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
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
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
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, Green-span 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."