ALAN GREENSPAN: PIGMY OF THE UNIVERSE?

There was a time when Alan Greenspan, Chairman of the Federal Reserve Bank, was considered the master of the economic universe. Each time he appeared before a Senate committee, the meetings were so important to the well-being of the nation that the television cameras whirred and he was usually the main feature on the nightly news. He was a giant, and the entire world of developed nations seemed to hang on his every word.

But not lately.

Something has gone radically wrong. In the past 14 months, he has raised interest rates 10 times, with little or no effect. As he and the Fed keep raising short-term interest rates a quarter point at a time, the ten-year Treasury Bond is supposed to increase accordingly, which would dampen both inflation and the economy, especially the overheated housing market.

But much to the surprise of Mr. Greenspan (and most economists), the ten-year Treasury Bond keeps hanging around at about 4.3 percent. And there is widespread fear among economists that short-term rates may soon exceed long-term rates ... which would plunge the American economy into fearful circumstances. Nobody knows exactly why this would happen, if it would, but the economists are certainly fretting. In any event, it is the ten-year Treasury Bond which influences mortgage rates, not Mr. Greenspan's short-term rates. So mortgage rates remain historically low and the housing market burbles on despite Mr. Greenspan's best efforts to dampen things.

It appears to me that Mr. Greenspan is being hung by his own petard: liquidity.

Back when Mr. Greenspan was a giant, he attempted to explain his role in the economy in terms of "liquidity," which means how much money is floating around in the economy. When liquidity goes up too much, there are too many dollars available for the amount of food, clothes, cars and other goods available to the consumer. This results in inflation, which is a bad thing.

When the economy is illiquid, there are too few dollars buzzing about for the number of goods available. This results in deflation, which is a bad thing because recessions can result. The Great Depression of the 1930s was an extreme example of an illiquid economy. It took the huge deficit spending of World War II to pump enough dollars into the economy to pull us out of that horrible economic quagmire.

To Mr. Greenspan, adjusting short-term interest rates was simply a tool with which the Federal Reserve could adust liquidity so as to control the economy's tendency to move toward inflation or deflation. It was sound thinking, being based on the only economic theory that actually works – the Law of Supply and Demand. But the members of the the Senate and Congressional committees who listened to Mr. Greenspan insisted on concentrating on interest rates and not the concept of liquidity, perhaps because to them liquidity meant bourbon and scotch.

In fact, Chairman Greenspan should have listened more closely to himself because the concept of liquidity is what has rendered him powerless in the last 14 months. You see, in the years Mr. Greenspan was narrowly focused on national liquidity, the American economy had gone global. Which means that we are now confronted with the issue of global liquidity, which no single country can control, let alone one individual.

As long as the governments of China, Japan, India and others keep snapping up U.S. ten-year Treasuries, the price of the bonds will remain high and the yields or interest rates will remain low. It really doesn't matter what Mr. Greenspan does with short-term interest rates. The whole thing is quite out of his control. As the kids used to say, the honored Chairman is up the creek without a paddle. He still has some influence, but it's difficult to paddle a canoe with a dinner knife.

In fact, things have changed so much with the globalization of liquidity that the economists seem shackled to the past. They continue to look at the ten-year Treasury Bond as a financial instrument, although it has morphed into something quite different. Today the long bond is a simply commodity like steel, cement or oil. With an excess of dollars, yen and yuan in the world chasing after American ten-year Treasuries, the price will stay high and the yields or interest rates will remain low. It's all a matter of adhering to the laws of supply and demand: a law which is much more powerful than any Federal Reserve chairman, or President, for that matter.

Mr. Greenspan will continue to raise short-term interest rates, but demand for the American ten-year Treasury Bond will keep mortgage rates low, and the housing market will move merrily up and on.

The truth is that Alan Greenspan is not a pigmy. But he never really was a master of the universe, either.