Greenspan, Still in Control
Jude Wanniski
February 1, 1994


With the surprise resignation today of Fed Vice Chairman David Mullins, to make room for a White House candidate, it is all the more important that Chairman Alan Greenspan is in full command of his political faculties. The surmise is that Mullins, the kind of man who would leave quietly if the President wanted his chair, was the innocent bystander of a political play. In this election year, the Democrats want more control at the central bank, to make sure there are no unpleasant partisan surprises. Greenspan's position is now unassailable, as his two-hour appearance yesterday before the Joint Economic Committee indicated. Being able to fill the Vice Chairmanship gives the President the assurance he needs. Let's bet he names Bob Rubin, his closest link to Wall Street. Rubin, who came to the White House from Goldman Sachs and now chairs the powerful National Economic Council from the West Wing, is too big to simply replace Wayne Angell, a mere governor. The vice chairmanship would give him an appropriate post from which he could learn the ropes. Considering the alternatives, it would be great for the financial markets if Rubin were named. He's not an academic, but a Greenspan type of a younger generation, who learned about markets on the firing line. Let's hope it's he.

We watched Greenspan's testimony twice yesterday, the second time at home on the C-SPAN evening replay. It was a remarkable presentation, his best yet, but curiously flawed. If there was ever a demand-side economic bone in Greenspan's body, it must have been surgically removed, because we could not see a trace in this exposition. He's not always easy to follow, because his mind races through a unique data base at the speed of light. This is one of his biggest problems -- that there are only a few people in the world with whom he can talk monetary policy at the highest levels. I told him this not long ago, citing a parallel comparison with Gary Kasparov, the world chess champion, who can really converse with only a half dozen grand masters. Because Greenspan is the central banker of the world reserve currency, he is at the summit, the myriad variables he has to juggle beyond the ken of his fellow G-7 bankers. Mullins and Angell are two who can communicate with him at this Everest level. When Greenspan said today that they will be sorely missed, he wasn't kidding. Larry Lindsey is getting to that point, but has a way to hike, along with the other three governors. For the moment, there is nobody in Congress and nobody in the Administration, including Rubin. The only Democrat I could think of was Paul Volcker. Brookings economist George Perry, whose reported nomination is for some reason "on hold," has never been on the Wall Street firing line and is no match for Greenspan.

In his presentation yesterday, Greenspan said the following, in so many words: He absolutely does not believe in the Phillips Curve inflation/employment trade-off. There is no set percentage limitation that caps the growth rate of the U.S. economy. Growth could be faster than 3% as long as productivity increases apace. Force-feeding via monetary policy will cause unemployment to rise, not fall. The government can't tell in advance how fast growth will occur; it is only clear in retrospect. Economic growth is good for the bond market, and short-term interest rates should not be raised in order to cut off or limit economic expansion, only to sustain and enhance it. Lower interest rates not only enable the government to economize on debt service, but also enhance revenue flows by inviting higher levels of economic growth. Long-term interest rates rise because of inflationary expectations, and it is the Fed's job to remove those expectations. The 6.2% yield on the long bond contains considerable inflation expectation (which implies the Fed can bring it down by chipping away at it). A firm anti-inflationary stance would assure long-term investors that the value of bonds or mortgages would not be eroded. The capital gains tax is a poor way of raising revenue and should be eliminated. At least, it should be indexed for inflation, which could only be positive. The U.S. economy remains in fragile condition and could be damaged by miscalculating finance costs of new programs, i.e., health care. 

Greenspan was helped along during his presentation by the J.E.C. members, including Chairman David Obey [D-Wis], who actually praised Greenspan's performance over the last year. Sen. Bob Bennett [R-Utah], Rep. Dick Armey [R-Tex], and Rep. Chris Cox [R- Cal] got in the mood and asked intelligent questions instead of arguing about which party gets credit for the low interest rates. The only gap in the entire performance was on the central issue, a point raised by Sen. Paul Sarbanes [D-Md]: If there is to be a rise in short-term interest rates in order to puncture inflationary expectations, what objective evidence would it require for Greenspan to make that judgment? If there is to be a "preemptive strike" against inflation, what is the theory that would justify the move? Sarbanes, who produced charts and graphs in support of his argument that there is no inflation in sight, deserved an answer. If the Republicans on the committee had coaxed Greenspan as well, he might have revealed more of his strategy, but he slipped away. Greenspan thus left the Hill having done little to chip away at the inflationary expectations he had cited. At the end of the day, bond yields were higher, an admonishment to him. 

His answer can only lie in the signal of inflationary expectations being thrown off by the gold market. The gold price did weaken at first, but soon moved up, ending higher on the day. Greenspan did not mention gold in his prepared statement and no member of the committee brought it up. They should have, for in his Senate Banking Committee testimony last August, Greenspan for the first time revealed his thinking that the gold price provides information about inflationary expectations that is not replicated by other commodities. It was the obvious question to ask Greenspan yesterday, relative to the preemptive strike. Greenspan could easily have pointed out to Sarbanes that the great inflation of the 1970s was preceded by a dramatic rise in the gold price, and if the Fed had acted at the time, before the inflation was already embedded in the system, two decades of financial turbulence could have been avoided. He could have noted that the Savings & Loan crisis would not have occurred, with its nearly $1 trillion cost to the taxpayers. He could have reminded Sarbanes that gold almost quadrupled in price, to $120 an ounce from $35, before the oil sheiks announced a four-fold increase in the price of a barrel of oil. If the Fed, then chaired by Arthur Burns, had struck preemptively, the national debt would be closer to $500 billion rather than $5 trillion. Maybe lower. 

The gold price sat there, like the walrus in James Thurber's living room, nobody wanting to mention it. Congressman Cox, who was still in knickers when President Nixon let the walrus in, came closest to getting Greenspan to discuss it. He asked the Chairman if he could cite examples in recent history when inflation appeared after it was already too late to stop it. The Chairman said he could, but would not, implying that many of the people responsible for those terrible decisions are still alive, and it would make them feel bad if he discussed their errors in public. In today's New York Times account of the hearings, Robert D. Hershey, Jr., recalls the 1979 period, "when Paul A. Volcker was summoned by Jimmy Carter in near emergency conditions to take over the Fed and arrest oil-fueled inflation that wound up at 13.3% that year." Oil-fueled inflation? If prodded just a bit, Greenspan might have reminded the J.E.C. and the Times that the rise in the oil price was preceded by the gold price, and that under Volcker's stewardship the price of gold leaped as high as $850 an ounce, from the $200 range when Jimmy Carter summoned him. 

These discussions cannot take place in public, though, because too many people would feel bad. It was awkward enough when Greenspan was asked last summer how he could be so out of step with Milton Friedman and Paul Samuelson, both Nobel Prizewinners, who argued last year that the Fed should be inflating. They are both good fellows, Greenspan replied, "but they are wrong." If you make it to the Oval Office as a member of the Establishment, and make grave errors of governance on the advice of that Ruling Class, you will be protected from that knowledge during your lifetime. It's kind of a rule of the club. If you ignore the advice, as outsider Ronald Reagan did, your success must be denied.

On the day Alan Greenspan was preparing his testimony for the J.E.C. last Wednesday, former President Nixon was in town. It was the 25th anniversary of his first inaugural, and some of his old friends in Congress who are still around hosted a commemorative lunch for him on Capitol Hill. The last time I spoke to Nixon face-to-face, I asked him if it ever occurred to him that he would not have been impeached because of Watergate if he had not gone off gold in 1971. "It's true," he said, "It's very rare in history that a political leader is touched by scandal and is brought down during an expanding economy." It struck me that President Clinton these days is doing everything he can to keep the economy expanding, which may be another reason Alan Greenspan is still in control.