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OLD FRIENDS ARE BEST

Although President Bush comes off as a pillar of the Eastern Establishment, he has always displayed a Texas-bred penchant for bank-bashing. So it's hardly surprising that almost from the day he entered the White House, Bush has grumbled about the Federal Reserve. The President and his lieutenants have used every weapon at their disposal--from barbs in State of the Union speeches to behind-the-scenes arm-twisting--to pressure the Fed to lower interest rates. Not that they got much for their efforts. Rather than hyping the economy, the Fed tried to slow growth into a "soft landing" that skidded instead into a recession.

So why did the President tap Alan Greenspan for a second four-year term as Federal Reserve Board chairman? For one thing, Bush sticks by people who stick with him. For all the White House grousing, Greenspan has kept any criticisms of Administration economic policy to himself. And even if he gets the blame for the recession, Greenspan can also claim credit for a recovery that got under way 18 months before the 1992 election. "I would not be standing here with this man if I did not have full confidence in him," Bush told reporters on July 10.

EYES ON THE POLLS. Can Greenspan keep Bush's confidence for four more years? The White House doesn't share Greenspan's goal of wiping out inflation by the mid-1990s. Bush wants to keep the recovery going, with lower interest rates when necessary, and he'll expect Greenspan to deliver, even though the Fed has grown increasingly fractious. But reappointment, particularly once the 1992 election is over, could give Greenspan the freedom to follow his lifelong belief that sound money and low inflation are the best way to guarantee steady growth.

That dyed-in-the-pinstripes, central banker attitude was responsible for Greenspan's mistakes during his first term. Greenspan's greatest triumph was to keep the aging economic expansion going through the 1987 stock market crash. But he admits that he was caught off-guard when banks choked off business lending last summer. Greenspan still argues that the recession began in October, months after Saddam Hussein's invasion of Kuwait. That puts him at odds, however, with the official business-cycle arbiters, who date the slump to July. Although the Administration doesn't buy Greenspan's argument, a top Bush aide says "no one would argue that Greenspan exclusively caused" the slump.

Such faint praise reflects some White House ambivalence about keeping Greenspan. But the internal debate that preceded the decision was brief and mild. Treasury Secretary Nicholas F. Brady briefly championed E. Gerald Corrigan, who has impressed Brady's Wall Street friends during six years as president of the New York Fed. But other aides, including Budget Director Richard G. Darman, argued that Corrigan is an inflation hardliner like his mentor, former Fed Chairman Paul A. Volcker. Corrigan also opposes key elements of Brady's own bank-reform plan. Eventually, aides realized that their dissatisfaction wasn't strong enough to overcome Greenspan's ties to Bush.

While they couldn't block Greenspan, Bush aides used delay over reappointment to squeeze him. The tactic may have worked: At the July 2-3 meeting of the Fed's Open Market Committee, the panel left its targets for M2 money-supply growth unchanged for next year. Greenspan has cut those targets in three of the past four years, and lower 1992 targets would fit with his long-term strategy of reducing inflation to zero. Fed officials note the decision could be changed once the economy's strength becomes clearer. But, adds a senior Fed official, "we also had to look at where we are in the chairman-selection cycle."

A steady rebound would work wonders for White House-Fed relations.

With the recession "barely cold in its grave," a senior Administration official frets that "it's very important that the Fed not follow a policy that prematurely snuffs out the recovery." But most forecasters--including the Fed--see growth of only about 3% for the next year, with inflation falling. The Fed may have no reason to raise rates for months.

The honeymoon may not last, though. Next summer--in the heat of the 1992 Presidential campaign--the Fed may have to decide whether to increase rates to meet its goal of "price stability" by the mid-1990s. Greenspan believes that controlling inflation "is a necessary condition to maximizing growth and employment." But cutting inflation may require years of below-par growth and high unemployment. To a public inured to 4% annual price hikes, that cost may well seem too high. Greenspan sidestepped those concerns in his first term. The Fed's goal then was a gradual squeeze, presented as the best way to correct the excesses of the Eighties. But if the economy shows signs of flagging, any kind of squeeze will be tougher. If Greenspan persists in seeking price stability, "he'll risk being so far out of step he'll put the Fed's independence in jeopardy," warns H. Erich Heinemann, chief economist at brokers Ladenburg, Thalmann & Co.

Continued turmoil in banking may also force the chairman to tread lightly. The financial system made it through the recession without a major crisis. But many banks are still bleeding from bad loans. Neither the credit crunch nor the threat of major failures is behind the banking system.

To avoid being blindsided again, Greenspan is spreading his intelligence net wider. He still watches such financial indicators as money supply growth (charts). But those signals will become harder to read as the financial industry evolves, a process that will accelerate sharply if Congress passes sweeping bank-reform legislation. So Greenspan has stepped up surveillance of lending and is paying more attention to anecdotal evidence about credit conditions. That, says former Fed Governor Lyle E. Gramley, "will be crucial to staying on top of the economy."

Meeting that challenge will require stronger leadership than the cerebral Greenspan has shown to date. He has allowed a debate to rage between Fed traditionalists, who are vigilant about inflation, and superhawks, who are willing to put the economy through the wringer. Greenspan's reluctance to knock heads could lead the Fed to tighten earlier than either he or the White House would like. "Most people in the Fed system like Alan's style," says a former official. "But he doesn't have the sort of fear-respect thing a chairman needs."

SECOND CHANCE. Democracy within the Fed has produced some embarrassments. In mid-April, for example, Greenspan wanted to cut the discount rate, but he had only one other vote on the Fed board. So the Fed chairman let Treasury Secretary Brady, who was trying unsuccessfully to persuade U. S. allies to reduce rates in concert, to lobby Fed governors for the cut. When the Fed's move finally came, it "came across as 75% political on Greenspan's part," says David M. Jones, chief economist at Aubrey G. Lanston & Co.

A second term will offer the 65-year-old Greenspan a chance to go down in history as the man who restored the brief, shining era of the mid-1960s, when the economy enjoyed steady growth and low inflation. But Greenspan is also loyal to the Republican Party, which could need a more vibrant economy to hold on to the White House. That conflict between historical possibility and political reality will weigh on every decision he'll make in the next four years.Mike McNamee, with Douglas Harbrecht, in Washington


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