What the Fed Has Wrought
The Committee for the Direction of the American Economy--sticklers know it as the Federal Reserve Board--met last week and declared itself satisfied with the resurrection of national prosperity. Unfortunately, this provides only marginal comfort, because a possible roller-coaster economy may take Americans for a double-dip recession ride in 2003.
Over the last three decades, under the ever more prominent guidance of the Fed, the U.S. business cycle has developed a little-understood quirkiness. Recessions aren’t over when they’re announced to be, and two downturns--one in the 1970s, the other in the 1980s--became spine-tingling double-dips. To add to the risks of 2002-2004, Fed Chairman Alan Greenspan, 76 and wearying, may retire and be replaced by a minimally credentialed person few Americans have heard of.
Fed meetings now command as much media attention as a presidential press conference, a celebrity unimaginable 40 years ago. Few citizens back then knew or cared about chairmen like William McChesney Martin (1951-70) or G. William Miller (1978-79). By contrast, the Fed chiefs since the late 1970s, Paul A. Volcker and Greenspan, have become household names, and their position is often called the nation’s second most powerful.
This is partly because deregulation of interest rates and finance during the 1970s, ‘80s and ‘90s, along with the floating of international currency rates, has made the Fed’s job of managing the money supply a lot more complicated--and also a lot more determinative of the ups and downs of the U.S. economy. Central banks in other nations have also gained clout, but none can hold a candle to the U.S. Fed. Fellow central-bank chiefs treat Greenspan with a deference the College of Cardinals reserves for the pope.
The Fed’s new global role is more than paralleled by its firmer hold on the U.S. economy, but that has not meant it can better predict when recessions are over. Take the bad downturns in the early 1970s and 1980s. Both, in a sense, came in two separate stages. The recession of 1970-71 staged the economic equivalent of a second coming in late 1973. The recession in early 1980 had barely abated when a new downturn developed in the second half of 1981.
Important interconnections support the two-stage thesis. In 1971 and then again in early 1980, moderate recessions were underway largely because the Fed had raised interest rates to cool the overheated economy. Both White Houses became nervous because the presidential elections of 1972 and 1980 were on the horizon. The Fed, in turn, was just a telephone summons away. So, each time, a newly appointed chairman--Arthur F. Burns in 1971-72, Volcker in 1980--gunned monetary policy, accelerating the economy out of looming election-year doldrums.
The trouble was, these revs added a powerful stimulus and renewed inflation; interest rate hikes resumed and new recessions began in 1973 and in 1981. Moreover, each of these follow-up recessions was a humdinger, deeper than their lead-ins.
In 1990-91, Fed policy shaped a different kind of recession--short for the big hitters in the financial markets, drawn out for the folks in convenience stores. The Fed and the economics profession said the recession ended in spring 1991, when gross domestic product and the stock market rebounded. Main Street knew better. Federal data showed that white-collar unemployment continued to rise, peaking in 1993, two years after recovery supposedly began. Ross Perot’s third-party presidential candidacy bid tapped a real economic frustration and helped drive George Bush out of the White House in 1992.
This history suggests that what’s a recession, and what isn’t, has become increasingly blurred and debatable. More and more, the yardsticks reflect a finance-weighted economy, not a goods-producing one. Besides, that’s what the Fed represents--finance, in general, and banking, in particular.
The Fed, you see, isn’t a regular government agency. It’s a hybrid, partly controlled by the U.S. government and partly by the banking industry. The Federal Open Market Committee, the body that votes to expand or shrink the nation’s money supply, includes a number of regional Federal Reserve Bank presidents who are selected by district boards, on which bankers sit.
Some economists find this a damning conflict of interest. Milton Friedman, a 1976 Nobel laureate, complained a decade ago that banking is a “major sector of the economy in which no enterprise ever fails, no one ever goes broke. That’s because the banks have been the constituency of the Federal Reserve.” Labor halls, Main Streets and suburban subdivisions don’t rank as high.
Controversy has also dogged Greenspan’s recent years at the economic helm. Did he get us out of the recession in 2001-2002? Did he first get us into it in 2000? Or did he do both? There’s no doubt that the Fed’s 11 rate cuts in 2001, a record, gave the economy just about its biggest hot shot ever. Bank profits soared, but manufacturing crumbled, and goods-producing America still has one leg in the dumpster.
History, alas, suggests that the piper still has to be paid for the Fed’s unprecedented stimulus. Stage two has yet to be felt. Conceivably, 2002 and 2003 could resemble 1991 and 1992--a weak “recovery” period, during which the GDP remains in positive territory because of finance, while unemployment continues to drift higher.
But a double-dip recession along the lines of the 1970-75 or 1980-83 pattern is attracting more attention. Each, with some oversimplification, can be described as a mild recession followed 12 to 24 months later by a deep recession.
Could it happen again? Conceivably. Savvy Wall Street advisory groups have dug into their economic histories and report that a quick double-dip--a return to recession this summer, say--is probably impossible. No down quarter has been recorded during the first year after a recession all the way back to 1954, excluding 1980.
But this is less reassuring than it may first appear. Official data have already put the fourth quarter of 2001 back in the economic growth column. Thus, by September 2002, the recovery would be 1 year old, expiring the assurances from past experience. And the stock market, remember, is described by analysts as looking some six to nine months ahead. By that chronology, any perception of a double-dip beginning in early 2003 could start to pull the market down as early as next month.
Cynics suggest that another downturn is almost inevitable, because the one just passed has left record consumer debt more swollen than ever, the real-estate bubble untouched and stock price-to-earnings ratios at unsafe heights. As for inflation triggering interest-rate hikes, some economists say that the best predictive measure--the median Consumer Price Index--is already running at a worrisome average of 4% for 2002. The bond market has begun to price in future rate hikes, boosting long-term rates. Such circumstances make a double-dip in 2003 quite believable.
Either way, the next few years are likely to have some unprecedented follow-through economic contortions, which may help explain the new talk about Greenspan considering retirement. He most likely wants to quit while he’s ahead, and he’s got a respectable reason. The problem is, there are no obvious high-powered GOP successors.
The two most credible choices, former Clinton Treasury Secretary Robert E. Rubin and William McDonough, president of the New York Federal Reserve Bank, are both Democrats. The Republicans are talking about John Taylor, U.S. Treasury undersecretary for international affairs, who is barely known in politics and government, and White House economic advisor Lawrence B. Lindsey, who suffers from too much politics and too many Enron connections.
It’s probably essential for Greenspan to stay, despite his age and despite the possible roller-coaster ride ahead. Otherwise, besides worrying about unusual economic after-effects, we--and the rest of the world--might also have to worry about a U.S. economy being run by a new Fed chairman hardly anyone has ever heard of.
