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3/5/1997

Mr. PAUL. Thank you, Mr. Chairman.

Mr. Chairman, I want to bring up the subject again about the CPI. We have talked a lot about the CPI and an effort to calculate our cost-of-living in this country, and specifically here, to measure how much we are going to increase the benefits that we are responsible for. But in reality, is not this attempt to measure a CPI or a cost-of-living nothing more than an indirect method or an effort to measure the depreciation of a currency? And that we are looking at prices, but we are also dealing with a currency problem.

When we debase or depreciate a currency we do get higher prices, but we also have malinvestment. We have distorted interest rates. We contribute to deficits. And also, we might not always be looking at the right prices. We have commodity prices, which is the usual conceded figure that everybody talks about as far as measuring inflation. But we might at times have inflated prices in the financial instruments.

So to say that inflation is under control and we are doing very well, I would suggest that we look at these other areas too, if indeed we recognize that we are talking about the depreciation of a currency.

One other thing that I would like to suggest, and it might be of interest to my colleagues, is that one of the characteristics of a currency of a country that depreciates its currency systematically is that the victims are not always equal. Some suffer more than others. Some benefit from inflation of the currency and the debasement of the currency. So indeed, I would expect the complaints that I hear. I would suggest that maybe this is related to monetary policy in a very serious manner.

The consensus now in Washington, all the important people have conceded that we should have a commission. But when we designate a commission, this usually means everybody knows what the results are. I mean, nobody complains that the CPI might under-calculate inflation or the cost-of-living for some individuals, which might be the case. So we have this commission.

But is it conceivable that this is nothing more than a vehicle to raise taxes? the New York Times just this week editorialized in favor of this because it raised taxes, and also it cuts benefits, and they are concerned about cutting benefits. But would it not be much more honest for Congress to deal with tax increases in an above-board fashion, especially if we think the CPI is not calculable? I think it is very difficult.

Also, I think that if it is a currency problem as well, we cannot concentrate only on prices. There have been some famous economists in our history who say, look to the people who talk about prices because they do not want to discuss the root cause of our problem, and that has to do with the inflation of the monetary system or the depreciation of the currency.

Mr. GREENSPAN. Dr. Paul, the concept of price increase is conceptually identical, but the inverse of the depreciation of the value of the currency. The best way to get a judgment of the value of the currency as such, if one could literally do it, is to separate the two components of long-term nominal interest rates into an inflation premium component and a real interest rate component. The former would be the true measure of the expected depreciation in the value of the currency.

We endeavor to capture that in these new index bonds that have been issued in which the Consumer Price Index, for good or ill, is used to approximate that. It does not exactly, and I think that is what I have been arguing with respect to the commission is to take the statistical bias out of the CPI and get a true cost-of-living index.

It is certainly the case that that is a measure of inflation. There are lots of different measures of inflation. I would argue that commodities, per se, steel, copper, aluminum, hides, whatever, used to be a very good indicator of overall inflation in the economy when we were heavily industrialized. Now they represent a very small part of the economy and services are far more relevant to the purchasing power of the currency than at any time, so that broader measures of price, in my judgment, are more relevant to determining what the true rate of inflation is.

Mr. PAUL. Can the inflated prices in the financial instruments not be a reflection of this same problem?

Mr. GREENSPAN. They are. This is a very important question and one which I was implicitly raising: do asset price changes affect the economy? And the answer is clearly, ''yes.'' What you call it, whether it is inflation or not inflation, that is a nomenclature question. But the economics of it clearly means that if one is evaluating the stability of the system, you have to look at product prices, that is, prices of goods and services, and asset prices, meaning prices on items generally which have rates of return associated with them.

Mr. PAUL. Much has been said about your statements regarding the stock market and I wanted to address that for just 1 minute. In December when you stated this, of course, the market went down and this past week there was as sudden drop. The implication being that if you are unhappy with it, they assume that you will purposefully push up interest rates. But really since the first time you made that statement it seems that almost the opposite has occurred. M3 actually has accelerated, to my best estimate in the last 2 months it has gone up at a 10 percent rate. The base actually has perked up a little bit. Prior to this time it was rising at less than a 5 percent rate and now it is rising a little over 8 percent.

But then too we have another factor which is not easy to calculate, and that is what our friends in the foreign central banks do. During this short period of time they bought $23 billion worth of our debt. We do know that Secretary Rubin talks to them and that maybe there is an agreement that they help you out; they buy some of these Treasury bills so you do not have to buy quite so many.

Mr. GREENSPAN. There is no such agreement, Dr. Paul.

Mr. PAUL. You read about that though.

Mr. GREENSPAN. Sometimes what you read is not true.

Mr. PAUL. OK, we will get your comments on that. But anyway, they are accommodating us, whether it is policy or not. Their rate of increase on holding our bills are rising at over 20 percent, and even these 2 months at maybe 22 percent.

My suggestion here and the question is, instead of the sudden policy change where you may increase interest rates, it seems like to me that you may be working to maintain interest rates from not rising. Certainly, you would have a bigger job if we had a perfect balance of trade. I mean, they are accumulating a lot of our dollars and they are helping us out. So if we had a perfect balance of trade or if their policies change, all of a sudden would this not put a tremendous pressure on interest rates?

Mr. GREENSPAN. We have examined the issue to some extent on the question of what foreign holdings of U.S. Treasuries have done to U.S. interest rates. I think the best way of describing it is that you probably have got some small effect in the short run when very large changes in purchases occur. There is no evidence over a long run that interest rates are in any material way affected by purchases.

The reason, incidentally, is that they usually reflect shifts--in other words, some people buy, some people sell. Interest rates will only change if one party or the other is pressuring the market. There is no evidence which we can find which suggests that that is any consistent issue, so that the accumulation of U.S. Treasury assets, for example, is also reflected in the decumulation by other parties. We apparently cannot find any relationship which suggests to us that that particular process is significantly affecting----

Mr. PAUL. For the past 2 years, the accumulation has been much greater.

Mr. GREENSPAN. That is correct, it has been.

Mr. PAUL. Thank you.

7/22/97

Dr. PAUL. Thank you, Mr. Chairman.

I think the Banking Committee must be making progress, because even others now bring up the subject of gold, so I guess conditions are changing. But I might just suggest that the price of gold between 1945 and 1971 being held at $35 an ounce was not much reassurance to many that the future did not bode poorly for inflation. So the price of gold being $325 or $350, ten times what it was a few years back, should not necessarily be reassurance about what the future holds. Unlike my colleague from the other side accusing you of searching for gloom, I might wonder whether or not we might be hiding from some of it? So I thought that the last thing I would suggest is that we lack monetary stimulus and all we need is a little more monetary stimulus, and all of a sudden we are going to take care of the problems. And by the way, the problems that are described are the problems that I am very much concerned about, but I come up with a different conclusion on why we are having those problems.

Earlier, I made the case in my opening statement that quite possibly we are using the wrong definitions and we are looking at the wrong things, and we continue to concentrate and to reassure ourselves that the Consumer Price Index is held in check, and therefore things are OK and there is no inflation. Real interest rates and the long bond remain rather high, so there is a little bit of inflationary expectation still built into the long-term bond. But the consumer prices might be inaccurate, as Sindlinger points out, and they may become less important right now because of the various technical things going on.

And also I made the suggestion that the money-supply calculations that we use today might not be as appropriate as they were in the past, because I do not think there is any doubt that we have all the reserves and all the credit and all the liquidity we need. I mean, it is out there. It might not be doing what we want it to do, but there is evidence that it is there. The marginal debt today was reported at $113 billion, just on our stocks. So there is no problem with getting the liquidity. My argument is that what if we looked at the prices of stocks as your indicator as you would look at the CRB? I mean, we would have a rapidly rising CRB-or any commodity index. It would be going up quite rapidly. For instance, in the past 3 months, we had a stock price rise of 25 percent. If it continued at that rate, we would increase the stock prices 100 percent in one year. If that was occurring in the commodities or Consumer Price Index, I know you would be doing something.

My question and suggestion is maybe we ought to be doing something now, because there is a lot of credit out there doing something else, causing malinvestment, causing deficits and debt to build up, and that there will be a correction. We have not repealed the business cycle. So we have to expect something from this.

I think there are some interesting figures about what has happened to the stock market. In 1989, Japan's stock market had a greater value than our stock market does. Our market now is three times more valuable in terms of dollars than Japan. We have 48 percent of the value of all the stocks in the world, and we put out 27 percent of the output. So, there is a tremendous amount of marking up of prices, a tremendous amount of credit. So, instead of being lacking any credit, I think we have maybe an excess amount. I would like to know if you can reassure us that we have no concerns about this malinvestment, that we do not have excess credit and that these stock prices are not an indicator that might be similar to a Consumer Price Index?

Mr. KENNEDY. What?

Mr. GREENSPAN. Let me first say, Dr. Paul, it is certainly the case that if you look at the structure of long-term nominal Government interest rates, there is still a significant inflation premium left. In the 1950's and the 1960's, we had much lower nominal rates, and the reason was that the inflation premium was clearly quite significantly less. I think we will eventually get back there if we can maintain a stable noninflationary environment. I do not think we can remove the inflation premium immediately, because it takes a number of years for people to have confidence that they are dealing with a monetary policy which is not periodically inflationary.

To follow on the conversation I was having with Congressman Frank, the type of conversation we have at the Federal Open Market Committee is indeed the type of conversation that is coming from both of you. In other words, we are trying to look at all of these various forces and recognize where the stable relationships are and those which tell us about what is very likely to occur in the months, the quarters, and hopefully, in the years ahead.

It is a very intensive evaluation process, especially during a period when there seem to be changes in the longer-term structure which we do not yet know are significant or overwhelming. But we are experiencing changes which lead us to spend a considerable amount of time trying to evaluate what is going on. But we would be foolish to assume that all of history has somehow been wiped from the slate and that all of the old relationships, all of the problems that we have had in the past, have somehow in a period of a relatively few years, disappeared. The truth of the matter is that we suspect that there are things that are going on. We do not know yet how important they are. But we are keeping a very close evaluation of the types of events that are occurring, so that we can create what we believe to be the most appropriate monetary policy to keep this economic expansion going in a noninflationary way, because that is what is required to keep growth going.

Dr. PAUL. So, you are saying the stock price index is of a lot less value than the commodity price index or the Consumer Price Index?

Mr. GREENSPAN. I would say our fundamental purpose is to keep inflation, meaning basically the underlying general price index, stable, because that is the most likely factor which will create financial stability overall. As I have said in previous commentary and discussions before this subcommittee, we of necessity look at the whole financial system, but it has always been our conclusion that the central focus is on the stability of product prices as the crucial determinant in the system, which if you solve that one, you are likely to solve the others as well.

Dr. PAUL. Thank you, Mr. Chairman. I have two brief points to make, then I have a couple of questions.

First, your comment about the deficit is very important in keeping interest rates high. It seems to me that the level of Government spending has to be even more important, because if you have a $2 trillion budget, and you tax that money out of the system, that is very detrimental, just as detrimental as if you borrowed out of the economy. So I think the level of spending is probably more important.

And as a follow-up to the question from the gentleman from Washington on the currency, we certainly do export a lot of our currencies. More than 60 percent ends up in foreign hands. And it serves a great benefit to us because it is like a free loan. It is not in our own country, it does not bid up prices, So we get to export our inflation. At the same time, they are willing to hold our debt; central banks are holding $600 billion worth of our debt. So again, we get to export our inflation, and the detriment is the consequence of what we are seeing in Southeast Asia.

But the real problem, though, is not the benefits that we receive temporarily, but the problem is when those dollars come home, like in 1979 and 1980, and then we have to deal with it because it is out of your hands, this money has been created. So I think we should not ignore that.

But my first question has to do with Mexico. It is bragged that we had this wonderful bailout of Mexico three years ago, and yet Mexico still has some of its same problems. They have tremendous bank loans occurring right now. The peso has weakened. Last month it went down 5 percent. Since the conditions are essentially the same, my question to you is when do you anticipate the next currency crisis in the Mexican peso?

And then another question that I would like to get in as well has to do with a follow-up with the gentleman from Massachusetts dealing with the inequity in the distribution of income. And in your statement you come across almost hostile or fearful that wages might go up. And I understand why you might be concerned about that, because you may eventually see the consequence of monetary inflation, and it will be reflected in higher wages. But where has the concern been about the escalation of value of stocks? People are expecting them to go up 30 percent a year. They are benefiting, but labor comes along and they want to get a little benefit. They want to raise their salaries 5 or 10 percent. Unlike the other side, I think the worst thing to do is interfere in the voluntary contract and mandate an increase in wages and give them minimum wage rates. That is not the answer.

But to understand the problem I think is very important. This is a natural consequence. They want to share as well, and this is a natural consequence of monetary inflation is that there is an equal distribution of income.

I would like you to address that and tell me if there is any merit to this argument and why you seem to have much greater concern about somebody making a few bucks more per hour versus the lack of concern of a stock market that is soaring at 30 percent increases per year.

Mr. GREENSPAN. Let me say that when I believe that there are trends within the financial system or in the economy generally which look to me and to my colleagues to be unsustainable and potentially destructive of the economic growth, we get concerned.

I am not aware of the fact that if I see things which I perceive to be running out of line, that I have not expressed myself. At least some people have asserted that I have expressed myself more often than I should. And I have commented on innumerable occasions, as I have, in fact, done today, that there are certain values in the system which by historical standards, are going to be difficult to sustain. And I am concerned about that, because it potentially is an issue which relates to the long-term values within the economy.

I have no concern whatever about the issue of wages going up. On the contrary, the more the better. It is only when they are real wages, whether they are wages which are tied to productivity or related to productivity gains. But wages which are moving up more than the rate of inflation, for example, I think are highly undesirable, and indeed to the extent that we do not get real wage increases, we do not get increases in standards of living. So I am strongly in favor of any increase in real wages and not strongly in favor at all of wages that go up and are wiped out by inflation.

Dr. PAUL. But the real wage is down compared to 1971. You have a little flip here or so, but since 1971 it is down.

Mr. GREENSPAN. Part of that issue, Congressman, is a statistical problem. I do not believe the real wage is truly down since 1971.

Dr. PAUL. But we cannot convince our workers of that. At least in my district they are not convinced by some statistic.

Mr. GREENSPAN. Let me put it this way: Productivity after the early 1970's flattened out fairly dramatically, and that slowed real wage increases very dramatically as well. And to the extent that the sense in which earlier generations experienced significant increases in standards of living during the 1950's and 1960's and the early post-World War II period, of course productivity was advancing rapidly. That came to a dramatic end in the early 1970's and persisted until very recently. And if people were concerned about that, they should be, and they should have been, and we should have been, as I think we were.

Dr. PAUL. Do you have a comment on when the next Mexico crisis is going to occur?

Mr. GREENSPAN. Yes. I am not concerned about a crisis in Mexico at this particular stage. I think they are doing reasonably well. The peso at this particular stage is floating appropriately. I do not see any immediate crisis at the moment. And while I do not deny that, as in any country, things can go askew, they have come out of the 1995 crisis frankly, somewhat better than I expected they would.