an interesting read in tomorrow's washington post magazine:
washingtonpost.com
Unlikely Alliance Helped Build Economic Boom
By Bob Woodward
Sunday , November 12, 2000 ; Page W08
Federal Reserve Chairman Alan Greenspan jumped at the invitation to visit the man who would be the next president. Arkansas Gov. Bill Clinton had just won the election in November 1992, and he wanted to reach out to the powerful Fed chairman. So a month after the election Greenspan was asked to come to Little Rock.
Greenspan, 66, had been chairman of the Fed for five years. A lifelong Republican, he had first been appointed by President Reagan in 1987. President Bush had reappointed him in 1991, even though Greenspan had had a very uneasy and contentious relationship with Bush's economic advisers. The chairman was determined to establish a good relationship with the new president, though Clinton was a Democrat.
With a somewhat severe face, bespectacled, a bit hunched, narrow-eyed and pensive, Greenspan radiated gloom. He spoke in a gravelly monotone, often cloaking his thoughts in indirect constructions reflecting the economist's "on the one hand, on the other hand." It was almost as if his words were scouting parties, sent out less to convey than to probe and explore.
On December 3, Greenspan took a commercial flight to Little Rock to meet with Clinton. As they talked alone in the governor's mansion, Greenspan found himself quite taken with the new young leader. Clinton was totally focused, as if he had no other care in the world and unlimited time. They ranged over topics from foreign policy to education, and Greenspan saw that Clinton's reputation as a policy junkie was richly deserved. The president-elect seemed not only engaged but engrossed.
Greenspan saw an opening to give an economics lesson. The short-term interest rates that the Fed controlled were at 3 percent, as low as they could practically go in these economic conditions, he said. But the Fed could keep them there.
The 10-year and longer rates were an unusual 3 to 4 percentage points higher than the short-term rate, at about 7 percent. The gap between the short-term rate and the long-term rate, Greenspan lectured, was an inflation premium being paid for one simple reason: The lenders of long-term money expected the federal deficit to continue to grow and explode. They had good reason, given the double-digit inflation of the late 1970s and the expanding budget deficits under Reagan. They demanded the premium because of the expectation of new inflation. The dollars they had invested would, in the future, be worth less and less.
Perhaps no single overall economic event could do more to help the economy, businesses and society as a whole than a drop in long-term interest rates, Greenspan said. The Fed didn't control them — the market did. But credible action to reduce the federal deficit would force long-term interest rates to drop, as the markets slowly moved away from the expectation of inflation, and could trigger a series of payoffs for the economy.
Clinton was so sincere and attentive that Greenspan continued. He outlined a blueprint for economic recovery. Lower long-term rates would galvanize demand for new mortgages, refinancing at more favorable rates and more consumer loans. This would in turn result in increased consumer spending, which would expand the economy.
As long-term rates dropped, investors would get less return on bonds and move into the stock market instead. The market would climb — an additional payoff. The federal deficit was so high and cumulatively unstable, Greenspan said, that increased government spending to increase jobs — in accordance with the traditional Keynesian model — no longer worked. The economic growth from deficit reduction could actually increase employment — a critical third payoff.
Greenspan noted that the economy was rebounding from the brief recession of 1990-91, but there was no telling if it would last. As had happened in the past, the recovering economy could fall on its face. Getting the long rates down and keeping them down with a strong deficit-reduction program could sustain and increase economic growth even more than the conservative estimates that were circulating in the government or privately.
This conversation continued for 2 1/2 hours. Greenspan had not intended to stay for lunch, but he did. From the beginning he sensed that Clinton was different from the four Republican presidents Greenspan had seen up close — Nixon, Ford, Reagan and Bush. The chairman left the meeting thinking, Either this guy has a lot of the same views as I do, or he is the cleverest chameleon I have ever run into.
On the five-hour trip back to Washington, Greenspan tried to assess what he had observed. Clinton was what Greenspan termed an "intellectual pragmatist." The term also applied to Greenspan himself. Clinton's campaign promises included tax increases on the wealthy, a violation of Republican orthodoxy. But increasing taxes reduced the federal deficit — and those deficits, Greenspan thought, were such a threat to the future of the economy that it might just be worth it to support Clinton's proposal.
One of the paradoxes, Greenspan realized, was that by running up the federal budget deficits, Reagan had effectively borrowed from the period that was now going to be the Clinton era. Clinton would have to pay it back by paying down the deficit in some way. The irony was that Clinton probably wouldn't have been elected if Reagan hadn't created the deficits.
Reagan had given Bill Clinton the opportunity to win the presidency, but he had also bequeathed to the new president a major problem.
Greenspan's real connection to the new administration was Lloyd Bentsen, the former Texas senator who was now Clinton's treasury secretary. They were close friends and regularly played tennis together. Though a partisan Democrat, Bentsen had been chairman of the powerful Senate Finance Committee and was conservative on fiscal and money matters.
Bentsen arranged for Greenspan to see Clinton on Thursday, January 28, the eighth day of the new administration. Greenspan told the president that it would be dangerous not to confront the deficit very soon. The problem would not make itself immediately apparent during the next several years, because defense spending cuts would obscure the ballooning deficit. After 1996, though, the data projections showed that the deficit and interest on the federal debt would become explosive.
"You cannot procrastinate indefinitely on this issue," Greenspan warned. Without action, he forecast "financial catastrophe."
Clinton made clear that he had received the message.
With Bentsen, Greenspan went further. He urged the new administration to set ambitious deficit-reduction targets for the federal budget. On February 5, the White House economic advisers sent Clinton a 15-page memo that summarized budget options and Greenspan's analysis.
It read, in part: "Greenspan believes that a major deficit reduction (above $130 billion) will lead to interest rate changes more than offsetting" the contraction to the economy caused by less government spending. This meant long-term rates would come down if the deficit reduction was sufficient to have credibility in the financial markets.
On his copy, Bentsen had written with his lead pencil referring to Greenspan, "He urges 140 or above," meaning Greenspan thought a $140 billion reduction in the economic plan four years out (1997) would be more credible than $130 billion. It revealed their most private, confidential talks.
Bentsen urged the president to develop a personal relationship of trust with Greenspan. He also emphasized to Clinton the importance of deficit reduction as a catalyst for lower long-term interest rates.
In a sense, Bentsen and Greenspan were using each other. For Bentsen, Greenspan's view on a specific deficit target was a potent weapon in the Clinton administration deliberations. For Greenspan, a big reduction in the federal deficit would make his job immensely easier, because lower deficits would likely mean lower actual inflation.
Clinton adopted the $140 billion target for 1997.
When the president unveiled his economic plan at his first State of the Union address to a joint session of Congress on February 17, 1993, Greenspan was there in the gallery, in seat A6 — right between Hillary Clinton and Tipper Gore, the vice president's wife, on full display as the national television cameras swung over to get reaction. The first lady had invited him to sit in her box for the speech, and Greenspan had accepted on the basis that protocol dictated he not refuse.
As Clinton spoke, Greenspan applauded stiffly. He believed the White House had given him enormous power, because if he chose to criticize the Clinton economic plan, he could do substantial damage — even perhaps do it in. But the large deficit- reduction portion was in part his own design, and he was hardly going to shoot it down.
On February 19, in testimony before the Senate Banking Committee, Greenspan said that the Clinton plan was "serious" and "credible," making headlines with his support. Greenspan thought that Clinton had broken the gridlock on dealing with the deficit. He couldn't say it publicly, but he believed the president had displayed an element of political courage. He was taking a stance that some in his own party would fight him on. In Greenspan's view, Clinton deserved commendation if there was any justice in the crazy town of Washington.
It had been a remarkable four months for Greenspan. His impact on the new Democratic president was real and positive — a degree of influence he had not begun to approach during the more than five years he had been chairman under Reagan and Bush.
Within a week, long-term interest rates began to fall, and Clinton said in a speech, "Just yesterday, due to increased confidence in the plan in the bond market, long-term interest rates fell to a 16-year low." The yield on the 30-year Treasury bond had dropped below 7 percent.
Bentsen was delighted. He was all over Greenspan, peppering him with questions about the chairman's forecast and projections for the bond market. The long bond rate was the new talisman in the Clinton administration.
On May 18, 1993, Greenspan and the Federal Reserve Open Market Committee, the key-interest-rate-setting body at the Fed, voted to "lean" toward higher interest rates and gave the chairman the authority to raise rates by himself before the next meeting. The vote — due to be made public six weeks after the meeting — indicated that interest rate hikes were likely coming because the economy was overheating and high growth was almost certain to trigger a new round of inflation.
Six days later, the Wall Street Journal scooped everyone with a story reporting that "Federal Reserve officials voted to lean toward higher short-term interest rates." The New York Times wrote that the Clinton White House "would view such action as a declaration of war. And it would probably direct its heavy artillery at Mr. Greenspan."
Greenspan wanted to avoid war between the Fed and the White House at almost any cost. He spoke with David Gergen, a longtime communications adviser to Republican presidents Nixon and Reagan who had just joined the Clinton White House staff in the same capacity. Greenspan had been friends with Gergen for years, part of his Washington network. Gergen urged the chairman to give Clinton a pep talk. Polls showed Clinton's approval rating at 36 percent, the lowest of any new president in his first four months. Greenspan needed to encourage Clinton to continue to push his deficit-reduction plan.
On Wednesday, June 9, Greenspan went to the White House to see the president. The chairman was upbeat. The new consumer price index due out the next day was expected to show an increase of only 0.1 percent, suggesting inflation was in check, he said. They could feel some relief. The long-term economic outlook was the best and most balanced in 40 years, he told the president. He confirmed the authority his committee had given him to raise rates.
"If I have to do something, it will be very mild," he assured Clinton. A small increase would signal to the markets that the Fed was on top of the situation, and it was likely that the long-term rates would come down.
Several Democratic senators suggested publicly that Clinton drop his five-year deficit target. This was precisely the wrong message, Greenspan felt, and on July 20 he testified before the House Banking Committee with unusual directness, "If you appear to be backing off, I think the markets would react appropriately negatively."
Clinton's hands were effectively tied. He stuck with his deficit-reduction plan, though Bentsen had to bat down an effort from populist advisers to trim it some more.
In August, Clinton's deficit-reduction plan passed Congress by the narrowest possible margins, 218 to 216 in the House, and 51 to 50 in the Senate, with Vice President Gore breaking the tie. Not a single Republican had voted for the plan, which cut $500 billion from the deficit over the next four years by increasing taxes and cutting some federal spending. The only real Republican support had come from Alan Greenspan.
For years there had been discussions in the media and elsewhere of the possibility that the Fed could execute a so-called soft landing. That meant the Fed would take preemptive action to increase interest rates months before actual inflation showed up. This could take the top off any coming boom, moderate and stabilize the economy and prevent inflation — and a recession.
Greenspan followed the discussion of this theory scrupulously. There was no doubt that raising or lowering interest rates worked with a lag, having an impact on the economy as much as a year or more later. Greenspan thought there was persuasive evidence that the Fed needed to be ahead of the game. Rates would have to be increased in anticipation of actual inflation. But when? And by how much?
Earlier efforts at a soft landing had failed, including the Fed's effort in 1988. Still, Greenspan was willing to give it a try. If the soft landing succeeded, he could see no downside for the economy. But if they failed, they might hamper or even strangle the economic recovery. Because it was untested and because it was not a concept rooted in economic theory, Greenspan recognized that it was very risky. To him, it was like saying, Let's jump out of this 60-story building and land on our feet.
Some signs of a major expansion in the economy became apparent to Greenspan by early 1994. Lower interest rates had helped the banks make money and save themselves from collapse. Credit was easing and businesses could get loans. The system had been "liquefied," as he liked to say. High inflation could not be detected, but he suspected it was around the corner. He was almost sure.
On January 21, 1994, Greenspan went to the White House to meet with President Clinton and his economic advisers to warn them that rate increases were likely. "We've got a dilemma, and you should understand," the chairman said. "We haven't made a decision, but the choices are, we sit and wait and then likely we'll have to raise short-term interest rates more. Or we could take some small increases now."
"Obviously," the president said, "I want to keep interest rates low, but I understand what you may have to do."
Bentsen saw that the president was reluctant. Clinton was swallowing about as hard as he could.
"We've been flat so long," Greenspan said, referring to some 15 months of a 3 percent short-term interest rate. "We almost have to show that we can do something, that we're willing to move."
"Wait a minute!" Vice President Gore interjected. "What about the possibility that you introduce uncertainty?" Historically, the Fed moved in a series of stair-step increases. Gore noted that in 1988-89 the Fed's short-term rate increases had gone from about 6.5 percent up to nearly 10 percent in a dozen small moves. With that expectation in the market, long-term rates could be driven back up.
It was an interesting point, Greenspan said, but the long rates were high because of the inflation expectation, which the administration was addressing with its deficit-reduction plan. Even if long rates went up initially, he did not think they would stay up.
Clinton and his advisers now had to face what potentially could be a profound change in their relations with Greenspan. Politics was often a matter of choosing sides. Which side was Greenspan on?
For that matter, it was difficult to determine exactly which side Clinton was on. The president's economic policies were difficult to label. He tended to talk liberal, especially as he pushed for his wife's health care reform, which would extend universal health care insurance to more than 40 million Americans. But his actions so far had been a blend.
The term Clinton liked was "New Democrat," meaning someone who was pro-business but also concerned with the middle class and the poor.
But his policies also included the more visible deficit-reduction, bond market, free-trade Eisenhower Republicanism that was more in tune with Greenspan than Clinton wanted to acknowledge.
The blend was embodied in Robert E. Rubin, the former head of Goldman, Sachs & Co., the premier New York City investment banking firm, who was director of the White House National Economic Council, the administration's coordinator of economic policy.
Rubin had built a strong relationship with Clinton, and he reinforced Greenspan's and Bentsen's arguments that the first order of economic business had to be deficit reduction. Now, with interest rate hikes coming, Rubin urged Clinton to hold off on any public criticism of the Fed. Criticism simply would not be effective. The Fed considered itself almost religiously independent, and any effort to influence it would be counterproductive.
Bentsen argued in turn to the president that it was better for the Fed to move now, in 1994. Given the one-year lag in the impact, any economic slowdown would occur in 1995, with a pickup in 1996. If the Fed waited and raised rates in 1995, the slowdown would be in . . . Before Bentsen could get "1996" out of his mouth, the president had grasped the point.
Greenspan himself was certain that if they did not raise rates, history and experience dictated that at some point in 1995-96 there would be a recession. That Clinton would be running for reelection in 1996 obviously made it easier for Greenspan to sell an attempted soft landing. He would be taking economic growth from 1994 — lopping off the top of an expected boom of excessive growth — and saving it for 1995 and 1996. That is, if it worked.
Continued on Page 2
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