by Bob Woodward
“Suppressing inflation over the past decade, and more, has obviously not been without cost. To fritter away this substantial accomplishment by failing to contain inflationary forces that may emerge in the future would be folly.”
Lest anyone miss the message, he added, “A society’s central bank is rarely popular.”
• • •
On May 13, the Labor Department released the April consumer price index. It had bounced up 4/10 of a percent, an unexpected surge that foreshadowed inflation. Greenspan was troubled. What was happening?
If he was forced to raise interest rates, Greenspan could shatter Clinton’s deficit reduction plan, which was limping through the Congress with no Republican support.
Since the middle of 1989, Greenspan had felt at least conceptually in control of what was going on in the economy. His numbers and forecasts hadn’t always been right, expected trends had been off a little, but there had been no significant surprises. By the Keynesian models of the 1960s and earlier, a weak economy and inflation could not coexist. The 1970s had shattered that construct. When Greenspan had been Ford’s chief economist in 1974, the consumer price index had risen 12 percent as the economy slid into a recession. Then in 1979 and 1980, so-called stagflation—a coincidence of high inflation and low or negative economic growth—struck again, with the CPI up above 12 percent and an economy that had ground almost to a halt.
Now the chairman summoned three top senior staff members to his office. They were confronting a situation that he likened somewhat to Galileo’s problem, he told them. Galileo, the famous 17th-century Italian astronomer, mathematician and physicist, had stuck to his conclusion that the earth revolved around the sun, despite the accepted wisdom that the earth was at the center of the universe.
Greenspan said that things were being observed in the economy that shouldn’t be happening. Either measurements were wrong, or they were measuring the wrong things, or the old models weren’t adequate to explain what was occurring. It would be unacceptable for them not to come up with an explanation. Though it was possibly just a short-term aberration or the result of faulty seasonal numbers, Greenspan said they had to deal with the possibility that new forces were at work. Suppose, he said, in two months inflation had continued to increase? “What could have caused us to be wrong? What is wrong with our structure of analysis, our body of concepts, which can explain it? In other words, I’m not asking you to construct a concept which forecasts. I’m asking the reverse.” Let’s shake ourselves up, question everything.
The data indicated that some businesses, particularly small, non-incorporated businesses—the mom-and-pop shops of the world—were using their own resources to grow, instead of borrowing money. That did not constitute a classic inflationary environment. Inflation was usually the result of increased demand for credit and loans as businesses attempted to finance their growth through borrowing. If inflation continued without rising demand for loans and credit, it would be a kind of “immaculate conception,” Greenspan said. It would be the first time significant inflation had ever occurred in such a low-credit environment. Was there an assumption they were making that they hadn’t identified? Greenspan asked. The situation was both mystifying and dangerous. It could mean that the economy was out of control and in worse long-term shape than he and they had imagined.
The harsh reality was that they were responsible for the economy, not for whether they got the data right. If they made the wrong choice, there would be no forgiveness.
Greenspan and his team went into crisis mode. It was as if the CIA had suddenly discovered that the Russians had developed a secret weapon that could undermine the American military. The top Fed officials bounced ideas off each other, about inflation psychology and about what factors could possibly be causing an inexplicable surge. The Fed’s vast statistics and research operation started cranking out forecasts incorporating some of the conflicting data, using a large computer model that didn’t actually forecast well but was still useful in establishing consistent, logical interrelationships among all the elements of the economy. Greenspan also called on a number of specialists at the Fed to ascertain what could possibly be going on that the Fed had not yet detected. None of the explanations satisfied him.
• • •
At 9 a.m. on Tuesday, May 18, 1993, Greenspan convened the full committee.
“I think you are all aware that what will be going on here today has very considerable interest outside,” he said. The stakes were high. Public and media expectations that the Fed might increase rates were palpable. He urged that no one talk or leak. “Let’s be cautious, and I think we can fend off the clever endeavors on the part of a lot of our media friends on the outside who will try to infer how this meeting came out.”
He summarized a meeting he had just attended in Switzerland with the world’s leading bankers. “There was quite an extraordinary number of subdued people in Europe; there is an underlying fear that that system is continuously eroding,” he said. “Even among the Brits a slightly hollow cheerfulness is evolving.” The European economies were also under stress.
Turning to the perplexing inflation signs in the U.S. economy, Greenspan worried aloud, long paragraph after long paragraph. The increase in steel prices didn’t make any sense. Perhaps the subtle rise of efforts to protect American industry from foreign trade had emboldened the makers of steel to increase prices, he speculated. Whatever the case, Greenspan said that the chances of choking off inflation in these economic circumstances were nearly impossible. “I would say that history tells us the chances of doing that are zero short of a 2 or 3 or 4 percent rise in interest rates.” He went on, “But I will tell you that at this stage we are pretty much testing the limits of our theoretical knowledge as to what the actual inflationary process is really doing.”
One bank president suggested that the recent spate of bad weather might be a factor. Yes, but only in fruit and vegetable prices, others answered.
The members used words like “puzzled,” “disturbing,” “a mystery,” “uncertainty,” “uncomfortable” and “very disturbing.” One old hand recalled how they had been good at explaining away inflation in the 1970s and then had waited too long and eventually ended up with sky-high inflation. Another asserted that the Clinton health care proposal being drafted under the supervision of Hillary Clinton would be inflationary. One noted that if they increased the fed funds rate, they could kill the Clinton deficit reduction and budget discipline efforts. Greenspan knew only too well. Another spoke of a remote possibility of a new recession.
Wayne Angell said they had to increase rates at this meeting. “The longer we go with this situation, the more we’ll have to increase rates and the higher long-term rates will go.” He gave a passionate speech and said a move up was essential. “I don’t feel very strong about it!” he declared when he finished, mocking his own excited rhetoric. The others laughed.
David Mullins argued that the sooner they raised rates the better. With rising inflation unchallenged by the Fed, the long rates would go up.
After a coffee break, Greenspan told his colleagues that he sensed a pessimism about the ability of the political system to solve problems such as the deficit. He said he had contemplated the overall picture as much as possible. Given all the alternatives, he proposed that they agree to an asymmetric directive to tilt in favor of increasing rates. That directive would be made public in six weeks when summary minutes were released.
“I would have no intention of acting on that directive without full consultation of this committee because it’s a very important move.” He promised they would have a telephone conference call.
Corrigan said that it was important to leave the chairman maneuvering ability. The directive tilting toward a rate increase, he said, would show that they were watching inflation carefully. “I think institutionally that makes us look better,” he said. “In other words, the signal is still there that we weren’t insensitive to what was going on.”
Mullins agreed, “We can only look good.”
Greenspan stepped in. “I think we ought to try first to find a means by which to separate what policy is and then to discuss the issue of how we wish to be perceived.” They were different issues, he noted gently. “And from what I can judge, I think most of us would be willing to do that.”
As they went around the room, three committee members, including Angell, spoke for an immediate rate increase that day. Mullins, a possible fourth vote to raise, said, “I wouldn’t be opposed to moving now.” Several others spoke against an immediate increase.
The chairman had a sharply divided committee. He couldn’t let it float. Over his years as chairman, he had heard in detail how Bill Miller, Jimmy Carter’s first Fed chairman, had let the committee members vote as they wanted, without much guidance or influence from the chairman. He felt such a course was weak and ineffective.
Greenspan reminded them again that they had not moved interest rates up since 1989. “This committee is going to be highly visible,” he said. “It’s going to be quite important for us to be as close as we can to each other.” He emphasized their shared philosophy. “I think it would be very tragic if a group of this extraordinary capability . . . were perceived to be in disarray.
“If it ever gets to the point where this committee is either in disarray or perceived to be in disarray, there is no other institution in this government that can substitute for us.
“It is crucially important that we stand tall as a group and try to find the means by which we can merge our differences,” he said. He reminded them that he had made this plea only two or three times in the past. By his reading, the consensus was for a directive that would empower him to raise rates before the next meeting, but he again promised a telephone conference before that happened. He added that he hoped the conference call wouldn’t be necessary and that the data that would come in over the next six weeks would be “benevolent”—but the chances of that happening, he said, were “less than 50-50.”
He believed he knew how each FOMC member would vote. “I could take the vote myself if I had to, and I bet I’d get it on the nose three times out of four!” He then asked for the vote on his recommendation.
It was 10 to 2 in his favor, with only Angell and Philadelphia Fed president Boehne dissenting.
Six days later, The Wall Street Journal scooped everyone with an inside story reporting accurately 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 1/10 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.
Clinton spoke yet again with such depth and passion about his deficit reduction plan that Greenspan concluded once more that unless Bill Clinton was the best actor ever, the statements were genuine.
• • •
On Friday, June 11, White House spokesperson Dee Dee Myers was asked at a White House press conference to comment on the consumer price index.
“Obviously, it’s good news,” she said. “Producer prices did not go up in May, inflation was zero. We think that that will help keep the long-term interest rates low.
“We’re going to continue to press to get the president’s economic plan through Congress. We think that the deficit reduction included in that plan has helped bring interest rates down. And we think if we get the plan passed, it will help keep them down.”
Hallelujah, Greenspan said to himself when he read Myers’s comments. The world had indeed changed. He was amazed that economic lessons had penetrated so deep into the new administration. He had spent a good deal of time explaining to them that the Fed was not working out of a black mystical box. The goals of the Fed and the administration, he had argued to them, were exactly the same—to get maximum sustainable economic growth and to restore the system. He had even offered that if the administration had any better ideas on how to achieve this, he wanted to hear them. But if long-term interest rates started up now, the housing markets would fall apart and the substance of the economic recovery would disappear. It might even be worse than a recession, Greenspan believed.
• • •
That’s the most interesting op-ed I have read since I have been here, Greenspan remarked to Senator Daniel Patrick Moynihan, the New York Democrat.
Moynihan had written a long, somewhat scholarly article in The Washington Post on Sunday, June 6, about Baumol’s disease, named for William J. Baumol of New York University. Baumol argued that jobs in which productivity does not increase substantially over time tend to wind up as part of government. Moynihan cited, among these, the police, the postal service, sanitation services and the performing arts as fields that were once entirely private but now depended on government funding because they had not been able to become more productive. To Greenspan’s amusement, Moynihan had cited a Mozart string quartet as an example of how some fields cannot become more productive. In 1793, a Mozart quartet required four players, four stringed instruments and roughly 35 minutes to play, and it was just the same in 1993.
As socially useful enterprises ceased to become more productive and lost out in the marketplace, the government took them on in order to keep them going—thus increasing its obligations.
Moynihan and Greenspan worried that Hillary Clinton’s new health care initiative might prove the same thing about health care. Greenspan was quite concerned about the health care plan and its possible consequences for the federal deficit. The more entitlements there were, the more spending there would be. He was quite happy to see that Moynihan had some of the same concerns. Greenspan thought Moynihan’s article was quite clever, and he felt a kinship with the professorial senator from New York. He was also aware that Moynihan, as chair of the Senate Finance Committee, would be critical to any Clinton deficit reduction program, and he liked to keep in touch.
• • •
By July, Greenspan realized that the earlier inflation data had been a false signal.
At the July 7 committee meeting, one of the major topics was the leak of their earlier decision to The Wall Street Journal and a more precise leak, with the 10–2 vote, to the television network CNBC. Greenspan noted that the reporting had changed, that reporters were more aggressive and often competent in economics. When he had been President Ford’s economic adviser in 1975–76, he told the committee, “You could just feed them pabulum and they pretty much accepted it. That clearly has changed quite dramatically.” He demanded discipline. If there were another leak, he would ask for a voluntary sworn statement from everyone in the room that each had not talked with reporters.
“Just remember that there was an organization called the Plumbers,” he cautioned, recalling the notorious group in the Nixon White House that tried to plug leaks and eventually became the Water
gate burglary team, “and the last thing we need in the Federal Reserve is a 1993 version of same.”
• • •
Soon 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 Greenspan.
• • •
In September, Greenspan was huddled with the latest government statistics. He settled into the newest monthly 11-page Commerce Department report called “Current Industrial Reports, Manufacturers’ Shipments, Inventories, and Orders.” Chock-full of tables and charts, it was released September 2, but the chairman usually received the data a day or so early.
New orders for manufactured goods were down 2.1 percent for July, the most recent month for which data were available. Poring over columns of figures, Greenspan noticed two big numbers, dramatic increases from the previous July. Computer and office equipment orders up 21.6 percent. Communications equipment up 19.8 percent. Except for a few explainable aberrations in shipbuilding and tanks (up 461 percent), these were the biggest numbers among hundreds of measured new orders. He had noticed the same pattern for months. That meant businesses and their plant managers were spending billions of dollars more for high-technology equipment. Why?
