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It was your columnist's pleasure and privilege to speak last week at the White House conference on the New Economy, and then to listen to the estimable chairman of the Federal Reserve in person. I listened with great care. And it seems to me that Mr. Greenspan's defense of his policy has now taken a dangerous turn.

In the original version, lasting up to the most recent

Humphrey-Hawkins

testimony, the Federal Reserve took the view that interest rates must be raised because labor markets are unacceptably tight. Inflation must therefore follow. The difficulty with this view is that the evidence is entirely against it. Predictions that inflation would accelerate following the reduction of unemployment below

X

have been offered up for many years now. And as unemployment has fallen below

X

, inflation has stubbornly refused to emerge.

Mr. Greenspan seems finally to have gotten that message: Nowhere in his speech did the unemployment rate

as such

play a role in the justification for higher interest rates.

Instead, he has offered up a revised version, the one first offered in his March 6 speech at

Boston College

on the New Economy. In this version, the rate of productivity growth -- of all things -- emerged as the chief villain. Productivity growth was said to be problematic, even progenitive of inflation, because it was too high. Not too low -- too high.

I have since studied the syntax of Mr. Greenspan's speech on this matter in considerable depth and detail. The argument is (or more precisely, was) that high rates of productivity growth generate high expectations of future corporate earnings. These then drive up stock prices, creating wealth or the illusion thereof, and so generating demand for which, as Mr. Greenspan said, no corresponding increase in productive capacity had been provided.

Twisted Logic

There are two difficulties with this argument. The first and lesser difficulty is that it presumes what is not proven -- that existing productive capacity is not sufficient to provide the supply for which the hypothesized wealth effect provides the demand. Usually, the evidence for this is rising inflation. But inflation is not rising.

The second and more serious difficulty is that people cannot purchase stocks, or anything else, out of thin air. Either stocks have to purchased out of current savings, in which case the purchases cannot, by definition, result in increased consumption. Or, the stocks must be purchased on credit.

There is, of course, a great deal of these purchases going on. It is called, for the most part, buying on margin. If the Federal Reserve is truly concerned about the volume of stocks bought on credit, it has a direct responsibility and, namely, the power to set and increase the margin requirement. But Mr. Greenspan refuses to use this policy instrument.

At last week's meeting, I offered a stout defense of high productivity growth, and repressed the very strong temptation to speak my mind on the subject. Just as well that I withheld. In his speech, Mr. Greenspan made no further reference to the dangers of excessively high productivity growth, and it seems a fair prediction that this aberrant argument will be heard no more.

The New Economy's Latest Enemy

What cacodemon does he offer up as replacement? Demand is outrunning supply, says Greenspan, and it must be brought into check. How do we know this? Not the unemployment rate, not the productivity growth rate, and not the stock market. Rather, the problem, as the chairman now sees it, is the

trade deficit

.

Can I be the only economist on the planet who finds this to be the most desperately old-fashioned of notions? To make the trade deficit the bogeyman of the New Economy is to be unaware -- at least, he did not acknowledge -- that we do not live in the idealized world of the

Bretton Woods

institutions, in which a supra-national authority (like the

International Monetary Fund

) would supply the reserve asset for the world economy. On the planet as it exists, that privilege falls to the U.S. The U.S.

must

run a trade deficit, generally speaking, so long as other countries need to buffer themselves with dollar assets or to pay off dollar debts -- as so many are obliged to do.

Can the trade deficit be too high? I suppose so. But in the present case, the problem is a failure of the world economy, and particularly of the developing regions, to take up a sufficient quantity of the advanced exports that we produce. This is not because of American prosperity, but because we have failed to create an overarching framework of stability in global finance. To solve this problem by cutting imports will only tighten the financial constraints on developing countries, and deepen the crisis of globalization. From the standpoint of a prosperous world order, Mr. Greenspan's argument, therefore, borders on the suicidal.

But there is worse. Suppose we accept -- which I do not -- that the trade deficit is a serious problem, demanding immediate reductions of imports. Isn't there an easier way to do this? Of course there is! Raise tariffs! Impose quotas! "Mitigation by Tariff," as

Keynes

called it in a particularly desperate moment of the Great Depression. Solve the trade deficit without raising unemployment or otherwise wrecking the economy. Recession or Protection! A killer argument: I could write the slogans for this campaign.

Let's face it: These are the signs of a desperate man, reaching for any argument to defend what cannot be defended.

James K. Galbraith is author of Created Unequal: The Crisis in American Pay (Free Press, 1998) and director of the University of Texas

Inequality Project. A professor at the University of Texas at Austin and senior scholar at the Levy Economics Institute, he worked for many years on the staff of the House Banking Committee, where he conducted oversight of the Federal Reserve. He welcomes your feedback at

Galbraith@mail.utexas.edu.