AS THE ECONOMY TURNS

FOLLOWING IN THE FOOTSTEPS OF A GOD

Dr. William Shingleton

October 24, 2005

ALAN GREENSPAN has not been Chairman of the FEDERAL RESERVE BOARD forever; it only seems that way. It’s hard to imagine now, but when he was appointed to the position by President Reagan back in 1987 there was some question of whether or not he would be up to the task. The question lingered for a while because, after all, he was replacing a legend, PAUL VOLCKER, who had tamed a roaring inflation rate and re-established the Dollar as the international currency. By almost all reasonable standards, Mr. Greenspan has done a magnificent job. In February 2006 it will be BEN BERNANKE’S turn to attempt to follow a financial god. Let’s use this opportunity to take a look back at the footsteps in the shifting financial sands.

Assuming today’s nomination goes through; Mr. Bernanke will regain a seat as a Governor on the Federal Reserve Board, the institution that has the greatest influence over our short-term interest rates and over-all economic health. While he had previously been a Governor from 2002 to 2005, representing the Atlanta District, he has now been named as Chair, so he will be the face of the Federal Reserve to the public. Like all of the other members of the Federal Reserve Board, the Chair is appointed by the President of the United States. There are restrictions on being a member and some of those are being misunderstood in some of the early media reports. The restriction that Mr. Greenspan ran into, other than his age, was the requirement that, under the BANKING ACT OF 1935, no member of the Federal Reserve Board can be reappointed to the Board once he/she has served a full 14 year term. [Mr. Greenspan served more than 14 years because he was initially named to finish out the balance of Paul Volckers’s 14 year term. His own 14 year term started in 1992.] Since Mr. Bernanke will be appointed to fill Mr. Greenspan’s seat on the Board he will be eligible to be a member of the Board until January 31, 2020. In addition, while he is a member of the Board, he will simultaneously represent one FEDERAL RESERVE DISTRICT, probably Atlanta again, and no other Governor can be appointed from that district during that time [NOTE: Boston, Chicago, Minneapolis, and Kansas City are also represented. Mr. Greenspan, who represented the NEW YORK district, will be the third member to leave the seven member board. The other two seats are still vacant and will be filled by people who are from some of the seven other Federal Reserve Districts not currently represented on the Board. http://www.federalreserve.gov/bios/boardmembership.htm].

While the average term of a Chair to date has been seven years, the Chair appointment itself is currently for only four years, because of recent legislation. However a Chair can be reappointed, as Mr. Greenspan has been. It is probably this restriction that will end Mr. Bernanke’s term. After four years, Mr. Bush will no longer be President and the decision of whether or not to reappoint will be up to our new President. It is entirely possible that he may be reappointed, as Mr. Greenspan has been, but it is not certain. And the tradition at the Federal Reserve is that if he is not reappointed as Chair he would resign his term as a member of the Board as well. The four year restriction on the term of the Chair, while relatively new, is a tribute to the dogged stubbornness of William McChesney Martin, who was Chairman from 1951 to 1970. Appointed by President Truman, even the otherwise persuasive Lyndon Johnson was unable to get him to resign and Mr. Martin served as Chairman into Mr. Nixon’s Administration until the day his 14 year term expired.

Starting with Mr. Martin, we have had a string of notable Chairs. Mr. Martin ruled a Federal Reserve that allowed little inflation in the economy, perhaps at the cost of reduced growth in the economy. He was followed by Arthur Burns (1970-1978), who was a tenacious, if somewhat less-than-successful business cycle fighter with his “stop-go” monetary policy and, according to MELTZER (A History of the Federal Reserve, 1913-1951, pub.2003) was the last person to simultaneously serve on the Board and in the Administration. Like Mr. Bernanke, Mr. Burns was more of an academic and a former head of the President’s COUNCIL OF ECONOMIC ADVISORS (1953-1956). Unlike Mr. Martin, the policies of Mr. Burns allowed inflation to creep higher and higher, until prices were rising nine percent per year by the time he left. Mr. Burns, in turn, was followed by the worst appointment ever made by President Carter, G. William Miller. To be generous, Mr. Miller had no clue what he was doing and was in so far over his head that inflation was over 13 percent by the time he was done after only 17 months. His apparent “qualification” for the position was that he had been Chairman of President Carter’s Finance Committee during his successful election campaign. I guess FEMA had not been invented yet.

Once Mr. Miller was fired in August 1979 we began to walk among the giants, both figuratively and literally, with Paul Volcker. A devoted MONETARIST, believing that the growing inflation problems were caused by too much money sloshing around the system, Mr. Volcker was willing to slam on the monetary brakes, allow the PRIME interest rate to jump over the 20 percent mark, and have the economy crash into a recession in 1981-1982. He wasn’t being cruel, he was being bluntly logical. If too much money was causing the runaway inflation, then the monetary brakes were necessary to break the back of inflation. The inflation came down from 13.3 percent in 1979 to 3.8 percent in 1982 and stayed pretty much in the lower end of that range throughout the remainder of Mr. Volckers’s term (1979-1987). Mr. Volcker also played another role. The Chair of the Federal Reserve became a well-respected public figure. Other than academics, most people had little idea who most of the previous chairmen were. Even President Kennedy himself is said to have only remembered Mr. Martin’s name because it “starts with an M and M stands for money” [Arthur M. Schlesinger. A Thousand Days pub. 1965]. After Mr. Volcker’s very public term there was no need to worry about what V stood for. (Although the joke among economists was that the V stands for “Velocity” that’s how you know he’s a monetarist. Our sense of humor may be a bit dry.)

When Mr. Greenspan came into the picture in 1987 long-run inflationary expectations had been tamed and still the markets were nervous about whether or not he was capable. Over time, he has instilled confidence in himself, in the Federal Reserve, and in the United States. He refused to be guided by any one variable, whether it was the rate of inflation or the price of gold, and perhaps because he was so flexible, he was one of the first policymakers to see the role of an upward shift in productivity for the American economy. He was willing to allow the economy to go further and faster because he believed that we had effectively increased our AGGREGATE SUPPLY because of our improvements in technology. This shift meant that there was more room for the economy to grow than most conventional economists (myself included) believed. He was 100 percent correct on that very important point. Finally, he was a RISK MANAGER, moving from crisis to crisis without a clear or even comprehensible guide.

So what does Mr. Bernanke bring to the table? He is a known proponent of a TARGET RATE for inflation. His target rate, however, is not zero, that’s too dangerous. He advocates a BUFFER ZONE, which reduces the risk of deflation. Watching the way deflation has left the Japanese economy, the world’s second largest, dead in the water for most of the last ten years that seems like a reasonable approach. He also is an advocate of TRANSPARENCY in the decisions at the Federal Reserve, which has been drifting in that direction over the last few years. Certainly he will speak with more clarity that the famously exasperating Mr. Greenspan.

The biggest negative is that he is not Alan Greenspan. When the first crisis comes up we’ll find out what kind of a legacy he will leave. For myself, I’m a little concerned about a couple of things. He has almost no connections with Wall Street. That would not be as much of a concern if we had a balancing element at Treasury, but we do not. Mr. Snow has a background in railroading. The other side of the same coin is that Mr. Bernanke is almost entirely an academic. I know some of those guys and most of them don’t have a good feel for the real world. They spend afternoons writing newsletters to students and friends when they should be out, oh never mind that last part.

[Note: If you are interested in the history of the Federal Reserve then ALAN MELTZER’S A History of the Federal Reserve, 1913-1951, pub.2003 is the place to go. Mr. Meltzer has probably forgotten more than most of us will ever know about the institution. It is not easy reading.]

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