by Bob Woodward
He knew from his business days in New York that such expenditure bursts normally occurred at the beginning of an economic recovery. But the United States was more than two years into its recovery, a time when such capital expenditures would normally be going down. These increases would not be made month after month unless something was happening, unless the businesses were getting significant returns from the large investments or perceived they soon would. But what was happening?
From his study of Albert Einstein’s theories, Greenspan knew the importance of finding discrepancies—light bending, time slowing, light being both a wave and a particle.
It looked as though the discrepancy might be more productivity growth—more output per hour for workers. But that was only a theory, and Greenspan knew it could dissolve with the next month’s statistics.
He examined the Labor Department unemployment statistics out September 3. For the latest month, August, the unemployment rate was down to 6.7 percent. In the last year nearly 2 million more people had joined the workforce, and they were working a half hour more a week when compared with figures from the 1990–91 recession.
Next he examined the Labor Department’s productivity statistics, which measured the changes in output per hour for the second quarter of 1993. Released September 9, the department’s report showed that productivity had decreased by 1 percent in the business sector during the second quarter of 1993—the same rate of decline as the first quarter.
Something was in error. More high-technology investment, more workers, more hours and less productivity? Prices weren’t rising that much, and business profits were increasing. A business could not hold prices relatively stable, have a less efficient workforce and make more money. It was mathematically impossible.
At the FOMC on September 23, Greenspan said that the interest rate policy question was pretty easy. They didn’t need to raise or lower rates. Everyone agreed. But something else was bothering him—the very statistical foundation for their decisions.
“There is something wrong with the numbers we are looking at,” he said.
“Now, I don’t know what is going on in the statistical system, but I’m almost certain that out in the real world in an economy that is growing, the thought that we are having declining productivity just doesn’t square with my understanding of the real world.”
He continued to pick apart the data. “Something is wrong with the data system . . . the numbers just don’t square.”
Greenspan finally let the matter rest, and the FOMC voted unanimously to keep interest rates the same. But he was sure there was a missing link. The “Survey of Current Business” from the Bureau of Labor Statistics, one of his favorite monthly publications, indicated that business inventories were shrinking significantly while the economy was growing, suggesting that the new computer technology was allowing just-in-time orders. Instead of stocking products weeks or months in advance, businesses could keep detailed track of what was needed and order within days. In addition, competitive pressures were also forcing quality control.
At the November 16 FOMC meeting, Greenspan said, “I think the argument has to be that the missing link in all of this is the inventory patterns.” The result was better-quality products. “The finding of fault in a particular product or a particular element in the fabrication process means that it can get fixed relatively quickly. In other words, you don’t have two months’ worth of widgets which are slightly off. If it’s just-in-time, you have three days. So you don’t lose the quality and you don’t lose the production.”
But much of this argument was theoretical and tentative, he knew. He was noticing discrepancies, but he was a long way from explaining what they meant, if anything.
• • •
Just before Christmas, on Tuesday, December 21, the FOMC met again. Angell and Lindsey wanted to raise rates at once, and several bank presidents were leaning that way. David Mullins noted that the unemployment rate had dropped over 1 percent in the last 18 months, and overall economic growth had been a very high 5 percent in the last three months.
“In short,” he said, “the world has changed. The fed funds rate has not changed.” He said he did not favor raising the rate right away, but it needed to go up at some point in the near future.
Greenspan remarked how extraordinary it was that a full 2 percent of the economic growth was coming just from motor vehicle sales. Still, the recovery was accelerating and had some legs. “All this leads me to conclude, as a number of you have concluded, that the days of accommodation have got to be over.”
Angell passed Mullins a note: “We’ve won.”
Greenspan said that sometime over the next year they would probably have to raise rates. “When do we begin? I don’t see any material reason to begin today.” He recommended an unchanged policy and won 10 to 2, with Angell and Lindsey dissenting.
“We have one additional item on the agenda,” Greenspan said after the vote. For years, the FOMC meetings had been secretly tape-recorded and a verbatim transcript kept. The existence of the transcripts had been kept secret not only from the public, but from the Congress and even some of the FOMC members. Greenspan maintained he had not learned about it until a year before. He had disclosed the existence of the system and the transcripts in testimony to the House Banking Committee two months earlier, as the members knew. Committee chairman Henry B. Gonzalez, an old-style Texas populist Democrat, had launched a crusade to get the tapes.
The FOMC had spent hours discussing the matter, including an hour-and-a-half conference call of the FOMC on October 15. Gonzalez now wanted the transcript and tape of that discussion. He was alleging that the FOMC had conspired to hide the tapes.
“There is deep-seated suspicion of this institution,” Greenspan said. “It’s regrettable, but I guess it comes with the turf.” The matter would not be put to rest very quickly. He proposed that they allow a senior staffer from the Gonzalez committee to come to the Fed and listen to the full tape of their October 15 discussion. He had listened to it himself, and there was no conspiracy. “There are a few sentences which, out of context, could very readily be employed to raise an issue,” he said. He wanted to make sure that a senior Republican staffer also attended the session so nothing would be taken grossly out of context.
Greenspan was not entirely comfortable with this idea. It could set a bad precedent. But he knew that failure to disclose that session could fuel efforts to force out all the tapes and parade all of their debates and remarks before the public. The only antidote was full disclosure of this tape to prove they were hiding nothing.
After much discussion, the members agreed. The House Banking Committee staffers listened to the tape, and the issue subsided. The Fed agreed to release a lightly edited transcript of each year’s FOMC meetings five years after they occurred.
Soon the chairman came to see that providing the public and the markets with more information about the Fed and its interest rate decisions not only brought more attention and timely focus on their work, it also gave him more power. The Fed had always been viewed as a temple of important secrets. Revealing some of them drew the press and others in, which in turn magnified the importance of the Fed’s decisions. As interest rates became more closely monitored, they also became more important as a critical indicator of the state of the economy to an increasing number of Americans.
8
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SOME SUBTLE and some less subtle signs of a major expansion in the economy became apparent to Greenspan in early 1994. The banks had been saved. 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.
For years, there had been discussions in the media and elsewhere of the possibility that the Fed could execute a so-called soft landing, taking preemptive action to increase interest rates months before actual inflation showed up. This could take the top off the 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 the raising or lowering of interest rates worked with a lag, having an impact on the economy as much as a year or more later. Milton Friedman, the Nobel Prize–winning economist, had taken the extreme position that the Fed was always 180 degrees wrong—meaning that they raised rates too late, when the economy had already turned down, or they lowered rates when the economy had already turned back up. He argued that the average lag was about half a business cycle.
Greenspan thought Friedman wasn’t exactly right, but 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? Effective early action could prolong the expansion. Eliminating the wild highs could eliminate the lows. Not only would a preemptive soft landing be good for the economy, it would eliminate some of the social unrest that accompanied a recession. But this was all theory, yet untested. Earlier efforts at a soft landing had failed, including the Fed’s effort in 1988.
Greenspan was willing to give it a try. If the soft landing succeeded, he could see no downsides for the economy. Normally any action, he believed, had a price or a downside, even if it succeeded. This did not. But if they failed, they might hamper or even strangle the economic recovery—and that was a huge risk. 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.
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.”
Treasury Secretary 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 fed funds 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 funds increases had gone from about 61/2 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, the opposite of a soft landing.
It was an interesting point, Greenspan said, but the long-term rates were high because of the inflation expectation, which the administration was addressing with their deficit reduction plan. Even if long-term 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 concerned as well 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, a slight man with soft eyes and a gentle, at times even shy, manner, was fabulously wealthy, but he wore inexpensive suits and could be taken for a staffer. Forged in the crucible of the nerve-racking bond arbitrage market on Wall Street, the 55-year-old Rubin had advised the president to hold Greenspan even closer. Perhaps one of the most careful listeners on the planet, 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. Rubin had also argued successfully to the president that the administration would topple itself if it were perceived to be anti-business and anti–Wall Street. One result had been that the administration was widely seen to have adopted a deficit reduction plan that was dependent on the financial markets.
Like Greenspan, Rubin believed nothing could be known for certain—that everything was “probabilistic,” as he put it. No matter how good your information or judgment might be, you can always turn out to be wrong. He liked to offer the example of someone from another firm who had called him at Goldman Sachs, saying that he’d found a takeover deal that couldn’t go wrong.
I’m buying enormous amounts of stock in the company that’s being bought out, the banker said.
I think you’re right, Rubin said. I think this is very good, but there’s nothing that can’t go wrong and everything is “probabilistic.”
No, the other banker said. We can’t lose on this one.
Rubin bought tons of the same stock, but not so much that any potential losses would sink his firm. The other banker was not quite so careful. When the situation ultimately did go bad, Rubin lost a great deal of money for Goldman but stayed at his firm for 20 more years and eventually ran it. The other banker lost his job. Since then, Rubin often reminded people that even the best-looking deals could go wrong on the basis of things that you could not anticipate. It was necessary to take risks, but it was important to recognize your fallibility.
With interest rate hikes coming, Rubin urged Clinton to hold off on any public criticism of the Fed. First, he said, criticism would not be effective. The Fed considered itself almost religiously independent, and any effort to influence it could be counterproductive. The Fed wouldn’t listen, so short-term rates would stay the same. The financial markets would listen, and they would see such criticism as motivated by politics. If the markets grew distrustful of the administration’s motives, long-term rates would go up. If the administration refrained from criticizing the Fed, it would enhance the administration’s and the Fed’s credibility.
Bentsen argued 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 was certain that if they did not raise rates, history and experience both 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. He also wanted to send a message to the markets that the Fed would never again allow the runaway inflation of the 1970s.
Making it work had a lot to do with timing, which in turn had to do with economic forecasting, an imprecise science that did not approach the mathematical certainty Greenspan loved. There was no alternative to forecasting, which at least incorporated some data. It wasn’t guessing or fortune-telling, but the forecasters, including himself, were going to be wrong some of the time.
• • •
On January 31, Greenspan appeared before the Joint Economic Committee of the Senate and House. He testified that Fed interest rate policy “must not overstay accommodation” and “short-term interest rates are abnormally low.” Unless there was a prolonged weakening of the economy, he said, “We will need to move them to a more neutral stance.” Though it was oblique and somewhat veiled, Greenspan believed his testimony made it clear that interest rate increases were coming. It had been five years since any rate increase, and he did not want the Congress, the public or the markets to be surprised. The more he thought about it, the more he believed he was beating the drums quite loudly, sounding a warning. But there was little reaction. Where’s the parade? he wondered. It was remarkable. He felt as if he were walking around, banging on a pot, “Hey, you know, we’re going to raise rates!” Still, there was little reaction.
The FOMC met on the morning of Friday, February 4.
As he listened to the reports of economic conditions in the various Fed districts, Greenspan saw his colleagues all over the place. Because they hadn’t moved rates in a long time, it was going to take longer to arrive at consensus. He didn’t have a lot of data to hang his conclusion on.
“We are at the point where we finally have to start moving,” he said. “We haven’t raised interest rates in five years, which is in itself almost unimaginable.
“The presumption that inflation is quiescent is getting to be a slightly shabby notion,” he went on, concluding, “I would put on the table my preference that at this meeting we move up 1/4 percent.”
