Mr. Chairman, You Can't Control China. So Just Relax.

It is sad that even Ben Stein understands the economy's troubles and Greenspan does not!

By BEN STEIN
Published: May 22, 2005

To: Alan Greenspan
Chairman, Federal Reserve Board
Washington, D.C.

Dear Mr. Greenspan:

You have always been a great friend to the little Stein family. You invited us to your viewing of the Fourth of July fireworks for many years. You spoke warmly and kindly of my father on his 80th birthday and after his death. My father, an economist like you, often said that you were the best Fed chairman ever. And I am sad that you will soon retire.

In the same spirit of friendship that you have shown to my family and to the nation and world, I hereby offer you some possible mental and emotional relief on two perplexing economic and monetary policy issues.

First, you recently pronounced that you were puzzled by what you called the "conundrum" of why long-term interest rates were so low, as the economy gathered steadily more strength and as inflation heated up, albeit to a lukewarm temperature.

May I suggest a reason for the low long-term rates? It has to do with a certain circularity in the world flows of capital. American consumers and businesses buy far more from the Japanese and the Chinese than the United States sells to them. The difference is in the hundreds of billions of dollars annually. The Asians do not respend this money in America by buying Big Macs. Instead, they use a large chunk of it - again, hundreds of billions - to buy Treasury bonds.

That creates a floor under the dollar, keeps their own currencies low and makes their products very competitive. But this voracious buying of Treasury bonds - at varying lengths of maturity - keeps a high floor under bond prices as well. That, in turn, keeps the interest rate low, because interest rates move inversely to bond prices.

In other words, interest rates are suppressed at very low levels by the recycling of the trade deficit into Treasury bonds. It may be just that simple.

In turn, this keeps the mortgage rates low, props up the amazing housing boom and starts to affect commercial real estate in a big way, too.

Maybe I am missing something here, but this is at least a possible answer to your conundrum.
Second, there has been much speculation in the financial press and in the groves of academe to the effect that the inflation, such as it is, is caused by the rise in oil prices in recent months and years. At my local gas station in Beverly Hills, self-service - yes, self-service - high test is now $3.22 a gallon, so I believe that the concern is real. But why will raising interest rates to slow down American growth affect those oil prices?

As we both know, much of the increased demand for oil in recent years has come from the soaring Chinese economy. If Chinese demand is setting oil prices at the margin, why bother curbing the already-slowing American economy to lower oil demand? It can't be so that slower demand here will slow the Chinese economy, too. American interest rate changes will have a tiny effect on China, because slower demand would have to work through many layers of currencies, exports and lack of replacements.

So maybe we have had enough effort at curbing the United States' economy, and we should just let the slow processes of price elasticity work their magic and find substitutes for oil.
To put it another way, why cut down growth in America if that growth has nothing or little to do with the causes of inflation? It may be that this is a case beyond the control of monetary policy in the United States. It is probably not even remotely beyond the reach of Chinese monetary policy.

But why punish the small-business owner in Canton, Ohio, because a large business in Canton, China, is demanding more oil and can pay for it? Why put us even remotely at risk of recession over a cause for inflation that is, like the computer on which I am writing this letter, made in China?

IT may be better to keep a close eye on the housing situation. In Florida, buyers are lining up at new developments to buy three houses or condominiums at a time - and I was told while I was at a conference on finance in Key Biscayne two weeks ago that some developers are demanding that the buyers kick back a share of any gains made on flipping the homes within a year.

This has the distinct look of something that should not be happening. Good, solid homes for people to live in: that's fine. Their prices should go up. Limo drivers in Key Biscayne speculating in property on no money down? That does not look like a good harbinger.

By any chance, are your interest rate increases aimed at this issue? If so, I don't think they'll work as long as China and Japan are distorting interest rates downward. Maybe the bubble in resorts has to burst all by its bad self.

Anyway, these are my humble thoughts. They may well be wrong.
And wherever you go after leaving the Fed, we shall miss your sensible hand at the tiller. And the fireworks.

Respectfully submitted,

Ben Stein