Greenspan's retirement could take longer than 257 days

Thursday, May 19, 2005

Next Thursday is thickly underlined on my agenda, as I had wanted to blog about Fed chairman Alan Greenspan's last 250 days in office. This story in Wednesday's Washington Post has given it priority a week earlier. According to the speculations in the Washington Post, based on anonymous sources in the administration, president Bush could take a little longer than expected until he names the future Fed chairman. A short extension might be attractive to Greenspan because if he remains at the helm until May 11, he would become the longest-serving Fed chairman ever, exceeding the 18 years, nine months and 29 days served by William McChesney Martin Jr., from 1951 to 1970. Greenspan's personal pride set aside, the hard part will be left to his successor. Since 1970 every incoming new chairman immediately encountered a crisis to master within the first few months in office.
Greenspan, who climbed on the top chair on August 11, 1987, had to iron out the crash of '87, when stocks plunged 22 percent on October 19. He succeeded by keeping the liquidity tap wide open. Although only one of several conference calls of the FOMC after the crash remains on record on the Fed's website, it is still very interesting to read the staff statements and the transcript of the following meeting on November 3, 1987. Some FOMC members were then obviously concerned about the dollar's weakness and discussed whether they had an opportunity "to flip" the trend. Greenspan himself advocated the idea to let the markets go their course.
To quote Greenspan in this past context, "I think we have to remember what the issue of the dollar is. It is not that it is falling per se, but that whatever it is doing creates a judgment in the market that it will continue to do that. There are really two ways to look at this and that is really, I think, what divides the economic fraternity at this stage. If somehow, somebody could wave a wand and move the exchange rate down sharply to a point where the expectation of future change was zero, then the yield spreads between intermediate or long-term issues in dollars and those denominated in the other currencies would dramatically come together: and we would get the type of stability that we would like. The problem, unfortunately, is that the other potential is that a sharply (falling) dollar merely will be extrapolated, as Sam Cross has implied. Here, we don’t know, largely because we don’t know where the bottom is. Obviously, the lower we are the closer the bottom is, by definition. Exchange rates tend to be non-negative. though sometimes you wonder. Judging from the way the markets have been behaving the last several weeks, I think the probabilities that a freefall is about to happen or could happen have diminished. Unfortunately, the trouble is that even if the probabilities have diminished, the consequences of that event are extremely dangerous. Even if we get to the point where we are all fully, unequivocally convinced that there are no secondary reaction problems in the exchange rate. I think we had better keep up our guard."

The newbies always faced a crisis very soon
Greenspan was so far only the latest in a row of Fed chairmen haunted by some sort of crisis soon after entering office. Arthur F. Burns, chairman from February 1, 1970, climbed the top chair only to oversee the beginning of the 1970's bear market, the closing of the gold window and the first oil shock 1973. When he stepped down on August 6, 1979, his successor Paul A. Volcker had to fight double digit inflation with the highest Fed Funds rates seen ever and managed that the economic downturn through his tightening only became an on-and-off recession from 1979 to 1982 with GDP never declining more than a quarter in a row. (For a good book on this look into my profile.)
With this past and the current uncertain economic outlook hampered by an administration that does not seriously think about fighting the triple deficits, as described in this post, it is understandable that every reasonable person will think twice about stepping into Alan Greenspan's oversized shoes.
Referring to Mark Thoma's blog post the shortlist of possible names is in my opinion already one name shorter: Ben "Helicopter" or "Printing Press" Bernanke has obviously quoted himself out of the musical chairs game. Markets will not trust a chairman that would rely on the money printing press to throw more paper on every problem that could show up in the future.
Mark Thoma ask the right questions:
Is the Administration somehow rewarding Greenspan for supporting tax cuts? I doubt it. Instead, the possible delay more likely reflects the challenges of finding a suitable replacement. Academic? Industrialist? Financier? Or academic turned industrialist? Moreover, is there pressure in the Administration to appoint simply on the basis on politics, rather than on the best person for the job? This is my greatest fear. The economy can survive a John Snow as Secretary of Treasury. The same is not true for the Fed Chair.

It should also be added that Greenspan never, ever, talked himself into purgatory. His unsurpassed art of calm and logic rhetoric unter the immense pressure from policymakers and the spotlight of live TV cameras transmitting his every word and movement onto trading floors worldwide never faded for a second. No man has done more to sedate markets when they needed it most. This unique capability makes it even harder for his successor; whoever it will be. Greenspan gained so much credibility by steering the markets through the longest economic expansion in a times of war and peace because he kept markets from panicking in the aftermath of October '87.
Any delay could wreak havoc on the markets
Finding a successor should therefore follow the established schedule. Keeping Greenspan in office past his scheduled retirement could be seen as a signal that the policymakers in the White House have difficulties making up their mind about who would be best suited to step into Greenspan's shoes. Any delay in this single most important announcement of the administration regarding the economy could wreak havoc on the markets.
Greenspan sees himself leaving his post on schedule, one can take from his latest public statement, "...members of the 2005 graduating class. I have more in common with you graduates than people might think. After all, before long, after my term at the Federal Reserve comes to an end, I too will be looking for a job," he said at the Wharton School on May 15. The countdown marks 257 days to go today.
This in itself could pose a problem for the markets. As it is entrenched in human nature not to take blame for one's own actions, Greenspan could be tempted to act to dovish in the face of accelerating inflation. He certainly would earn a bigger wreath of laurels when the economy is still on a sound path on the day he retires, thanks to a then still accomodative policy of the Fed. Let's hope his care for the markets will stand above any idea of self-importance even the greatest persons in history have fallen victim to too often.


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