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Channeling the Fed Chairman


It's July 16, 2002. In a ritual begun about a quarter century ago as a remedy for chronic back pain, Greenspan is starting his morning with a long soak in a hot bath. As the world's most powerful financier poaches himself, he pores over staff reports and begins preparations for the workday.

Today, he's putting the finishing touches on the Fed's semi-annual economic report to Congress. His testimony before the Senate Banking Committee later in the morning will be laced with a surprise. In a move that he has fitfully mused about for months, he is planning to announce his retirement--some two years before his tenure expires in June, 2004.

That will catch the world's money mavens off guard, Greenspan thinks. As the steam rises and he conjures up images of the next day's headlines--"Global Stocks Dive on News of Greenspan Exit"--the chairman's mind wanders...

When Bill Clinton reappointed me back in 2000, I said to myself--and more importantly, promised [my wife] Andrea--that I would step down this year. I'm 76, for Ayn Rand's sake! Time for a break. And, besides, I've always wanted more time to work on my tennis game. Heck, [ex-CIA chief] Bill Webster and I almost won the seniors' doubles cup at the club last year. He's got that sneaky backhand.

Besides, if I serve out my full term, Bush's boy Dubya would have to put up with a bit of awkwardness--naming my successor in the midst of his reelection campaign. I've spent the past 15 years trying to convince everyone that the Fed is largely above politics. We're not, of course, but why should I throw all that hard work away by exposing the Fed to the sturm und drang of a campaign? Bush is going to have a hard enough time finding someone to replace me as it is.

Anyway, this is a great moment to be saying goodbye. I'm going out on top. My faith in the New Economy has been vindicated. Growth is taking off with nary a whiff of inflation in the air. Before you know it, we'll be back in that sweet spot and hitting "four by four" again--4% growth with unemployment falling toward 4%.

Getting there hasn't been easy. The last year has been, well, a bear. It all started with our meeting in August, 2001. Everybody was on board for another quarter-point rate cut. But a lot of my colleagues wanted to signal that this one would be our last by jettisoning our bias toward easier credit. Larry [Meyer] started lecturing me about the lags in monetary policy and all the stimulus that we had already pumped out. I knew I was in trouble when I saw heads nodding around the table. But my gut told me it was the wrong way to go. The economy was still too fragile. After a lot of back and forth, I won, and we kept the bias.

It was a good thing, too. Stuff really started to hit the fan last October. First that big Japanese bank went bust. What a surprise! I've only been telling Tokyo for the past dozen years that they needed to do something to purge the bad loans from their banking system. Next, that European telecom company missed an interest payment. And then our stock market headed south as investors finally got fed up with waiting for a revival of tech company profits and bailed out.

What is it about October, anyway? I was only on the job a couple of months back in '87 when the Dow dived more than 20% on Oct. 19. I'll never forget it. I was going to give a speech to some bankers in Dallas and had to turn around and come back to patch things up. Then there was 1998. The whole financial system looked as if it was coming unglued. I had to cut rates between meetings just to show that I was still in charge. Ah liquidity, the mother of invention.

Of course, last year's little episode didn't hold a candle to those earlier conflagrations. But it was interesting nonetheless. The best thing was that it served to concentrate the minds of our friends overseas--and some of my more complacent colleagues at home. We cut rates another half-point. (I resisted the temptation to tell Larry "I told you so.") Wim [Duisenberg, head of the European Central Bank] finally got off his duff and started easing credit, too. It was about time. I had only been urging him to move for months. Even the Japanese did their bit. They came up with a plan to mop up the bad loans that I had to admit had a good chance of working. In the face of all that financial firepower, the markets turned, the crisis passed.

Ta-dah! The maestro had done it again! Truth be told, though, the real hero is the American consumer. Through it all, the shoppers just kept at it. With all the stuff they'd bought over the years, I thought they'd slam shut their wallets. Just look at me. How many more suits can I fit in my closet? They look more or less the same, anyway. But I should have known better. Americans just love to shop. And all that buying of cars and electronics and computers kept the economy afloat.

Some of those so-called researchers at the New York Fed have tried to make the argument that there's no such thing as the wealth effect. Baloney. It's just a lot more complicated than we thought. I realized something was up when Andrea told me last year that one of our neighbors had just sold his house at 20% over the asking price. I knew it was more than just Republicans moving in and Democrats moving out. House prices were going up nationwide. If that's not a wealth effect, I don't know what is. Sure, a lot of people lost a lot of money in the market. (Fortunately, all my money is in T-bills, which is a good thing now that I'm going to retire.) But for most Americans, rising house prices are far more important than falling stock prices. So naturally, they kept on spending.

Of course, that drop in energy prices and the tax cut didn't hurt. I've got to give [Bush economic adviser] Larry Lindsey credit. I've always thought his gloom-and-doom act was over the top, but it turned out he was ahead of the curve in seeing that the economy would need a fiscal boost.

ALMOST A WHOPPER. But no sooner did the economy start showing signs of life in early 2002 than the bond-market vigilantes began to bang the drum for higher interest rates. And a couple of our regional Fed presidents quickly jumped on board in March. They were convinced that the New Economy was dead and that the inflation bogeyman was at the door. Productivity hadn't perked up much, and capital investment was still lagging.

I must confess that I was a bit worried. I don't like admitting when I've made a mistake. And this one would have been a whopper. That's why I was so glad to see capital spending start to take off in May, 2002. I got such a start when it showed up in the data that I accidentally dropped a spreadsheet in the tub.

Oh, well. All this is going to be someone else's baby soon. I wonder who Bush is going to pick to take my place. Maybe John Taylor. He's an Under Secretary at Treasury now, and he did a lot of good work on the Fed and central banking at Stanford. That Taylor Rule, linking changes in interest rates to fluctuations in inflation and unemployment, was certainly a nifty piece of business. I just hope John's got what it takes. It's one thing to come up with a rule to tell what you should do with rates. It's another to actually raise them.

And it's starting to look like it's time to do just that. Not because there's any real risk of inflation. In the New Economy, most of the price pressure is downward. No, the risk is that if we don't start raising rates now, we could see a replay of dot-com mania next year. I couldn't stand that. What a waste of money.

But how far should we go? Do we just snug up rates a bit? Or do we do the full monty and go back up to 6 1/2%, or more? How do we manage a boom so it doesn't ever have to go bust?

This stuff is so fascinating, maybe I should just stick around to make sure that things stay on course and that the New Economy skeptics keep eating my dust. Of course, there's that little matter of what to tell Andrea. By Rich Miller


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