In a competitive, cutthroat world where no-one escapes derision and mistakes are trumpeted to kingdom come, Alan Greenspan is considered a man above others. Wall Street – tired of ordinary men – looks for more and more ‘supermen’. By all accounts, Alan Greenspan is a ‘superman’. He has steered the American economy through historic crashes, terrorist attacks, wars, record inflation, and spectacular natural disasters. He is the most powerful Central Banker in the world – and in the opinion of a few, the most powerful man in the world. But there comes a time for even superheroes to retire, and Mr. Greenspan, whose 18 year reign as Chairman has been rather good for the economy, is leaving next year.
The announcement this week that Ben Bernanke, a Princeton economist and Chairman of the Council of Economic Advisors, will be replacing Mr. Greenspan provided some relief to legions of bankers, investors, and economists, for whom this selection is excitement equivalent to the outcome of the Superbowl. It seems rather perverse, but the fact that everyone breathed a sigh of relief when the President did not pick an unqualified crony for the job of Federal Reserve Chairman speaks volumes about the competency of the current administration.
Fittingly enough, the new Chairman will have to deal with the excesses of a supposedly conservative President who spends like a drunken sailor. America’s twin deficits – the current account deficit and the fiscal deficit – are a cause of concern to many, chief amongst them Mr. Greenspan, who sounded noticeably concerned about consequences of the Republican spending binge in his recent address to Congress. He noted that rises in health care costs were outpacing economic growth, resulting in increased Federal spending on health and retirement programs. In his testimony he stated, "Specifically, large deficits will result in rising interest rates and an ever-growing ratio of debt service to G.D.P. Unless the situation is reversed, at some point these budget trends will cause serious economic disruptions."
America’s current-account deficit, currently higher than $700 billion, was identified as one of the chief threats to the global economy in the International Monetary Fund’s World Economic Outlook. Economists from all sides – even left-wing economists – have been shouting themselves hoarse over the record imbalances. With $200 million bridges to nowhere (I am looking at you Alaska), pork-happy Congress doesn’t seem to care. Only a full-on recession (which many economists deem likely) will command their complete attention.
Thankfully, Mr. Bernanke seems more than qualified to combat any such recession. He has experience on the Board of Governors, serving as a member from August 2002 to June 2005, when President Bush tapped him to head up the Council of Economic Advisors. He is a celebrated academic economist, having served in the Economics departments at Stanford and Princeton. He is currently the department Chair at Princeton.
Economists seem upbeat about the nomination; Mr. Bernanke, unlike most of President Bush’s appointments, has drawn praise from both sides of the political aisle. Right-of-center economist Andrew Samwick, Director of the Rockefeller Center at Dartmouth, extolled Mr. Bernanke’s research credentials, stating “I am particularly pleased that someone with such a talent and insight for research will be at the head of the Fed's staff of professional economists.” Tyler Cowen of Marginal Revolution gave Mr. Bernanke high grades on almost all measures, but expressed reservations about his credibility on Wall Street, noting that he has spent most of his career as an academic and it will be some time before he develops a good stature in the corporate world. Even Paul Krugman, a prominent economist and New York Times columnist known for his militant aversion to the Bush administration, had kind words for Mr. Bernanke.
These academics are probably calmed by Mr. Bernanke’s commitment to continuing Mr. Greenspan’s policies. Yet the two men differ in their views regarding the chief concern of the Federal Reserve – inflation-fighting. Mr. Bernanke brings with him a new tool: inflation-targeting – the idea that the Central Bank should set a public target for inflation. It has already been adopted by other Central banks around the world, most prominently by the European Central Bank (ECB). Mr. Greenspan did not warm to the idea during his tenure. Mr. Bernanke has also made clear that he won’t shrink from using radical tools to combat deflation, such as buying long-term bonds. Critics see this as directly handing money to the citizens; he has received the epithet “Helicopter Ben” for his views.
Although Mr. Bernanke is no political stooge, his views on the issue of America’s external imbalances is troublesome. He subscribes to the theory that America’s deficits are natural and have come about due to excess saving in Asian countries where there are few profitable investment opportunities – a ‘global savings glut’. The evidence for this hypothesis is sparse and contradictory. Most disturbingly, his hypothesis gives political ammo to the non-economists in Congress who can point to it when explaining away record deficit spending and massive increases in the size of government.
Mr. Bernanke shares Mr. Greenspan’s views on asset-market bubbles: they will take care of themselves. Mr. Greenspan famously allowed the dot-com bubble to burst, allowing the Fed Reserve to become active only afterwards by pumping excess liquidity into the market through interest-rate decreases. This is important because Mr. Bernanke will likely have to deal with the aftermath of the growing housing bubble. Estimates of its size vary, but everyone agrees that a correction will be painful. The issue is directly related to Mr. Bernanke’s ‘global savings glut’ theory, as The Economist notes, “Mr. Greenspan himself has argued that surging house prices and massive home-equity extraction explain the fall in America's household saving in recent years, and hence much of the increase in the current-account deficit.”
The Economist reports that 40% of all new private-sector jobs have been in areas related to housing, a direct result of the asset-market bubble. Borrowing against home equity, Americans are living beyond their means; the household savings rate this year has been negative, falling to -1.1 percent last month. Also, the investment Mr. Bernanke talks of is going towards US government securities, which do not spur economic growth allowing for the repayment of our debt. Indeed, the US government has squandered most of the capital in foreign wars and massive increases in entitlements. If there is a global savings glut, America sure isn’t using it productively.

As Fed Chairman, there is little he can do to combat the situation. The IMF sees balancing the budget as a more appropriate strategy than raising the interest rates. Of course, while the Fed Chairman – elected for a 4-year term – is free from political pressures, his counterparts in Congress, who control fiscal policy, are free from any willpower to go against political pressure.
Given the magnitude of challenges faced by Mr. Bernanke, it appears unlikely that he will attain the public-relations success of Mr. Greenspan, whom investors continue to worship. At the end of the day, it is a thankless job. The painful measures will surely need to take in order to ensure things go smoothly will certainly make him unpopular. Let us hope that when Mr. Greenspan exits, he leaves behind his famous ‘sixth sense’ for macroeconomic policy for his successor. Mr. Bernanke will certainly need it.