The Alchemists: Three Central Bankers and a World on Fire (12 page)

“
To this outsider
,” Bernanke said in January 2000, “Japanese monetary policy seems paralyzed, with a paralysis that is largely self-induced. Most striking is the unwillingness of the monetary authorities to experiment, to try anything that isn’t absolutely guaranteed to work.”

Indeed, Hayami was eager for any excuse to get away from a low-interest-rate policy—and began backing away from the policy in the early months of 2000, when the Japanese economy did seem to be gaining some ground. “
We are getting closer to the stage
where we can say deflationary concerns have been wiped away,” Hayami said in a May 2000 news conference that essentially reneged the earlier promise of a long period of low rates. The policy was formally abandoned in August as the bank hiked rates back up to 0.25 percent and then to 0.5 percent.

When the Japanese economy slumped again, Hayami’s BOJ took a different step: quantitative easing. “The BOJ had to do something to ease, but the governor did not want to do exactly the same thing, because it would be clear that he had made a mistake,” said Ueda. So in addition to cutting rates back to zero, the bank began buying bonds to increase the amount of money in the economy, aiming for the Japanese banking system to increase the number of yen on its books from four to five trillion, a rise then equivalent to about $8 billion.

“
The decision to end the zero-interest-rate policy was not wrong
,” Hayami said in a press conference announcing the change in March 2001. Driven by the governor’s desire to save face, the action was something that no modern independent central bank had undertaken before. Almost against his will, Masaru Hayami had pioneered a very unusual type of monetary policy—one that Helicopter Ben and the Federal Reserve would adopt a decade later to fight the megacrisis.

“
It was a very difficult decision to make
,” Hayami told reporters in 2003. “It was the first time that this had been done. I was very unsure and even felt fear. At times like those, I would remember . . . that God is always with me, that Jesus loves me and that He sees and knows all.”

•   •   •

C
entral bankers are a conservative bunch. The awesome responsibility that society grants them comes with a demand for certain traits: seriousness, sobriety, caution. No head of state would entrust control over an entire economy to someone inclined toward frivolity and risk-taking. Most of the time, that’s just fine. We want central banks to be led by people who are boring. The idea of “first, do no harm” is a powerful one, and a central banker who was too quick to experiment could do a great deal of harm to his economy.

But it is precisely when an economy needs the most help from a central bank that the job demands what seem like radical departures from orthodoxy. The very qualities that lead to a person’s being selected to help lead a central bank make him reluctant to engage in the bold experimentation that might help get an economy out of a deep rut.

For all its excessive caution, the Bank of Japan did eventually cut rates to zero, pledge to keep them there, and purchase a variety of assets with newly created yen—and even those efforts weren’t enough to “fix” the economy. A generation of Japanese has seen diminished prospects; if economic output per person had risen at the same pace from 1991 to 2011 in Japan as it did in the United States, the average Japanese person would have an extra $9,500 a year in income.

Monetary policy is indeed powerful—but it’s not all-powerful. As Princeton economist Alan Blinder put it in the closing session on that fall day in 1999 at the Woodstock Inn, “
Does an economy with a zero nominal interest rate
follow more or less the same economic laws as it does in normal times—except that one variable is stuck at zero? Or is the situation more akin to physics at zero gravity, or near absolute zero temperature, where behavior is fundamentally different, even strange? I think the conclusion we seem to be reaching here at Woodstock is that it may indeed be a new world.”

Ueda, representing the Bank of Japan, closed the event with a pledge—and a warning that would prove all too prescient once the Federal Reserve, the Bank of England, and the European Central Bank had joined their Asian counterpart in the strange new world of ZIRP.

“I promise
,” he said, “to bring all the interesting ideas I have heard in this conference to the attention of my colleagues in Tokyo. Meanwhile, I must say that one of the most important messages of the conference has been: Do not put yourself into the position of zero rates. I tell you it will be a lot more painful than you can possibly imagine.”

The Jackson Hole Consensus and the Great Moderation

F
or the world’s central bankers, the gathering at Wyoming’s Jackson Lake Lodge in August 2005 was a moment of triumph. After centuries in which their predecessors had frequently failed to guide the nations of the world through boom and bust, inflation and deflation, they had finally, it seemed, learned all the important lessons of how to manage an economy. The 110 central bankers and other economists convened in the Explorers Room seemed to have all the answers, and they had created a more stable and prosperous world than any known before.

One scholar after another took to the lectern in that Friday morning, standing beneath elk-antler chandeliers to pay tribute to the great man. Alan Greenspan, slightly hunched and with big glasses, a hangdog face, and a smile as enigmatic as that of the
Mona Lisa,
was soon to step down as the chairman of the Federal Reserve, the central bank that decided the fate of the then $12.6 trillion U.S. economy, the largest in the world. Colleagues from nations large and small in every corner of the globe had come together to see Greenspan off into retirement properly and consider his legacy. The official name of the event was the Federal Reserve Bank of Kansas City Economic Policy Symposium. But it’s known across the world of finance simply as Jackson Hole, for the ancient glacial basin where the gathering takes place each summer. If Basel is where central bankers come together to discuss the latest economic developments among themselves, Jackson Hole is where they address bigger, longer-range issues, surrounded by both the broader community of economic thinkers and spectacular scenery.

Taking the stage, Allan Meltzer, the leading historian of the Federal Reserve, asserted without reservation that Greenspan held “the top rank” among the many men who’d run the central bank in its ninety-two-year history. Bank of England governor Mervyn King said that Greenspan’s “departure from the central-banking scene will deprive us of a source of wisdom, inspiration, and leadership.” Two other colleagues, while acknowledging “some negatives” in Greenspan’s record, wrote that “when the score is toted up, we think he has a legitimate claim to being the greatest central banker who ever lived”—praise that seems all the more generous when one considers that the lead author of that paper was Princeton’s Alan Blinder, who had resigned as Greenspan’s vice chairman after a brief and unhappy experience a decade earlier.

If anything, people outside that room had been even more effusive in their praise. Bob Woodward titled his 2000 book about Greenspan
Maestro
. The year before,
Time
magazine had put Greenspan on its cover as a member, with Bob Rubin and Larry Summers of Bill Clinton’s Treasury Department, of “the Committee to Save the World.” He was named a commander of the French Legion of Honor and granted an honorary British knighthood. (“
It’s a very unusual day for an economist
,” Greenspan said after Queen Elizabeth II knighted him at her Balmoral estate in Scotland.)

It was the high point of what had already been dubbed the Great Moderation—a moderation, that is, of the various forces that had whipsawed national economies in centuries past: boom and bust, inflation and deflation, financial panic and its attendant destruction of wealth. The U.S. economy had been expanding for a quarter century, interrupted by only two brief and shallow recessions. The unemployment rate averaged 5.5 percent during Greenspan’s nineteen years in office, compared with 6.4 percent in the preceding two decades, and inflation was held in check. The great powers of continental Europe, after a century in which they regularly met each other on the battlefield, had become so intertwined economically that they were sharing a currency. The British economy was in a veritable boom, with London prospering as a global banking hub and threatening to reclaim from New York the title of world financial capital. China and other developing nations were growing rapidly, pulling hundreds of millions of people out of dire poverty into the global middle class, in no small part by absorbing the lessons of free markets and their sound management taught by the West’s leading economic thinkers.

The men and women in the Explorers Room had a sense of common purpose, believing that they were guiding the entire world toward an ever more prosperous future—and doing quite a good job of it, thank you very much. They had learned from the mistakes of their predecessors and had the knowledge, the tools, and the will to keep even the nastiest of economic events from leading to widespread human misery. During Greenspan’s time as Fed chair, there had been two recessions, and the Great Moderation also included two stock market crashes in the United States, a long economic stagnation in Japan, and financial crises in Mexico, Russia, and Argentina. But none of these became a global calamity.

In Jackson Hole in 2005, it seemed as if the world’s economic problems had been more or less solved.

•   •   •

T
he Federal Reserve Bank in Kansas City, Missouri, one of the twelve regional outposts of the U.S. central bank, in 1978 began hosting an annual conference for scholars to gather and present their research. It was a low-profile affair at first, rotating among various cities and focusing on matters close to the hearts of those living in the Rocky Mountain region the bank served. “Western Water Resources: Coming Problems and the Policy Alternatives” and “Future Sources of Loanable Funds for Agricultural Banks” were two early topics. No one attending the first few conferences would have confused them with events of global significance.

Roger Guffey, the Kansas City Fed president, and Tom Davis, its head of research, wanted to change that, to make the conference something special among economic policymakers. The first step was to shift the discussion from local concerns such as water and agriculture to broad issues of monetary policy. The next was to attract a top-tier crowd—which meant securing the attendance of Federal Reserve chairman Paul Volcker. Volcker was known to be a devotee of fly fishing, and Guffey and Davis surmised that if they could hold the event at a time and place with good opportunities to fish for trout, Volcker would come—and where Volcker went, the great economists and policymakers of the day would follow.

Davis called up a contact in Colorado, where the event had been held in the recent past.

We need a place for our symposium where people can fish for trout, he said.

“
What time of year are you going to hold it
?” the contact asked, Davis later recalled. August was the answer.

“Well, if you’re going to hold it in August, you can’t fish for trout in Colorado because it’s too warm . . . Can you go to Wyoming?”

As we’ve seen, Volcker was under intense criticism for his high-interest-rate policies back in the muggy former swampland of Washington; the neighborhood where the Fed’s offices are located is called Foggy Bottom for a reason. Debt-loaded farmers surrounded Federal Reserve headquarters with tractors. Texas representative Henry B. Gonzalez even called for the chairman’s impeachment. Guffey and Davis’s 1982 invitation to fish and talk shop somewhere far away from the office couldn’t have been better timed.

Volcker quickly became a regular
in the crisp mountain air of Jackson Hole, one year staying out so long fishing that he showed up for the formal opening dinner still wearing his angling gear. Soon many of the world’s other central bankers started making the voyage to the tiny airstrip hard by the Rockies every August as well. Today, most tourists roaming the Jackson Lake Lodge’s RV-studded parking lot seem unaware that the people milling around near the lobby’s stuffed grizzly bear are among the world’s top economists and most powerful policymakers. They are invariably more impressed by the CNBC camera crew set up outside and the intense-looking, earpiece-wearing security guards than the central bankers themselves.

The 110 attendees, including a handful of journalists, are chosen by the Kansas City Fed president, with the guest list constrained by the size of the Jackson Lake Lodge’s fur-trapper-modernist ballroom. This is surely the only conference of its type to which a Nobel laureate such as Berkeley economist George Akerlof would find himself invited only as the spouse of San Francisco Fed president Janet Yellen, not on his own account. Inevitably, small talk at the kickoff dinner devolves to analyzing who is and isn’t in attendance that year.
New York Times
columnist Paul Krugman
, himself a Nobel laureate and once a regular attendee, concluded that he was blackballed from the conference for criticizing Greenspan too harshly.

By 2005, Jackson Hole had its own traditions and even folklore. Don Kohn, who was a Greenspan adviser and vice chairman of the Fed until 2010, leads a Friday afternoon hike known as the
Don Kohn Death March
for its strenuousness; economists who are happy to chatter about monetary policy transmission mechanisms during the first mile tend to be too winded to do so by the last. The European attendees grumble about the American-style coffee, and one year—no one can quite remember which—European Central Bank president Jean-Claude Trichet gave from the podium a politically incorrect explanation of why the French trappers who first came across the nearby mountains called them “les Grand Tetons.” Then there’s the old saw, repeated with many permutations, about the central banker who entered the lodge’s gift shop and asked for a copy of the
New York Times
. “Do you want today’s or yesterday’s?” the possibly apocryphal clerk is said to have asked. “Today’s,” replied the perplexed banker. “Then come back tomorrow.”

In the formal sessions, a series of economists stand and present academic papers on which the rest of the participants then comment, sometimes scathingly. The major economic journals may be considered more desirable venues for works of high-grade macroeconomic theory, but Jackson Hole is where papers on the practical questions of how to manage a modern economy are delivered and discussed. Here the focus is on the concrete decisions facing policymakers. Were interest rates kept too low in major industrial economies in the early years of the 2000s?
At Jackson Hole, two top academic economists
, John Taylor of Stanford and Alan Blinder of Princeton, might offer contrasting views, both in response to a paper by Charles Bean, the number two official at the Bank of England charged with actually making interest rate decisions for a nation of sixty-two million people.

But the informal sessions might be a greater attraction for many central bankers, some of whom travel from the other side of the earth to attend. Besides fishing trips and hikes, there are between-session coffee breaks, western-style buffet meals on Friday and Saturday nights, and, for a persistent few, late-night talks at the Blue Heron Lounge over a bottle of Snake River Pale Ale or glasses of whiskey. A few smoke cigars.

It was over these cigars and meals and coffees and hikes that the “Jackson Hole Consensus” was formed. Bean coined the term in a paper presented at the conference in 2010, referring to the mutually agreed-upon “ingredients of a successful policy framework” for central banking. But the Jackson Hole Consensus was more than just the collective wisdom of the world’s leading central bankers; it was viewed as almost a recipe for how to keep the Great Moderation going. Among the ingredients:

• Monetary policy is the best means of economic stabilization. The messy realities of politics mean that fiscal policy—taxing and spending—isn’t a very good tool for dealing with the routine ups and downs of the economy. Let central bankers handle those by adjusting how much money to push into or suck out of the banking system.
  
• Central bankers are at their best when insulated from politics. Let us make our own decisions about what is best in the long term, without you politicians hassling us.
  
• Stable prices are the goal. The best thing we central bankers can do for an economy is make sure that prices change gradually and predictably over time.
  
• Markets work. The prices of assets—tech stocks, say, or houses in Florida—are determined in markets that are pretty darn efficient. Sure, there might be the occasional bout of irrational exuberance, but it’s better for us to clean up the mess afterward than to try to deal with those bubbles proactively.
  
• Financial crises are history. An advanced nation, with skilled central bankers and modern financial markets, could never have the kind of catastrophic financial crisis that drags down an entire economy for a generation. We know too much about how to prevent it.
  

These ideas weren’t outlandish given what the world was experiencing. Consider the events in the United States just a few years before. The stock market had ascended to too-good-to-be-true heights throughout the late 1990s, rising more than 20 percent each year from 1995 to 1999. Investors had convinced themselves of the emergence of a “New Economy” promising both perpetual prosperity and astonishing returns on even the most ill-planned ventures that happened to have “.com” in their names. Just as that bubble was bursting and reality was setting in, in September 2001 the United States suffered a devastating terrorist attack that created a wave of fear and panic across the land, instigated years of war, and even destroyed some of the physical infrastructure of the U.S. financial system by rendering much of lower Manhattan inaccessible.

And amid all that, what happened? The Federal Reserve began lowering its target for short-term interest rates in January 2001, just as the stock market decline began to pinch the broader economy, and it cut rates eleven times that year—once just six days after the September 11 attacks—so the tumbling stock market was counteracted by cheaper money, which created greater financial incentive for consumers to buy cars and houses and for businesses to borrow money to buy new equipment. The morning of the attacks, the Fed—Greenspan was in transit back from Basel, so Vice Chairman Roger Ferguson was in charge—issued a statement: “The Federal Reserve System is open and operating. The discount window is available to meet liquidity needs.” Translation: The Fed is ready and willing to flood the banking system with dollars to avoid a situation in which Americans show up at their ATMs to withdraw cash but can’t because their bank is out of money. Within a few days, the Fed was swapping dollars with the European Central Bank, the Bank of England, and the Bank of Canada to try to prevent the global banking system from shutting down.