Overwhelmed by excess global savings

Wall Street Journal Fed-channeler Greg Ip interviewed former Fed chief Alan Greenspan for the front page story How Credit Got So Easy And Why It's Tightening($) in today's paper, but the really good stuff from their talk is tucked away at the always interesting (and still free) WSJ Economics Blog.

In summary, here's what the old guy had to say:

1. Things are going to get worse
2. It's not his fault
3. Fiat money deflation terrified him
4. It's China's fault
5. Going to excess is good
   

Seriously, here it is:

1. Will the problems in the credit markets affect the broader economy? Former Federal Reserve Chairman Alan Greenspan suspects so. “There’s some evidence it’s beginning to affect present consumption expenditures, such as two months of softer motor vehicle sales,” he says in an interview.

2. Yet Mr. Greenspan doesn’t agree, as some critics do, that the Fed’s decision to keep interest rates low under his leadership earlier this decade was the main driver of the borrowing boom that preceded the current turmoil. Mr. Greenspan moreover suggests the policy must be evaluated against the environment and risks the Fed faced at the time, and that the innovations that fueled the boom are a net positive.
...
3. Mr. Greenspan had once believed deflation was impossible with a paper currency, since the Fed, unconstrained by the gold standard, could simply print money until it created inflation. But Japan’s experience with deflation and economic stagnation in the 1990s had demonstrated otherwise, and impressed upon him the importance of avoiding that experience.
...
“We decided that in 2003 that though we judged the probability of severe deflation as small, were it to happen, its consequences were seen as devastating. So we chose to take out insurance against them, fully recognizing at the time that we were taking risks in the process. But central banks cannot avoid taking risks. Such tradeoffs are an integral part of policy. We were always confronted with choices.”

4. Some at the Fed argue its policy can’t explain the greater part of the housing and borrowing boom, which took place in 2005 and 2006 — after the Fed had moved short-term rates up considerably.

Mr. Greenspan agrees: “We tried in 2004 to move long term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed. We were overwhelmed by excess global savings that continued to press real long term rates lower.”

5. Mr. Greenspan believes that in spite of the current turmoil, the U.S. is better off for having had the expansion of credit markets, alternative investment vehicles and derivatives.

“History tells us it’s far better to have people periodically going to excess with its adverse consequences than to try to block it off in the beginning. These adverse periods are very painful but they’re inevitable if we choose to maintain a system in which people are free to take risks, a necessary condition for maximum sustainable economic growth. We have learned to move risk from the leveraged institutions which are the major lenders in this country to those far more capable of absorbing loss. It’s why our economy in recent years has developed the flexibility to absorb severe adjustments.”

Go ahead and read that last paragraph a couple times because it contains more insight into what went through his head than 18 years of speeches and Q&A sessions before Congress.

In layman's terms it means, "Never, ever take away the punchbowl. Instead, spike it!"

Amazing.