Outlook: Greenspan's gong for services to global economic stability

Stability pact changes; Network Rail

In a speech yesterday to mark the opening of the new Treasury building, Alan Greenspan, chairman of the US Federal Reserve, mischievously made reference to the South Sea Bubble, which traces its origins back to 1711 when Her Majesty's Treasury unveiled a scheme to secure government debt by authorising its subscription into the capital of the South Sea Company. There then began one of the greatest financial speculations of all time. When the bubble finally burst in 1720 amid a wave of bankruptcies and frauds, the Chancellor of the Exchequer was held to account and sent to the Tower of London. Whether Mr Greenspan was deliberately titillating his audience by opening with this historical reference, is, as ever with Mr Greenspan, not entirely clear, but it certainly carried resonance.

Today Mr Greenspan is accused of playing a key role in the late 20th century's very own bubble, first by failing to address it and then by actively encouraging it with too loose a monetary policy. Mr Greenspan is over here primarily to collect an honourary knighthood for services to financial stability. With the stock market nearly 50 per cent off its peak after one of the worst bear markets in living memory, and with even the mighty US economy struggling to keep its head above water, the world doesn't look a particularly stable place right now. There is not much doubt about where the blame lies. It all began with the bursting of the technology bubble.

Mr Greenspan first referred to irrational exuberance in the stock market as far back as 1996 when the Dow Jones Industrial Average was still trading at not much more than 6,000. But he did nothing about it and, as time went on, he seemed rather to change his mind by making a number of speeches about how stock prices could possibly be justified by the productivity gains of the New Economy. Who was he, he once asked, to pit his judgement against that of hundreds of thousands of small investors. Even if it was a bubble, it wasn't his job to puncture it, Mr Greenspan would insist.

The crunch came in the autumn of 1998, when the Fed sharply cut interest rates and flooded the system with liquidity in response to the severe financial strains that followed the emerging markets crisis and Russian debt default. The effect was three fold. First it gave a further shot in the arm to an investment boom which was already running out of control. Second it gave the impression that the stock market was in some way underwritten by the Fed, which would always come riding to the rescue if things got sticky, and thirdly it accelerated the flow of capital into the US economy by making the US even more the place everyone wanted to put their money. It was in the vanguard of the technological revolution, it was high growth, and it appeared to be comparatively risk free.

All this seems to count against Mr Greenspan. On the other hand it's hard to argue that what Mr Greenspan should have done at that stage is to put interest rates up. There was no appetite for the Fed to prick the bubble, and had it attempted to do so, there would have been universal condemnation. The experience of the US in 1929 and Japan in the late 1980s would suggest that attempting to deal with an asset bubble through an increase in interest rates only succeeds in making the subsequent crash and economic downturn even worse.

Mr Greenspan has since said that central banks can do nothing about bubbles but they can do something about the fallout. Indeed, he sees big positives in what he last night called the "creative destruction" of free markets. His own view is that governments should not intervene to control risk taking. Well, maybe, but having failed to intervene himself, he would have to say that, wouldn't he. In the meantime Mr Greenspan can take comfort in the fact that these days they don't lock you up for stoking a bubble, only for fraudulently profiting from it.

Stability pact changes

MR GREENSPAN doesn't much believe in Government intervention. That's clear. What does he think about the euro? In his speech at the Treasury yesterday, Mr Greenspan went out of his way to congratulate the City on its "sterling" reputation as a place to do business, a reputation that doesn't seem to have been affected one jot by Britain's non participation in the euro. The City remains the primary location for foreign exchange trading and much else besides, not withstanding the launch of the euro or the dollar's position as the world's most traded currency.

So can the eurosceptics claim Mr Greenspan as one of their own? He's much too wise to say. His predecessor as chairman of the Federal Reserve, Paul Volcker, also in London this week, doesn't need to be so guarded, and as it happens he's a big supporter of the single currency.

What, even after the admission that the stability pact rules will have to be eased to accommodate the budget deficits of some of the eurozone's key economies? He doesn't want to comment publicly on that but it is clear from what he's said in the past what his underlying view is. Europe is not going to solve its problem with sluggish growth and high unemployment through fiscal and monetary policy. If it is to be tackled at all, it must be through structural reform, and although progress is still painfully slow, the euro may in time act as a catalyst for such change.

Loss of flexibility in monetary policy is not the cause of Germany's problems. Nor actually is the fiscal constraint imposed by the stability pact. There's a lot of nonsense talked about the way the US deals with regional imbalances through fiscal adjustment. Very little of it goes on. State budgets are also much more constrained than they are in Europe. Many states are constitutionally obliged to run balanced budgets, which means that in tough times the fiscal regime compounds the effects of the regional downturn. Quite so.

Reform of the stability pact is only a recognition of the inevitable, and since the new rules are more in tune with Gordon Brown's own view that budgets need to be balanced only over the lifetime of the cycle, it potentially removes another barrier to participation.

Network Rail

The Government's shiny new not-for-profit express, Network Rail, is about to trundle on to the line as Railtrack is shunted into the sidings of history. But the problems facing the industry remain depressingly familiar and they can be summed up in one word: money. Even with a guarantee from the taxpayer worth £21bn, Network Rail is not sure it will have enough cash to keep the tracks from buckling and has persuaded the Rail Regulator, Tom Winsor, to conduct a review of its access charges.

Mr Winsor huffs and puffs and says this does not necessarily mean more money but rather a chance to look at the industry's whole cost structure. Who is he kidding? It is already plain that Network Rail will need vastly more than even Railtrack was demanding and, if Mr Winsor won't oblige, it can always go back cap in hand to Alistair Darling. The regulator promises there will be no blank cheque for the new railway. He is there to "get a grip, not let it rip" as the radio soundbite put it. We'll see.

jeremy.warner@independent.co.uk