What is most notable in sifting through the variables that might conceivably account for the lacklustre rebound in GDP growth and the persistence of high unemployment is the unusually low level of corporate illiquid longterm 64257xed asset investmen ID: 34512
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AlanGreenspanTheUSrecoveryfromthe2008Þnancialandeconomiccrisishasbeendisappointinglytepid.WhatismostnotableinsiftingthroughthevariablesthatmightconceivablyaccountforthelacklustrereboundinGDPgrowthandthepersistenceofhighunemploymentistheunusuallylowlevelofcorporateilliquidlong-termÞxedassetinvestment.Asashareofcorporateliquidcashßow,itisatitslowestlevelsince1940.Thiscontrastsstarklywiththerobustrecoveryinthemarketsforliquidcorporatesecurities.What,then,accountsforthisexceptionallyelevatedlevelofilliquidityaversion?Ibreakdownthebroadpotentialsources,andanalysethemwithstandardregressiontechniques.Iinferthataminimumofhalfandpossiblyasmuchasthree-fourthsoftheeffectcanbeexplainedbytheshockofvastlygreateruncertaintiesembeddedinthecompetitive,regulatoryandÞnancialenvironmentsfacedbybusinessessincethecollapseofLehmanBrothers,derivingfromthesurgeingovernmentactivism.Thisexplanationisbuttressedbycomparisonwithsimilarconundrumsexperiencedduringthe1930s.Iconcludethatthecurrentgovernmentactivismishamperingwhatshouldbeabroad-basedrobusteconomicrecovery,driveninsigniÞcantpartbythepositivewealtheffectofabuoyantU.S.andglobalstockmarket.2011BlackwellPublishingLtd.9600GarsingtonRoad,OxfordOX42DQ,UKand350MainStreet,Malden,MA02148,USAInternationalFinance2011DOI:10.1111/j.1468-2362.2011.01277.x I.TheRiseofIlliquidityAversionTheLehmanBrothersbankruptcyofSeptember2008appearstohavetriggeredthegreatestglobalÞnancialcrisisever.Tobesure,theeconomicdisruptionoftheGreatDepressionofthe1930swasfarmoreextremeanddisabling,andthefailureofthousandsofbankscurtailedshort-termcreditavailabilityatthetime.Butthecall-moneymarket,thekeyovernightsourceofcreditinthosedays,remainedopenevenasratessoaredto20%.Incontrast,followingtheeventsofSeptember2008,globaltradecredit,commercialpaperandotherkeyshort-termÞnancialmarketseffectivelyclosed.ThefederalgovernmentÕsresponse,asubstitutionofsovereigncreditforprivatecredit(tomaintainvitalintermediation),canbeexpectedtoberequiredperhapsonceortwiceinacentury(Greenspan2010).ThedeÞningcharacteristicofthetepidrecoveryintheUnitedStatesthatfollowedthepost-Lehmanfreefallisthedegreeofriskaversiontoinvest-mentinilliquidÞxedcapitalunmatched,inpeacetime,since1940(Exhibit1).Althoughrisingmoderatelyin2010,USprivateÞxedinvestmenthasfallenfarshortofthelevelthathistorysuggestsshouldhaveoccurredgiventherecentdramaticsurgeincorporateproÞtability.Combinedwithacollapseoflong-termilliquidinvestmentsbyhouseholds,theseshortfallshavefrustratedeconomicrecovery.II.HumanNaturePrevailsTheinbredreactionofbusinessmenandhouseholderstouncertaintyofanytypeistodisengagefromthoseactivitiesthatrequireconÞdentpredictionsofhowthefuturewillunfold.Economistsseeanincreaseinuncertaintyintermsofrisingtailrisksofdistributionsofprospectivereturnsoninvestment.Moreover,sincealmostallhumanbeingsareriskaverse,weweighfearoflossmoreheavilythanequivalentprospectforgain.Hence,withincreasing Outrightsuspensionsofcriticalshort-termtradinginearlierperiodswererare.AsidefromWorldWarI,thecallmoneymarketshutdownforonlyonedayin1907.ThesigniÞcantriseinproÞtsandcashßowsincethespringof2009wastheresult,almostwholly,ofinvestmentsincost-savingfacilities.Throughouttheprolongedexpansionineconomicactivitybetween1983and2006,capitalinvestmentwaspredominantlyformarketexpansion,andyieldedquitehighprospectiveratesofreturn.Cost-savinginvestmentsduringthoseyears,whilemodestlyproÞtable,werefarlessattractivethanmarket-expand-ing,butriskieroutlays.Followingthecrashof2008,market-expandingcapitalinvestmentsdeclinedsharply.Butthebacklogofcost-savingpotentialinvestments,builtupovertheprotractedperiodofbusinessexpansion,offeredsigniÞcantopportunitiesforcost-savingoutlays.ThepayoffhasbeenamajorincreaseinproÞtmarginsandproÞtsthroughJuly2010,owingtosubstantialproductivitygainsintheuseofenergy,materialsandlabour.Marginshaveßattenedoutsince.2011BlackwellPublishingLtdAlanGreenspan uncertainty,negativetailrisksrisemorethanpositivetailrisks.Itistheweightedintegrationofthesedistributionsthatproducestherateofdiscountappliedtoexpectationsoffutureindividualinvestmentreturns.Arelatedcalculation,theequitypremium(theexcessreturnrequiredofequityovertherisk-freerate),hasbecomeexceptionallyelevated.AsestimatedbyJ.P.Morgan,inmid-2010itwasÔata50-yearhighÕbuthassinceeasedsomewhat.Fornon-Þnancialcorporatebusinesses(halfofgrossdomesticproduct),thedisengagementfromilliquidriskisdirectlymeasuredastheshareofliquidcashßowtheytoallocatetoilliquidlong-termÞxedassetinvestment(henceforth,thecapital-expenditure,orÔcapexÕ,ratio).IntheÞrsthalfof2010,thissharefellto79%,itslowestpeacetimepercentagesince(Exhibit1).FollowingtheLehmanbankruptcy,mostoftheremainderofnon-Þnancialcorporationcashßow,notexpendedonÞxedinvestments,wasreßectedinasurgeinliquidassetaccumulationthatamountedtomorethanUS$500billon. 0.51.01.5192919331985198920052009 Investment as a Share of Savingsplotted through 2009 Exhibit1:Investmentasashareofsavings Thispropensityismostevidentinstockmarkets,whoseaveragedailysizeoflosshas(statistically)signiÞcantlyexceededcomparableaveragedailygainsforthepasthalfcentury.Foradiscussionofinbredriskaversion,see(Greenspan2010,footnote18).Theshortfallisevenmorepronouncedfornon-Þnancialbusinessasawhole.BytheendofSeptember2010,totalliquidassets,accordingtotheFederalReserve,hadrisentoUS$1,932billon,comprisingthelargestshareoftotalassetsinahalfcentury.2011BlackwellPublishingLtd Thenotionofintolerancetowardsilliquidassetrisk,ofcourse,reachedbeyondthenon-Þnancialbusinesscommunity.Forhouseholders,thedisen-gagementwasreßectedinthesharpfallintheirpurchaseofilliquidinvestmentsinhomesandconsumerdurablesasaratiotohouseholdgrosssavings,theequivalentofbusinesscashßow.Thisratioisataquarter-centurylow,reßectingtheshiftintheinvestmentofcashßows(grosssavings)fromhouseholdilliquidinvestmentstothepayingdownofmortgagesandconsumerdebt,inadditiontotheaccumulationofsigniÞcantliquidassets.Americanbanksexhibitedasimilarreducedtolerancetowardsriskonpartiallyilliquidlending.Untilearly2011,therewaslittle,ifany,evidencethattheunprecedentedneartrilliondollarsurge(followingtheLehmancrash)indepositoryinstitutionsÕexcessreserveshadpromptedameasur-ableincreaseincommercialbanklending.Indeed,bankloansandleasesdeclinedfromlate2008throughtheendof2010.Theexcessreserves(overnightfunds)haveremainedparked,largelyimmobile,atFederalReservebanksyielding25basispoints.Thisreßectsnotonlythefear-inducedshortfallofnon-Þnancialbusinesscapitalinvestmentstobefunded,butalsobankloanofÞcersÕfearsthatlevelsofbankcapitalarenotadequatetoabsorbpotentiallossesonpartiallyilliquidloans.III.FullRecoveryThwartedGiventhetendencyofriskdiscountingtorisewiththeexpectedduration,orlifeexpectancy,ofanasset,theaversiontoinvestmentinÞxedcapitalismostevidentinourlongest-livedassetsÐrealestate,bothnonresidentialandresidential.Theshunningofhomeownershipandlong-termcommercialleaserentalcommitmentsprecipitatedtheheaviestpricediscountingofanyÞxedassetclassintheUSeconomy.Thisresultedinthedramatic43%declineinnewconstruction,inrealterms,fromitscyclicalpeakin2006toitstroughin2010.TheaverageexpecteddurationofrealGDPhasaccordinglydeclinedsigniÞcantly(Exhibit2).Sincethethirdquarterof2008,theannualgrowth Non-ÞnancialcorporationsalsousedthesurgeincashßowtoretiresigniÞcantamountsofequitythroughbuy-backs,mergersandacquisitions.Inearliergenerations,bankloanswererepaidlargelyatmaturityandwereclosetobeingwhollyilliquid.BankloanextensionsareseeminglyproÞtablebecausenewlycontracted,veryshort-term,commercialandindustrialloans,classiÞedbytheFederalReserveasÔminimalriskÕin2010,areyielding125basispointsmorethandepositsattheFederalReservebanks.AccordingtotheBureauofEconomicAnalysis(BEA),theexpectedservicelifeof,forexample,computersandperipheralequipmentisÞveyears,whilethelifeofnonresidential2011BlackwellPublishingLtdAlanGreenspan rateofrealUSprivatedomesticGDP,excludingproducedassetswithanexpecteddurationofmorethan20years,wasafullpercentagepointabovethegrowthrateoftotalprivatedomesticGDP(Exhibit3).TotalGDPexhibitedasimilarresult.Withouttheabnormalweaknessinlong-livedassets,thecurrentunemploymentratewouldbewellbelow9%.Thepronouncedlackoftoleranceforilliquidinvestmentriskisquiteatvariancewiththerelativelynarrowpost-crisiscorporatebondspreadsinÞnancialmarkets.Sinceaportfolioofliquidprivatelyissuedten-yearbondscanbesoldvirtuallyatwill,thisportfoliocanbeviewedastheequivalentofaveryshort-termasset.Thedifferencebetweenliquidandilliquidassets(withlongeffectivematurities)isthereasonnon-Þnancialcorporations,whoseassetsarelargelyilliquidplantandequipment(andinaforcedsalewouldsellatverydeepdiscounts),maintainednetworthamountingto45%ofassetsattheendof 0246810141950.Q11977.Q11980.Q11995.Q11998.Q12010.Q12013.Q1 GDP, in Yearsplotted through Q3.2010 Exhibit2:AveragedurabilityofrealprivatedomesticGDP,inyearsplottedthrough:BureauofEconomicAnalysis. structuresisjudgedtobe38years.Residentialconstructionisexpectedtolast75years.ApplyingthelifeexpectanciesoftheBEAandmylifeexpectancyestimatesoftheremainingcomponentsofGDPyieldsaquarterlyseriesontheaveragelifeexpectancyofprivatedomesticGDPasawhole(Exhibit2).(TheassumedlifeexpectanciesareshowninExhibit4.)TheaveragelifeofGDPin2010isthelowestinthehistoryoftheseriesthatdatesbackto2011BlackwellPublishingLtd 2006(justbeforetheonsetofthecrisis).CommercialbanksÕnetworth,bycontrast,wasonly10%ofassets.Thatnon-ÞnancialbusinesshadbecomemarkedlyaversetoinvestmentinÞxed,especiallylong-term,assetsappearsindisputable.Butthecriticalquestionis,why?Whilemostinthebusinesscommunityattributethemassiveriseintheirfearanduncertaintytothecollapseofeconomicactivity,theyjudgeitscontinuancesincetherecoverytookholdinearly2009tothewidespreadactivismofgovernment,initsall-embracingattempttoacceleratethepathofeconomicrecovery.Theremainderofthispapertendstosupportsuchjudgements.IV.PolicyDisagreementsIntheseextraordinarilyturbulenttimes,itisnotsurprisingthatimportantdisagreementshaveemergedamongpolicymakersandeconomistsontheissueofeconomicactivism.AlmostallagreethatactivistgovernmentwasnecessaryintheimmediateaftermathoftheLehmanbankruptcy.TheUSTreasuryÕsequitysupportofbanksthroughtheTroubledAssetReliefProgram,andtheFederalReserveÕssupportofthecommercialpapermarket 64282005.Q12005.Q32006.Q12007.Q32008.Q12008.Q32009.Q12009.Q32010.Q3 PercentChange Over Year Ago in Private Domestic GDPplotted through Q3.2010 Exhibit3:PercentchangeoveryearagoinprivatedomesticGDPplottedthrough:BureauofEconomicAnalysis.2011BlackwellPublishingLtdAlanGreenspan andmoneymarketmutualfunds,forexample,werecriticalinassuagingtheButtheutilityofgovernmentactivism,asrepresentedbythe2009US$814billionprogrammeofÞscalstimulus,housingandmotorvehiclesubsidiesandinnumerableregulatoryinterventions,continuestobethesubjectofwidedebate.Regrettably,theevidenceissuchthatpolicymakersandeconomistscanharbourdifferent,seeminglycredibleparadigmsoftheforcesthatgovernmoderneconomies.Thoseofuswhoseecompetitivemarkets,withrareexceptions,aslargelyself-correctingaremostleeryofgovernmentinterveningonanongoingbasis.Thechurningofmarkets,akeycharacteristicofÔcreativedestructionÕ,isevidencenotofchaos,butoftheallocationofanationÕssavingstoinvestmentinthemostproductivelyefÞcientassetsÐanecessaryconditionofrisingproductivityandstandardsofliving.Buthumannaturebeingwhatitis,marketsoftenalsoreßectthesefearsandexuberancesthatarenotanchoredtoreality.Alargenumber,perhapsamajority,ofeconomistsandpolicymakersseetheshortfallsoffaulty,human-nature-drivenmarketsasrequiringsigniÞcantdirectionandcorrectionbygovernment.Theproblemforpolicymakersisthatthereareßawsinbothparadigms.Forexample,abasicpremiseofcompetitivemarkets,especiallyinÞnance,isthatcompanymanagementcaneffectivelymanagealmostanysetofcomplexrisks.Therecentcrisishascastdoubtonthispremise.Butthepresumptionthatinterventioncansubstituteformarketßaws,engenderedbythefoiblesofhumannature,isitselfhighlydoubtful.Muchinterventionturnsouttohobblemarketsratherthanenhancingthem.V.LimitstoFiscalStimulusTherecentpervasivemacro-stimulusprogramsexhibitthepracticalshort-fallsofmassiveintervention.TheyassumethattheimpactontheUSeconomyofasetoftaxcutsandspendingprogrammescanbeaccuratelyevaluatedandcalibratedbyconventionalmacro-models.Yet,thesemodelsfailedtoanticipatethecrisis,and,giventheirstructure,probablycannotbesoevaluatedandcalibrated. Withoutsupport,economicactivityhavefallentothedepthsofthe1930s.Butitisanissueofconjecture,notcertainty.Hardevidenceiselusive.Mostmacro-modelsÞttothemeanofhistoricalseries,andthereforeinprojectioncannotimportantlyveeroffthatpath.Recessionforecaststhusrequirearbitraryadjustmentstotheparametersofthemodel.Moreover,forecastingcanbesuccessfulforonlyasmallminoritybecauseaÞnancialcrisisisdeÞnedasanunanticipatedbreakinassetprices.Ifanticipatedbymostmarketparticipants,economicimbalancesareusuallyarbitragedaway.2011BlackwellPublishingLtd HowcantheinternalstructureofmodelsthathavesuchpoorforecastingrecordsbeinformativeonthesizeandsignofcoefÞcientsandimpactmultipliers?Moreover,moststimulusprogrammesseekthoseappropria-tionsandtaxcutsmostlikelytobequicklyspent.ButiftheywereallcompletelyspentÐpresumablytheidealÐthen,ofnecessity,savingwouldbezero.Yetinthatcase,noproductionwouldhavebeendivertedtofosterinnovationsthatincreaseoutputperhourandstandardsofliving.TheargumentthathigherfederalspendingwouldraisenominalGDP,andcreatenewsaving,isaccurateuptoapoint.Butifaversiontoilliquidityriskremainshigh,capitalinvestmentandGDPwillpresumablyremainstunted.Thisraisesthebroaderquestionofgovernmenteconomicactivismasanimportanteconomicvariablecontributingtosuchheightenedriskaversion.VI.TheBoundariesofActivismIdeÞnezeroactivismorinterventionaspurelaissezfaire,wherethegovernmenthasnoeconomicroleotherthanenforcingpropertyrightsandthelawofcontracts.Thisparadigm,initspureform,hasneverexisted.TheUnitedStates,andmuchofthedevelopedworld,camecloseintheÞrsthalfofthe19thcentury.But,intheUnitedStates,slaveryandstateÞnancedinfrastructure,suchastheErieCanal,weredeparturesfromtheparadigm.Thisparadigmerodedduringthesecondhalfofthe19thcentury,andwasabandonedforaheavilyregulatedeconomyintheaftermathoftheGreatDepression.Forthesecondhalfofthe20thcentury,Americans,belatedlydismayedwiththerestraintsofregulation,dismantledmostcontrolsoneconomicactivity.Muchoftherestoftheworldfollowedsuit.Fewdenytheextraordinaryeconomicgrowthengenderedbycompetitivemarketsinthe19thand20thcenturiesÐatenfoldincreaseinglobalrealpercapitaGDP(Maddison2005).ButthedistributionofacompetitivemarketÕsrewards,anditsperiodiccrises,ledtotheemergence,insomecountries,ofvirtuallyfullstate(activist)controlofeconomicaffairs.TheSovietUnion,China(duringitsculturalrevolution)andIndia(withitsembraceofFabiansocialismfollowingindependencein1947)werethemostprominent.Yetthesemodelshavebeenabandonedasineffectivecreatorsofmaterialwell-being.TheeconomicpolicyworldiscurrentlysplitbetweentheadvocacyofastateofminimumactivismÐallowingmarketslargelyfreereignÐandtheadvocacyofamoreheavilyregulatedinterventionistmodel.Bothembracethewelfarestateandcapitalism.Theydifferonlyindegree. NorthKoreaandCuba,ofcourse,arethemostprominentexceptions.2011BlackwellPublishingLtdAlanGreenspan VII.TheÔUnthinkableÕBeforethebailoutofBearStearns,andlaterGeneralMotorsandChrysler,thenotionthatlargeiconicAmericancorporationswouldnotbeallowedtofailwasembodiedinnobodyÕsriskmanagementtemplate.Fewenvisionedamajorcorporation(asidefromFannieMaeandFreddieMac)beingÔtoobigtofailÕ.Virtuallyallriskmanagersperceivedthefutureaslargelydeterminedbycompetitivemarketsoperatingunderaruleoflaw.TheAmericangovernment,inresponsetotheLehmancrisis,didwhattomosthadbeenunthinkablepreviously.Henceforth,itwillbeexceedinglydifÞculttocontaintherangeofpossibleactivism.Promisesoffuturegovernmentrestraintwillnotbebelievedbymarkets.ThismustsigniÞcantlyfurtherraisenegativetailrisk.Thisbecameevident,post-crisis,inthefailureofelevatedriskspreadsonliquidlong-termdebttofullyfallbacktopre-2007levels.VIII.FinancialRegulationAmongthegrowingnumberofvariablesthatfuturebusinessmanagementmustnowevaluatearetheuncertaintiesrelatedtofuturesourcesoffundingofprivateinvestment.ThemajorplannedrestructuringsofourÞnancialsystemmustbebroadeningtherangeofcurrentlyexpectedoutcomesandperceivedrisk.ButwhiletheimpactoftherestructuringappearssigniÞcant,itssizeistooamorphoustomeasure.ItisimpossibletojudgethefullconsequencesofthemanyhundredsofmandatedrulemakingsrequiredofÞnancialregulatorsintheyearsaheadbytheDoddÐFrankAct.Thedegreeofcomplexityandinterconnectednessoftheglobal21stcenturyÞnancialsystem,eveninitscurrentpartiallydisabledform,isdoubtlessfargreaterthantheimpliedmodelofÞnancialcauseandeffectsuggestedbythecurrentwaveofre-regulation.Therewill,asaconsequence,bemanyunforeseenmarketdisruptionsengenderedbythenewrules.Mostimportantwillbethereactionoftheprivatenon-ÞnancialsectorsoftheUSeconomytoÞnancialreregulation,whichisboundtoreducethescopeandvalueofÞnancialintermediation.FinanceandinsuranceintheUnitedStatesasashareofgrossdomesticincome(valueadded)rosecontinuouslyfrom2.4%in1947to8.3%in2009,arecordhigh.Earlyestimatesofthepercentagefor2010appearlittlechangedfrom IncreasedÞnancialsharesareevidentintheUnitedKingdom,theNetherlands,Japan,KoreaandAustralia,amongothers.TheworldÕsmostrapidlyexpanding(andincreasinglymarket-oriented)economy,China,reportsariseinÞnancialintermediariesÕshareofGDPfrom1.6%in1981to5.2%in2009.2011BlackwellPublishingLtd Itwillpresumablybecomeclearinthecomingyearswhethertheever-higherlevelofÞnancialserviceswasrequiredtomaintaineconomicgrowth(nosuchtrendexistedpre-war).Theanswertothisquestionisofnosmallconsequenceforthenextdecadeandbeyond.IX.NewDealActivismWhilethedegreeofactivismbroughtonbytheNewDealwasfarmoreintensethananyoftheinterventionsofthelasttwoyears,therearedistinctparallelsininitiativestojumpstarttheprivateeconomy.TheGreatDepres-sionÕsNationalIndustrialRecoveryAct(NIRA)viewedexcessivecompeti-tionasthecauseoffallingpricesand,asHaroldColeandLeeOhanianpointout(Cole&Ohanian2004),itattemptedtocartelizeÞrmscomprisingfour-Þfthsofprivatenonagriculturalemployment.TheNIRAledtohugeeconomicdistortionsuntilitwasdeclaredunconstitutionalbytheSupremeCourtinMay1935.ButthelevelofeconomicrigidityremaineduntilwartimesubjectedvirtuallythewholeUSeconomytogovernmentcontrols.From1932to1940,theunemploymentrateaveraged19%andneverfellbelow11%.Non-ÞnancialbusinessÞxedinvestmentasapercentofcashßowsfellto63%in1934and69%in1938,butralliedin1937and1941.(Forcomparison,thepercentagewas83%fortheÞrsthalfof2010.)Thebusinesscyclehadupsanddownsinthe1930s,butthelevelofactivityforthedecade,onaverage,wassuppressedastatusconsistentwithapersistentlyhighdegreeofriskaversiontoilliquidassetinvestment.X.TheMetricsofGovernmentActivismItrytomeasuretheimpactofgovernmentactivismbyassumingÞrstthatthecapexratioembracesthefullrangeofsourcesofilliquidriskaversion.Ipresumethisrangecovers,inadditiontoactivistintervention,(1)theÔÔcrowdingoutÕÕofcapitalinvestmentbycyclicallyadjustedÞscaldeÞcits,aformofactivism;(2)thelevelofconventionaldemandforcapitalgoodsunrelatedtothedegreeofactivismorcrowdingout,asproxiedbythenonfarmbusinessoperatingrate;and(3)anindeterminatedegreeof ThesedataareforconsolidatedaccountsthatreßectdemandfromUSdomesticnonÞnance,andsmallnetpurchasesofUSÞnancialservices(mainlyinsurance)fromabroad.Excludingthevalue-addedoftheFederalReserveSystemdoesnotmateriallyalterthetrend.Thisstatisticmeasuresthepercentageofproductioncapacitybeingutilized.TheseriesisdevelopedfromtheFederalReserveBoardÕsmanufacturingoperatingratesandtheInstituteofSupplyManagementÕsnonmanufacturingoperatingrates.Theseareappliedtogrossnonfarmbusinessproduct,splitintomanufacturingandnonmanufacturingseries.2011BlackwellPublishingLtdAlanGreenspan fadingresidualcrisisshock.OnlytheÞrsttwoaredirectlymeasurable.Thelastcanhaveonlyalimitedimpact,giventhatitcoversonly5%oftheobservationsdeterminingthecoefÞcients.Overthepastfourdecades,regressingthecapexratioagainst(a)theoperatingrateand(b)thecyclicallyadjustedfederaldeÞcitasapercentofGDPyieldsanof0.45,withbothindependentvariableshighlysigniÞcantafteradjustmentforserialcorrelation(Exhibit5).TheresultsaresimilarfortheÞrsttwodecades(Exhibit6)andthelasttwodecades(Exhibit7)separately.Thecorrelationbetweenthetwoindependentvariablesiseffectivelyzero(nocollinearity)andhencethesumofthesofthecapexratioregressedseparatelyagainsttheoperatingrate(0.26)(Exhibit8)andthecyclicallyadjusteddeÞcitratio(0.18)(Exhibit9)approximatesthethemultipleregression.ThisimpliesthatnearlyoneÞfthofthechangeinthecapexratiooverthepastfourdecadesreßectsaÔcrowdingoutÕbytheUSTreasuryÕspreemption 75 yearsPrivate Fixed Investment: Residential38 yearsPrivate Fixed Investment: Nonresidential: Structures 19 yearsPrivate Fixed Investment: Nonresidential: Industrial Equipment 17 yearsPrivate Fixed Investment: Nonresidential: Transportation Equipment 12 yearsPCE: Durable Goods: Furnishings & Durable Household Equip 10 yearsPCE: Durable Goods: Motor Vehicles & Parts PCE: Durable Goods: Motor Vehicles & Parts 9 yearsPCE: Durable Goods: Recreational Goods & Vehicles 9 yearsPCE: Durable Goods: Other Durable Goods 7 yearsPrivate Fixed Investment: Nonresidential: Other Info. Processing Eqpt 1 yearPCE: Nondurable Goods: Other Nondurable Goods 6 monthsPCE: Nondurable Goods: Gasoline & Other Energy Goods 5.4 monthsChange in Private Inventories0PCE: Services Exhibit4:ExpecteddurationforthecomponentsofprivatedomesticGDP. .1.2.3.2.2.4 Exhibit5:EffectsofvariousfactorsonÞxedinvestmentbehaviourforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance2011BlackwellPublishingLtd ofsavingsthatwouldotherwisehavebeenavailabletofundprivateinvestment.TheUSTreasurywillpaywhateverinterestratethemarketrequirestofundthedifferencebetweenFederaloutlaysandreceipts.No .1.1.2.2.1.1.2.3 Exhibit7:EffectsofvariousfactorsonÞxedinvestmentbehaviourforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance. .2.1.1.2.3.2.2.4 Exhibit8:EffectsofvariousfactorsonÞxedinvestmentbehaviorforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance. .1.1.2.1.1.2.4 Exhibit6:EffectsofvariousfactorsonÞxedinvestmentbehaviourforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance. Theso-calledRicardianeffectÐapull-backincapitalinvestmenttoincreaseliquidassetstofundprospectivefuturetaxincreasesÐisdifÞculttoseparatestatisticallyfromtheoverallnegativeimpactofdeÞcitsonprivateinvestment.2011BlackwellPublishingLtdAlanGreenspan otherborrowingentityexhibitstheTreasuryÕsdegreeofpriceinelasticityofdemand.Credit-restrained(crowded-out)borrowers(e.g.issuingbondsratedCCCorlower)arethosewhocannotachievearateofreturnoninvestmentthatenablesthemtoaffordtheinterestratemarketsrequirethattheypay.Thus,crowdingoutoftheleastÞnanciallycapableborrowersoccurs.Whatisindeterminatearethecausesoftheunexplainedhalf(0.55)ofthevariationinthecapexratio.Theissueiswhatmotiveswouldinducecorporatemanagementtochoosetoconvertliquidcashßowintoilliquidcapitalinvestments?Explanationshavetocoverthefullfour-decadeperiodofourregressionanalysis.IthasthusproveddifÞculttoÞndadditionalsigniÞcantexogenous,uncorrelated,variablestoaddtothemultipleregres-Importantly,however,thetwoindependentvariablesderivedfrom .2.2.4.2.2.4 Exhibit9:EffectsofvariousfactorsonÞxedinvestmentbehaviourforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance. .2.2.4.4.2.2.4.6 Exhibit10:EffectsofvariousfactorsonÞxedinvestmentbehaviourforU.S.andU.K.non-Þnancialcorporations.-statisticcalculatedusingNeweyÐWestHACstandarderrorsandcovariance. CrowdingoutisalsoevidentintheUnitedKingdom(Exhibit10),buttheoccurrenceoutsidetheUnitedStatesandUnitedKingdomappearsrare.Contrarytoexpectations,thecostofcapital,whetherinterestcost(BBBbondyields)orcostofequity(equitypremiums),doesnothelptoexplainthevariationsinthecapexratio.If2011BlackwellPublishingLtd thefour-decadeperioddoappeartocapture,reasonablywell,boththesharpdeclineinthecapexratiofollowingthecrisisandtherecentsmallupturn,andasaconsequencecancrediblyrepresentrecentyearsÕbehaviour.The0.26ofcapexvariationattributedtotheoperatingrateisclearlynotafunctionofactivism.Butnoneoftheremainingthreequarterscanbesoreadilydismissed.Corporateexecutives,inlargemajorities,identifytheircurrentpronouncedcautionasdrivenbyaversiontoactivism,aviewconsistentwiththeircurrentbehaviourthathasparallelswiththe1930s.TheGreatDepressionwasfarmoredevastatingthanthecurrentcrisis.Nonetheless,theparallelsbetweenthedegreeofbusinessangstinthoseyearsandtodayÕscapexratioissupportiveofthepresumptionthatÔactivismÕisalikelyexplanationofthe0.55unexplainedvariationinshortfallsincapex,especiallyinthepost-crisisyears.Twoobservationsdonotoftenleadtogeneralizations.Butthesimilaritiesbetweenthenatureofbusinessangstandpropensitytoshunilliquidinvestmentinbothperiodsiscompelling.Accordingly,suchevidencemustbegivenconsiderableweightinexplainingwhycorporationshave,oflate,beenunwillingtoexchangemoreoftheirliquidcashßowforilliquidassetinvestment.GiventhatthemodelÕsregressioncoefÞcientsÞttodatagoingbackto1970,andgivenalsotheimportanceofthephenomenonofcrowdingout(itselfaproductofactivism),Ijudgethataminimumofhalfthepost-crisisshortfallincapitalinvestment,andpossiblyasmuchasthreequarters,canbeexplainedbytheshockofvastlygreatergovernment-createduncertaintiesembeddedinthecompetitive,regulatoryandÞnancialenvironmentsfacedbybusinessessincethecollapseofLehmanBrothers.XI.SpeculationOnalessmacrolevel,theU.S.governmentÕsactivistinterventiontosupportprices,forexampleofhomesandhomemortgages,delaystheliquidationrequiredtorestorebalancetomarketsupplyanddemand.Speculators(aregrettablypejorativeterm)areessentialtotheprocessofstabilityandrecovery.ItwasspeculativebuyinginearlyMarchof2009inequities,theonemarketthattheUSgovernmenthasnotsupported,thatsetinmotionthe anything,capitalinvestmentleadsinterestrates,althoughsuchregressionsarebarelyIfonlyone-halfofthe0.55oftheunexplainedcapexvariationisimputedtoactivism,thetotalshareattributedtoactivismwouldstillbeequalto0.46,asigniÞcantshare.AwheatfarmerÕsforwardsalesofhiscrop(hedging)wouldnotbepossiblewithoutspeculatorsbuyingtheforwardcontracts,therebytakingthepriceriskthefarmerchoseto2011BlackwellPublishingLtdAlanGreenspan huge,almosttwo-yearneardoublingofstockpricesthathasarguablybeenthemostpotenteconomicstimulustodate.Speculators,tobeeffective,havetobelievetheyareabletojudgeoversoldmarkets.Butunpredictablediscretionarygovernmentinterventionscramblestheprospectiveunder-lyingsupplyÐdemandbalance.Speculators,whomightaddsupporttoamarketwhenitisweakestandhencewhentheirbuyingismostrisky,losetheirperspectiveandwithdrawtothesidelines.Themereuncertaintyofwhen,andtowhatextent,governmentmightinterveneraisesriskenoughtothwartmuchdesirablespeculativesupportformarkets.XII.Risk-TakingisNecessaryandDesirableThesolutiontoriskymarketsisnottoshacklethemtoapointthatriskisminimized.Everydaylivingrequiresthetakingofrisks.Withoutrisk-taking,innovationwouldcease,productivitywouldstagnateandgrowthinstan-dardsoflivingwouldstall.InÞnancialmarkets,risk-takingisclearlyvisibleasmarketparticipantsseekoutmarketinefÞcienciescreatedbyinadequateinvestment.This,inturn,owestoafailuretorecognizeemergingeconomicallyproductiveopportunitiesÐalmostalltheresultofinnovativepracticesorproductsyieldingabove-averageproÞtrates.NewÞnancialinvestmentinsuchmarkets(newsupply)eliminatesboththeabnormalproÞtandtheinefÞ-ciencythatfosteredit.Non-ÞnancialÞrmsseekoutpotentiallyunmetconsumerneedsthatmanifestthemselvesinwidening(abnormal)proÞtmargins,anddirectnewercapitalfacilitiestoproducesuchgoods,therebysuppressingtheheightenedproÞtmargins.Markets,bothÞnancialandnon-Þnancial,lefttothemselvesarecontinuouslychurning,asinnovationaddsproductiveassetswithabove-averageoutputperhourthatdisplacesobsolescentloweroutputperhourfacilities.Thisprocessresultsineverrisingaverageoutputperhour.Intheprocessofchurning,asigniÞcantproportionofinnovationfails.(Innovationrisky.)But,becauseproductivitylevelscontinuetorise,muchrisk-takingclearlydoesnotfail.MonopoliesunderminetheefÞciency-seekingengenderedbymarketchurn-ing.TheemergenceinrecentyearsofeverlargerAmericanbanks,presumedtobeprotectedfrombankruptcybytheUSgovernment,hasfosteredmarket-suppliedsubsidizedcostofcapitalaformofactivistinterventionthathasallowedthemtoexpandfarbeyondwhereeconomicanalysishasrecognizedeconomiesofscale(Berger&Humphrey1994).FannieMaeandFreddieMac, IntodayÕsÞnancialmarketsthatarepartiallydisabled,inefÞcienciesaboundandoutsizedproÞtsoftengounarbitraged.2011BlackwellPublishingLtd beforetheirconservatorship,areegregiouscases.Thereis,Idonotdoubt,lessvisiblemonopolistpowerinnon-Þnancialmarkets.XIII.LookingAheadFromtheperspectiveofthosewhoseeinnovativeprivatemarketsasthesourceofmaterialwell-being,thecriticalquestionishowmuchofacontractionindeÞcitsandadecreaseinthefreneticpaceofnewÞnancialregulationsisrequiredtoassuagethesenseofafrighteningfuturewhichwouldallowthenaturalforcesofeconomicrecoverytotakehold.Theamountissurelylargeenoughtoraiseaquestionofpoliticalfeasibility.However,thepoliticalkick-backonfederalÔbailoutsÕ(andactivismgenerally)maydissuadepolicymakersfromarepetitionofthelarge-sizedinterventionsoftherecentpast.Andifindeedthecurrentcrisisisaonce-in-a-centuryevent,thecurrentÔanythinggoesÕregulatoryethosinacrisiscouldeventuallyfadeanddeÞcitsmayundergocontraction.Importantly,anywithdrawalofactiontoallowtheeconomytohealcouldrestoresome,ormuch,ofthedynamicofthepre-crisisdecade,withoutitsimbalances.XVI.TheImportanceofEquityPricesIstillembracetheviewIheldacoupleofyearsagothatÔ[w]etendtothinkofßuctuationsinstockpricesintermsofÔÔpaperÕÕproÞtsandlossessomehownotconnectedtotherealworld.But,theevaporationofthevalueofthoseÔÔpaperclaimsÕÕcanhaveaprofoundlydeßationaryimpactonglobaleconomicactivity....[such]thatmuchoftherecentdeclineinglobaleconomicactivitycanbeassociateddirectlyandindirectlywithdecliningequityvalues....[I]tisnotsimpletodisentanglethecomplexsequenceofcauseandeffectbetweenchangeinthe[stock]marketvalueofassetsandeconomicactivity.Ifstockpriceswerewhollyreßectiveofchangesin[other]economicvariables,movementsinassetpricescouldbemodeledasendogenousandgivenlittleattention.But,theyarenot.AsigniÞcantpartofstockpricedynamicsisdrivenbytheinnatehumanpropensitytointermittentlyswingbetweeneuphoriaandfear,which,whileheavilyinßuencedbyrealeconomicevents,nonethelesshasapartiallifeofitsown....[S]uchepisodesareoftennotmereforecastsoffuturebusinessactivity,butareanimportantcauseofthatactivity.StockpricesaregovernedthroughmostofthebusinesscyclebyproÞtexpectationsandeconomicactivity.Theyappeartobecomeincreasinglyindependentofthatactivityatturningpoints.Thatisthemeaningofbeingaleadingindicator,theconclusionofmostbusinesscycleanalysts. EconomicClubofNewYork,17February2009.2011BlackwellPublishingLtdAlanGreenspan ÔWhenwelookbackonthisperiod,Iverymuchsuspectthattheforcethatwillbeseentohavebeenmostinstrumentaltoglobaleconomicrecoverywillbeapartialreversalofthe$35trilliongloballossincorporateequityvaluesthathassodevastatedÞnancialintermediation.Arecoveryoftheequitymarketdrivenlargelybyarecedingoffearmaywellbeaseminalturningpointofthecurrentcrisis.Õ(AsofFebruary2011,globalequitymarketshadrecoveredfour-ÞfthsofthatUS$35trillionloss.)InJune2009,Iexpandedonthethesis(Greenspan2009).Ô...[N]ewlycreatedcorporateequityvaluehasaddedsigniÞcantlytothecapitalbufferthatsupportsthedebtissuedbyÞnancialandnon-Þnancialcompanies.Corporatedebt,asaconsequence,hasbeenupgradedandyieldshavefallen.Previouslycapital-strappedcompanieshavebeenabletoraiseconsiderabledebtandequityinrecentmonths.Marketfearsofbankinsolvency,particularly,havebeenassuaged.ÕEquityvalues,inmyexperience,havebeenanunderappreciatedforcedrivingmarketeconomies.OnlyinrecentyearshastheirimpactbeenrecognizedintermsofÔwealtheffectsÕ.Thisisoneformofstimulusthatdoesnotrequireincreaseddebttofundit.Isuspectthatequityprices,whethertheygoupordownfromhere,willbeamajorcomponent,alongwiththedegreeofactivistgovernment,inshapingtheU.S.andworldeconomyintheyearsimmediatelyahead.Asthepaceofnewfederalinterventionsslowedtowardstheendof2010,aversiontoilliquidriskappearedtobesubsiding.Ibelievetheevidencesupportsapolicyresponseofforbearancetoallowriskfearsandassociatedequitypremiumstocontinuetosubsideontheirown.DespitethesurgeincorporatecashßowoverthelasttwoyearsandexpectationsofsecurityanalystsofcontinuedgainsinproÞtability,equitypremiumsremainnearahalf-centuryhigh.Thisindicatesanexceptionallylargeandpresumablyunsustainablyhighdiscountrateappliedtoexpectedfutureearnings.Ifthelatterholdsup,andactivismrecedes,stockvalues,ofcourse,wouldmovehigherandcarrywiththemasigniÞcantwealtheffectthatshouldenhanceeconomicactivity.Shortofafull-blownMiddleEastcrisisaffectingoilprices,aeurocrisisand/orabondmarket(budget)crisisreminiscentof1979,theÔwealtheffectÕcouldeffectivelysubstituteprivateÔstimulusÕforpublic.Berger,A.N.,andD.B.Humphrey(1994),ÔBankScalesEconomies,Mergers,Concentration,andEfÞciency:TheU.S.ExperienceÕ,WorkingPaperNo.94-25. ThecapexratiohasrisenslightlyfromitsnadirintheÞrstquarterof2010.2011BlackwellPublishingLtd Cole,H.,andL.Ohanian(2004),ÔNewDealPoliciesandthePersistenceoftheGreatDepression:AGeneralEquilibriumAnalysisÕ,TheJournalofPoliticalEconomy112(4),779Ð816.Greenspan,A.(2009),ÔInßationÐTheRealThreattoSustainedRecoveryÕ,FinancialTimes,25June.Greenspan,A.(2010),ÔTheCrisisÕ,BrookingsPapersonEconomicActivity,Maddison,A.(2005),ÔMeasuringandInterpretingWorldEconomicPerformanceReviewofIncomeandWealth,51,1Ð35.Dr.AlanGreenspanGreenspanAssociatesLLC1133ConnecticutAvenueNWSuite810,Washington,DC20036katie.broom@greenspan-associates.com2011BlackwellPublishingLtdAlanGreenspan