't preoccupied with China's liquidity excesses. It's doubtful he'd even acknowledge a relationship between Fed polices and China's challenges, given how artfully he's sidestepped responsibility for excesses in U.S. stocks, housing and Treasury yields in recent years...

I agree this trip was no success from the administration's perspective. However, global excess liquidity caused by Fed policy is not the reason for China's asset bubble and since the premise is unacceptable, it's difficult to pin the result on Greenspan. As has been discussed thoroughly here and elsewhere, the global excess liquidity hypothesis finds very little support as a primary foundation for explaining low world interest rates. Let me first turn to Brad DeLong, then David Altig. Both Brad and David have links to further discussion on this issue. Here's Brad:

Brad Delong: Global Excess Liquidity?: I don't understand the argument that even though inflation is not accelerating, the world nevertheless suffers from "global excess liquidity" ... What happened was not a rise in savings, but a fall in investment as first the collapse of the dot-com bubble and then 9/11 increased uncertainty and diminished businesses' willingness to undertake risky investments. ... In response, the Federal Reserve (and other central banks) shifted to easy money... Are interest rates now "too low"? The usual answer is that interest rates are too low when inflation is accelerating. As long as inflation is stable, that means that the supply of goods and services is roughly equal to the demand for goods and services ... Inflation is roughly stable...

And here's David Altig:

David Altig: Global Dollar Demand And The U.S. Housing Market: ...This is ... a variation on a theme I have emphasized in the past: The "interest rate conundrum", ...[is] fundamentally driven by the desire of foreigners to send their financial capital to the United States. .... Several of my fellow bloggers -- Brad DeLong, pgl, William Polley, and Mark Thoma -- commented on an article appearing a few weeks back in The Economist, suggesting that an explanation that hinging on excess creation of liquidity. Several of these commentators were skeptical about The Economist's position. Count me in on that. Although this will seem hopelessly old-fashioned, here is the recent record on money creation in the United States ... Broad money growth in the 4-6 percent range with nominal GDP growing at a 5-6 percent annual rate just doesn't spell excess liquidity to me. ...

The article is remarkably silent, just a few words, on China's policy of fixing exchange rates. It also does not cite the usual reason for given for excessive risk taking, misperceptions of risk due to an unusually high degree of stability in financial markets in recent years. Even if the Fed had created China's asset bubble, it would only be concerned to the extent that it might feedback onto the domestic economy. There are twelve Fed districts. Period. There may be reasons to criticize Greenspan, but creating China's asset bubble is not among them.

    Posted by on Monday, October 24, 2005 at 01:23 AM in China, Economics, International Finance, International Trade, Monetary Policy | Permalink  TrackBack (1)  Comments (12)

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