The unpredictable and frequently astonishing events of the last several months have forced many people to change plans. Young entrepreneurs anticipating dot-com initial public offerings have had to shelve the blueprints for their mansions. Large companies are shying away from jittery bond markets. Consumers have postponed purchasing expensive sport-utility vehicles. And in Washington, D.C., after the most contentious Presidential election in American history, movers (and lobbyists) are busily preparing for a new Administration to take the reins of power.
These developments will also surely affect the man whose steady hand has guided the U.S. economy through unprecedented growth: Federal Reserve Board chairman Alan Greenspan.
As the new year dawns, CFOs and their colleagues in executive boardrooms are looking to the 74-year-old economist more than ever for stability and guidance. George W. Bush may formally take office on a chill January day, but Greenspan’s credibility and ability to control interest rates have effectively made or broken the last two Presidencies. “In some ways, it’s going to be a Greenspan Presidency,” says Justin Martin, author of the newly published biography Greenspan: The Man Behind Money.
Greenspan’s world is changing, however, and not just because there will be a new resident at 1600 Pennsylvania Avenue this month. Rather, as Governor Bush and Vice President Albert Gore slugged it out in their cross-country grudge match, the capital markets and the U.S. economy were downshifting. And Wall Street economists and political analysts warn that the Goldilocks economy of the late 1990s may be giving way to some economic porridge that is too cold.
If that proves to be the case, then Greenspan may start to hear something he hasn’t heard for a long, long time: criticism. “When the times turn sour, in particular if the Fed has manifestly had a role in souring them, the chairman loses a lot of popularity,” says James Galbraith, professor of public policy at the Lyndon B. Johnson School of Public Affairs at the University of Texas at Austin.
Inscrutable even in the best of times, Greenspan has been even more difficult to read of late. Last October, in one of his much-followed speeches, he was positively upbeat about the U.S. economy’s ability to continue to outperform the world without producing inflation. But at the meeting of the Federal Open Market Committee on November 15, he left interest rates where they were and maintained an anti-inflation stance. Then, on December 5, Greenspan indicated the Fed might be willing to lower interest rates after all. In response, shellshocked investors hit the markets like sailors hitting bars on a shore leave, pushing the Nasdaq index up 10.47 percent — its largest single-day gain ever.
To be sure, Greenspan’s relentless jihad against inflation paved the way for the 1990s boom. And over the years, he has frequently done battle with America’s growing investing public, trying to rein in what he viewed as its “irrational exuberance.” When Greenspan joined the Fed in August 1987, his first act was to raise interest rates. (He feared that the Dow, then at about 2,600, was overheating.)
In 2000, Greenspan’s slow-acting medicine may have finally worked. A prolonged period in which money was cheap and relatively easy to come by — even if you were a snowboarding 25-year-old Internet entrepreneur with an inane business plan–has come to an end. Indeed, money is getting more expensive for all kinds of companies.
Since May 1999, the Fed has boosted the federal fund rates from 4.75 percent to 6.5 percent. Meanwhile, the junk-bond market essentially chugged to a stop last year. Why? “Marginal firms are finding it far more difficult to refinance, and as a result are failing in increasing numbers and defaulting on their existing indebtedness,” says Edward I. Altman, professor of finance at New York University’s Stern School of Business. As of November 27, more than $25 billion in junk bonds lay in default, and the default rate was expected to approach 5 percent by the end of 2000 — the highest since the recession year of 1991.
The CFO of one capital goods company, a frequent high-yield issuer, notes that in the late 1990s, his company generally paid between 8.8 percent and 9.5 percent for its bonds. Today, the same money would cost 12 percent. “Investors are cautious and jittery, so it costs me more to get the money,” says the CFO, who spoke on condition of anonymity. “I think there’s just a general tightening of credit all around, and there aren’t as many places for people to go to get capital.”
The state of affairs isn’t much better in the equity markets. Promising dot-coms have melted down like so many marshmallows over a campfire, while the stocks of technology bellwethers have slumped. The IPO flow has dwindled to an occasional drop from the spigot, and the Dow and Nasdaq were ready to close the books on their first down years since 1990.
Ironically, this carnage may have been good news for Greenspan, who frequently warned about the pernicious influence of asset-price inflation. “After the year [we had] on Nasdaq and the tech sector and everything else, it would be hard to imagine that people would think there is any problem with asset-price inflation,” says David Gitlitz, chief economist at DG Capital Advisors, in Parsippany, New Jersey.
Since financial markets are leading indicators of the economy, there is a growing belief that Wall Street’s woes may be trickling down to Main Street. CEOs ranging from Dell Computer Corp.’s Michael Dell to John Smith of General Motors Corp. have warned that top lines simply can’t continue to grow as they have for the past several years. Morgan Stanley Dean Witter & Co. predicts that aftertax profits will grow just 0.9 percent in 2001, down from 15 percent last year. Throw in instability in Latin America, and the view through Greenspan’s famous thick-rimmed glasses isn’t looking so rosy.
Another problem: the possibility of a so-called poverty effect. With many Americans using mutual funds as their savings accounts, the declining stock market might make them feel collectively poorer. “The equity markets have been pretty much flat since May 1999, and it’s only a matter of time before consumers start to adjust their wealth expectation so their spending habits are more in line with their income growth,” says Mary Dennis, a senior economist at Merrill Lynch & Co.
A potential moderation in consumer spending neatly meshes with some other anti-inflationary trends. At the beginning of December, the inverted yield curve, the low price of gold, and the generally depressed state of commodity prices were all indications that inflation remained licked. Through October, the core Consumer Price Index had risen a tame 2.7 percent in 2000. “As long as that core rate stays relatively stable, the Fed will not raise interest rates,” says Robert Litan, vice president and director of economic studies at The Brookings Institution, a Washington, D.C.-based think tank. However, “given the gathering clouds of doom, Greenspan seems more ready to cut rates than he was [in November]. It just remains a question of when.”
In Greenspan’s book, the tight labor markets (unemployment crept up in December to 4 percent, from a 30-year low of 3.9 percent) and the soaring price of oil pose inflationary threats. Consumers, meanwhile, remain generally optimistic despite the recent stock market debacles, according to Delos Smith, senior business analyst at The Conference Board. Smith adds, however, that their optimism “is starting to falter.”
Indeed, Greenspan may have deprived himself of one of his favorite tools: interest-rate boosts. “In the past, the combination of high oil prices and low unemployment has been an indicator of potential inflation,” notes Tim Rogers, chief economist at Briefing.com Inc., a Chicago-based capital-markets analysis firm. But should Greenspan become convinced that inflation is rearing its ugly head, he may have a tough time convincing his colleagues at the Fed to raise rates in the face of a perceived slowdown and continuing market turmoil.
Debt and Tax Cuts
If macroeconomic factors may inhibit Greenspan’s ability to raise rates further, the shaky political situation in Washington should work to his advantage, enhancing his power and stature.
True, he will have to find a way to work with a new team of players, and he may have to contend with residual resentment from the Bush family and its loyalists. But Greenspan has strong ties to the new Administration. He is friendly with both Vice Presidentelect Richard Cheney and Colin Powell, the probable Secretary of State. The Bush economic team would be likely to include former Federal Reserve governor Lawrence Lindsey; John Taylor, a respected academic at Stanford University; and Martin Anderson, who, like Greenspan, served as an economic adviser to Presidents Richard Nixon and Ronald Reagan, and was also a devotee of philosopher Ayn Rand.
Regardless of its team, the Bush Administration will have to step gingerly. The Republicans lost two seats in the House of Representatives and now have just a nine-seat edge over the Democrats. Meanwhile, the Senate is evenly split, with the Vice President acting as tiebreaker if one is needed.
But the picture is even more complicated than it seems. Ninety-eight-year-old Sen. Strom Thurmond of South Carolina and his confederate, 79-year-old Sen. Jesse Helms of North Carolina, are both in poor health. Chances are, one of these Republicans will leave the Senate in the next two years. And since both Carolinas are controlled by Democratic Governors, their replacements would be Democrats. So Bush could find himself facing a Senate in hostile hands before the interim election in 2002.
Indeed, George W. Bush may find himself in the same position Bill Clinton did back in 1992–a President who failed to garner a majority of the popular vote presiding over a Congress in which his fellow partisans hold slim margins. For that reason, some observers don’t expect a radical departure from current fiscal policy when Bush sends his first budget message to Congress. “It really suggests that there is no mandate for either side,” says Merrill Lynch economist Mary Dennis.
That would be good news for Greenspan. Last fall, the Fed chief all but announced he would prefer that any federal budget surplus be used not for tax cuts but rather to reduce the nation’s still-substantial long-term debt. Indeed, Fed watchers had presumed that Greenspan might be averse to a tax cut, since it would provide a potentially inflationary jolt to the economy.
Still, the new President’s narrow margins may not stand in the way of a significant tax cut. After all, President Clinton managed to get his first spending plan through Congress in the summer of 1993 with a one-vote majority in each chamber.
In the campaign, Bush proposed a multiyear, $1.3 trillion tax cut. “A Republican government will have a substantial tax cut, but it won’t be everything people thought,” says Clint Stretch, director of tax policy at Deloitte & Touche. And because much of the budget surplus won’t materialize until the latter part of this decade, probably not more than $100 billion of the projected total cut would take effect in 2001, he adds. That could serve to minimize the immediate impact of a tax cut on interest rates.
Tax cut or not, Greenspan is sitting in the catbird seat — especially with a President about to take office under a cloud. Because of the credibility the Fed chairman has built up, any remark he makes about a budget proposal, however obscure, will send an unmistakable message to the bond markets. In effect, he can exercise a sort of veto over any proposal that comes his way. “He was close to [being] God before the election,” says Brookings’s Litan. “And he’s even closer now.”
Indeed, after 13 (largely) fat years at the helm, Greenspan has reached something of an apotheosis. And his most intelligent short-term move may be not to raise or lower interest rates, but to retire. After all, it’s a good bet the next four years won’t be as good as the last four–and presiding over an economic downturn is nobody’s idea of a swan song.
But it’s not likely that Greenspan, whose current term as Fed chairman ends in 2004, will avail himself of the rare opportunity to go out on top. As President Clinton says, perhaps a bit enviously, “I bet he’ll stay until they carry him out.”
Daniel Gross is a fellow at the New America Foundation, a public policy institute in Washington, D.C.
The wild card for the economy in the next several years may be the relationship between Federal Reserve chairman Alan Greenspan and George W. Bush. One would expect it to be a positive one. After all, Greenspan had been an active Republican for much of his adult life, and he is close to several members of Bush’s inner circle.
But Greenspan had a terrible relationship with the Administration of Bush’s father, George H.W. Bush. In 1991, as the economy began to slow under the weight of the savings-and-loan crisis and a general credit crunch, the Administration began to jawbone the Fed. “Interest rates should be lower — now,” Bush proclaimed in his January 1991 State of the Union speech. As the economy slid into recession, senior members of the Administration harangued the Fed chairman for not acting quickly enough. Nonetheless, eager not to spook the markets, Bush reappointed Greenspan in July 1991.
Greenspan did cut rates during Bush’s term. Between 1989 and 1992, in fact, the federal funds rate fell from 9.875 percent to 3 percent. But that wasn’t enough for the Bush Administration. Treasury Secretary Nicholas Brady essentially blackballed Greenspan, cutting off all contact. And after the election, the elder Bush explicitly blamed Greenspan for dooming his one-term Presidency. “I reappointed him, and he disappointed me,” Bush said.
Many observers have interpreted the campaign of George W. Bush as a mission to avenge his father’s loss. But Bush the younger seems to bear little ill will toward Greenspan. He endorsed the Fed chairman heartily during the campaign. And while Bush has reassembled his father’s foreign policy team, the economic team that fouled things up back in the early 1990s remains in oblivion. Nicholas Brady has been conspicuously absent from the Austin war councils. Says Merrill Lynch senior economist Mary Dennis: “Hopefully, the new Bush Administration will not repeat the mistakes of the past.” —D.G.