Central Banker Heaven and the U.S. Economy

Last Friday I attended the Business Forecast Luncheon in Dallas, sponsored by the University of Chicago Graduate School of Business. Guest speakers were Dr. Robert Aliber, Professor of International Economics and Finance (Emeritus) at the University of Chicago and Dr. Harvey Rosenblum, Executive Vice President and Director of Research, Federal Reserve Bank of Dallas. The talks were excellent as they were last year.

What really drives me to write this post is that we are seeing Alan Greenspan retire. When I think about things, he’s close to the only central banker that I have experienced during my entire adult/business life, where Greenspan has reigned for some 18+ years. Central banking has an important effect on business and the health of the economy, and this something that the luncheon speakers are renowned experts on.

The general consensus was that Alan Greenspan will go to “Central Banker Heaven”. More on this later.

While last year’s forecasts focused on the deficit and the exchange rates, what came to the forefront this year were three things that will impact the economy for the next twelve months. These are: the (deflating) housing bubble, term structure of interest rates (and the inverted yield curve), and the philosophies and makeup of the new chairman (Ben Bernanke).

Although I will gloss over the individual perspectives of the two speakers, my general takeaways on the three areas were the following:

• Housing bubble is deflating – Apparently in the areas of concern (e.g., Boston, Southern FL, CA), prices are starting to fall 10%ish. Well-known builder, Toll Brothers, has had its stock price fall some 50% (note I have not verified), plus they have cut back their forecast on building out. More generally beyond Toll Brothers, housing inventories are starting to build up. If one subscribes to a doom-and-gloom forecast, housing bubbles have historically demonstrated price declines of an additional 40%.
• Inverted yield curve is disturbing – In 8 of 9 times when the yield curve inverted, the economy had slumped into a recession within one year.
• New chairman philosophically tends towards being a price-level setting person, as opposed to one that takes a long-term view of the economy first – Price-level setting philosophies involve having a target inflation rate in mind and then setting the interest rates to obtain that rate. In some countries, this policy is taken to an “extreme” where concern for other factors, such as unemployment rates, are ignored. Wild cards in the U.S. include the fact that the international world is less stable, and that long-term energy/oil impacts associated with unstable countries (which may each comprise 5% to 6% of supply) should not be ignored when pursuing price-level setting at the central bank.

So all-in-all, the forecast for the U.S. economy over the next twelve months was mildly positive, with some areas for attention. The March meeting for the central bank will be key, as this will shed some light on how the new Fed chairman handles his new role.

Which brings me to my earlier about getting into Central Banker Heaven. Greenspan has been praised by having all of the key skills and a proven-performance record:

• an ability to show independence from the administration and partisan views
• deep knowledge of history and economics (which both Greenspan and Bernanke share)
• inflation-fighting skills with a long-term view.

But in some sense, while Greenspan has had all of these skills, it could be argued that he also got lucky (being good and lucky is the best of all worlds). During Greenspan’s tenure, he did not have to deal with chronic problems. Now, Ben Bernanke has a tough and important job ahead of him. He has a chronically unstable international world to deal with, and he has to show his inflation-fighting abilities with a long-term view that people like Greenspan so carefully considered.

I thank Alan Greenspan for his service. I wish Ben Bernanke the best of luck for our people and future generations.

Update (2/16/06): Bernanke addresses Congress just yesterday.