In December 1996, with the Dow Jones Industrial Average just above 7,000 and the technology-dominated Nasdaq Composite index under 1,500, Alan Greenspan made his famous pronouncements about “irrational exuberance” on Wall Street and “unduly escalated asset values.”
In the ensuing five years, this statement came to haunt the Fed Chairman. Until 2000, stocks kept climbing, with Nasdaq more than tripling in value and the Dow adding more than 50 percent. Naturally, Greenspan was ridiculed for missing a fundamental change in U.S. financial markets, which was going to catapult the Dow to 60,000, and even 100,000, and make everybody in America rich beyond their wildest dreams.
Then, when the crash finally came and by late 2002 stock market indices returned, uncannily, to roughly where they were on the day of the “irrational exuberance” speech, Greenspan was roundly criticized for not deflating the Wall Street bubble when it was still possible.
It was a unique statement in Greenspan’s 19-year career at the Fed. Never before — and certainly never after — did he say anything else about the economy or financial markets that could be so unambiguously interpreted. That slip of the tongue stands out among countless hours of his Congressional testimonies, Federal Open Market Committee minutes and other speeches, in which he honed his formidable skill of saying something without saying anything.
This ability to obfuscate is what made Greenspan so successful — so much so that by the end of his stay in office he became virtually irreplaceable. When he finally retired just before turning 80, it was probably to avoid dying in office.
Crisis of the Science
It was, however, a deep crisis of economics that prompted Greenspan to turn Delphic, making statements that could mean anything or nothing at all. To be sure, economics continues to flourish as an academic discipline at colleges and universities. But its usefulness as a guide to policy, or a means of predicting economic developments and movements in financial markets, has become suspect.
There has certainly been a sea change since the 1950s and 1960s, when tremendous hopes were associated with the application of economics in government policy. Economics was expected to ensure world peace, defeat poverty and eliminate or smooth out economic downturns. Bright academic economists from the left were drafted into the Kennedy administration, whereas conservative and monetarist luminaries were brought in by Nixon and Reagan. The pinnacle of public recognition for economics was reached in 1969, when a Nobel Prize for Economics was awarded for the first time, placing it into the same exalted category as physics and chemistry.
The Nobel Prize for Economics had a similar fate to that of the Nobel Peace Prize, which was first awarded in 1901 — in time for the advent of history’s bloodiest wars. Since about the 1970s, economists have been consistently proving their inability to provide rational policy prescriptions or to predict the future. Their reputation both in Washington and on Wall Street has been in a freefall.
On Wall Street in particular, trading and investment models based on economic forecasts or regression analyses have gone out the window even as mathematics-based trading models which purposefully ignore economic analysis have flourished. Economists are still called upon to interpret economic data, but they are not expected to provide accurate forecasts. Fewer of them are employed at financial institutions, with considerably less visibility and far lower salaries.