While the news media drown the nation with trivia about the presidential campaign, there is another election under way that isn’t getting much coverage. Yet the outcome of this other contest is sure to affect every American’s livelihood at least as much as which guy wins the White House – and perhaps more powerfully.
In the other election, held not in voting booths but in the trading rooms of Wall Street and other financial markets, wealthy investors and their brokers vote every day – thumbs up, thumbs down – on the future prosperity of the American economy. They are also voting – thumbs up, thumbs down – on the performance of Alan Greenspan, the chairman of the Board of Governors of the Federal Reserve System, so as to influence his decisions on managing the economy. The results of this contest will determine, among other things, whether or not the next president is greeted early in his term by an economic recession that crumples all his plans and expectations.
In this other election, only people and institutions of wealth get to participate – though everyone else will have to live with the consequences. Thanks to America’s new status as a debtor nation, these financial ‘voters’ include a lot of foreign investors, like the Japanese, who now own huge quantities of American stocks and bonds. If the Japanese were to decide to dump their American investments, it would be a devastating thumbs down for Greenspan and the economy of the United States.
The millions of Americans who don’t get to vote in this contest nevertheless have a huge stake in it, for they will suffer painfully if Wall Street succeeds in pressuring Greenspan and the Federal Reserve to slow economic expansion or even halt it. Wage earners, home buyers, farmers, miners, small businesses, retailers, manufacturers, oil states and others could be the big losers in this election. Yet, unlike democratic elections, this is a political debate in which only one side gets to talk – money.
So far it is this other contest – the obscure political dynamic surrounding the Federal Reserve – that is providing the high drama of 1988, much more so than the pedestrian campaigns being waged by George Bush and Michael Dukakis. If Greenspan gets it wrong and makes the Big Mistake, he will go into the history books as one of the great goats of our time – joined, no doubt, by whichever hapless politician happens to be in the White House.
A classic example of the power linkage through which the Wall Street voters drive the motor of Washington policy making occurred this spring and continues even now. Week after week the nervous chatter among traders and investors became conventional wisdom: the economy was dangerously healthy; inflation was about to come roaring back.
The Wall Street Journal, as it often does, picked up on the financial markets’ anxieties and amplified them as hard news: “Here We Go Again,” the Journal‘s lead headline on May 5th warned, deftly hinting that the harrowing days of double-digit price inflation in the late 1970s might be upon us again. News that would presumably delight most Americans – a faster-growing economy – put the money managers and their wealthy clients in a deep funk.
Higher interest rates would make them feel better. For anyone familiar with how Wall Street influences Washington, the message implicit in these inflation alarms was clear: raise interest rates now, or risk the wrath of investors and disruption in financial markets. The message came specifically from the bond market, where the owners of significant wealth park their money for the long term in government and corporate bonds. It was addressed not to elected politicians in Washington but to the Federal Reserve, the politically independent central bank. The bond market lives in perpetual dread of price inflation and regards the Fed as its special protector. “Consumer demand won’t die until the Fed kills it, a Drexel Burnham Lambert newsletter advised clients.
When the Federal Reserve raises interest rates (which it does by squeezing the supply of money circulating through the vast labyrinth of American banking and commerce), this automatically raises the price of everything else – from automobiles and houses to industrial machinery and business inventories – because the cost of credit is embedded in virtually every product. Higher prices naturally drive away customers, large and small. Sales decline, and so does production. The economy slows down, and the alleged threat of inflation is thereby averted. Not coincidentally, investors also collect a higher return on their financial wealth.
This spring the Federal Reserve obliged the bond market, but gingerly, nudging short-term interest rates higher. This was presumably not enough to do severe damage to the overall economy, though an interest-sensitive industry such as housing construction is already operating in a virtual recession of its own. The Fed’s action was meant to resemble a driver lightly tapping the brake. Wall Street was pacified.
But only temporarily. The Federal Reserve has discreetly tightened credit at least four times this season – inching up interest rates by a full percentage point in the midst of a presidential election. Each time the Fed was seeking to reassure Wall Street, even though the leaders of the central bank did not entirely agree with dire predictions about inflation. Each time the financial markets have demanded more.
But the Federal Reserve also dares not tighten credit too much; this would drive the economy into a recession in the midst of the campaign. The Fed governors are haunted by what happened last fall, when the financial markets were also badgering them to brake the resurgent economy. With considerable misgivings, the Fed complied, and six weeks later the stock market crashed. This credit tightening was not the fundamental cause of Black Monday, but even some senior officials at the Fed concede that it may have been a triggering event.
Even the smart money often gets things wrong (not unlike politicians and political reporters). Despite the cries of pain from Wall Street this spring, the monthly inflation rate, as measured by the Consumer Price Index, actually fell by nearly 50 percent from March to May. When Wall Street guesses wrong about inflation and the Federal Reserve goes along, it is the borrowers – businesses and consumers – that pay for their mistake.
This political push and pull between the bond market and the Federal Reserve is a scenario that has been replayed periodically throughout the 1980s. It is a major reason why interest rates in the United States are still at exorbitant levels, unprecedented in this century. Wall Street would throw its anti-inflation tantrums, and the Fed under Greenspan’s stern predecessor, Paul Volcker, nearly always responded to its histrionics – holding interest rates punishingly high. Inflation, meanwhile, remained modest or even declined.
The result is that a larger and larger share of the incomes generated by the American economy flows to the lenders who own most of the nation’s financial assets – multiplying their wealth by fantastic proportions while sapping the general strength of the economy. The return on one-year treasury bills, for instance, has been seven times larger in real value in the 1980s than in the previous three decades.
Though they won’t often say so directly, many on Wall Street are actually lobbying the Federal Reserve for a full-blown recession, and the sooner the better. Some of them regard recession as necessary therapy – a quick, brutal way to eliminate the trade deficit, among other things. But a recession can also artificially enhance the value of financial assets like long-term bonds because, as prices subside, deflation makes dollars harder – the same dollars will purchase more and more in real goods.
“The bond speculator right now very much wants the Fed to play hardball and tighten five times and put us in a recession,” says Robert J. Barbera, executive vice-president and chief economist at Shearson Lehman Hutton, who wants no such thing himself.
If a recession does unfold sometime in the next year, the Federal Reserve will likely be the proximate cause – as it has been of every recession since World War II. A lot of Wall Street traders are counting on the Fed to do it again, regardless of who wins the other election.
Instead of spending all their time on Bush and Dukakis, conscientious citizens ought to learn something about Alan Greenspan. He is a conservative Republican with owlish horn-rimmed glasses who for some years was the near equivalent of a celebrity economist, if such a thing is possible. After serving as chairman of the Council of Economic Advisers under Gerald Ford, Greenspan ran an economics consulting firm in New York with a long list of corporate clients. He became a favorite of financial reporters who turned to him for reliable forecasts, and he appeared often on television news programs as an expert talking head. For a time he was a minor figure on the Manhattan social scene, dating Barbara Walters.
In Washington, Greenspan has lowered his profile considerably, especially since the stock-market crash, because every utterance from the Fed chairman can drive traders into irrational flutters. He now dates Andrea Mitchell, one of NBC’s White House correspondents, and he is cozy with other media heavies – off the record, of course. Still, in both his public pronouncements and private conversations, the new chairman is refreshingly forthright compared with his predecessor, a master of evasive double talk.
Last summer, when President Reagan appointed Greenspan to succeed Volcker as Fed chairman, Republicans, looking ahead to the 1988 election, were delighted – principally because Alan Greenspan is not Paul Volcker. Volcker was aloof and strong-willed, adept at blunting political pressures from Congress and the White House. He drove the Fed’s money policy with such sternness that while inflation was subdued, to be sure, millions were ruined and economic growth was held to mediocre levels through most of the nearly six-year recovery.
In some ways, Greenspan is actually more conservative than Volcker, but he is much more pragmatic and in tune with elected politicians; he presides over a board that was entirely appointed by the Republican White House and carefully selected for its ideological compatibility. And, more important, Greenspan appears to be more sensitive to the injuries the Fed can inflict on the economy.
“In his consulting firm, Greenspan’s clients were mainly manufacturers – as opposed to Paul Volcker, whose whole life was spent in the financial economy,” says Richard Medley of Smick Medley International, a Washington firm that consults on financial politics. “In his gut, Greenspan understands the damage that high interest rates or recession would cause to manufacturing throughout the country.”
Nevertheless, Greenspan must play to the same audience as any Fed chairman – conservative investors at home and abroad – and he presides over a governing institution that is deeply biased toward banking and finance. Prices and interest rates in the financial markets are still the Fed’s beacon. In addition, the markets hammer on the Fed every day – sending signals through their buying or selling, scolding or applauding through their newsletters and press commentaries. Competing economic interests are rarely heard.
Therefore, the central question about Greenspan is whether he can avoid doing what a lot of investors want – putting the economy in recession sometime following the November election. (Everyone on Wall Street knows that George Bush would be wiped out if a recession came sooner.) This requires a subtle form of resistance from the Fed – yielding a little bit to fend off financial-market criticism but not so much that it truly sinks the real economy.
Greenspan has been tiptoeing along this tricky path – successfully, it appears so far – but the contest is only just beginning. If the economy slows down in the next few months, we will know that Greenspan has already overdone it.
Greenspan’s own remarks are vaguely reassuring. He told the Senate Banking Committee that he does not foresee a recession this year or next, and he agreed that given the burden of debts that have accumulated, a recession now would have “adverse” consequences for weakened financial institutions, not to mention bankrupt debtors. Furthermore, Greenspan does not buy the argument of the financial markets that the low unemployment rate is about to produce runaway wages – a necessary precondition for runaway inflation. His attitudes might change next year if Michael Dukakis becomes president Would this conservative Republican economist listen to Wall Street or to the liberal Democrats in power?
In the short term, a lot of smart people think that circumstances have forced the Federal Reserve into a comer where it cannot allow a recession to occur – regardless of what the financial markets want. The accumulation of corporate debt, the troubled banking system, the fragile state of Latin American debtor nations, among other conditions, suggest that a recession might swiftly unravel into a general crisis, resembling the global collapse that followed the stock-market crash of 1929. No one knows if this is true, but if you were the Fed chairman, you probably would not wish to find out.
If the Federal Reserve is locked into “a no-recession monetary policy,” as professor Benjamin M. Friedman of Harvard calls it, that means the central bank will have to tolerate a higher rate of inflation – which helps debtors get well gradually. If Greenspan’s Fed does produce a recession, it will probably be unintentional – a mistake.
Shearson’s Barbera agrees. “No hardball from the Fed,” he says. “If the Fed plays hardball now, it’s going to take more than some slight rise of rates. You’re going to have to push rates up sharply and take a recession, and the risk is that recessions aren’t always so controllable. The deeper you go, the nastier it gets.”
But Greenspan also faces ‘voters’ in Tokyo, Bonn and other foreign financial centers. They can exert just as much pressure on his decisions, and a lot of them are also chattering these days about the desirability of putting the United States in recession. If foreign investors don’t like what they see in Washington, they can simply sell their American stocks and bonds; American interest rates will rise and stock prices plummet – perhaps producing the same outcome, a recession.
America’s debtor status and the influence of foreign money over the U.S. government’s economic policy constitutes a potentially explosive political combination – one that has not been present in American politics since the 1890s. Average citizens will be dismayed and probably angered if they ever grasp the implications of this new dependence. But it is one of the inescapable consequences of being deeply in debt to foreigners. If you are not nice enough to your banker, he can always pull the plug.
The Japanese, for instance, now own something on the order of a couple hundred billion in American financial assets. Nervous Japanese investors, in particular, were selling off huge blocks of their American investments last year, which helped drive interest rates higher. The Japanese sell-off is widely regarded now as one of the cracks that turned into the October debacle in Wall Street and global financial markets.
Foreign investors have all the usual anxieties of the financial marketplace, but they have one special worry of their own – the losses they suffer when the dollar falls in value on the international exchange. The Japanese have been burned repeatedly on the yen-dollar exchange in the last two years, and they are extremely skeptical about American intentions right now.
As a result, American policy makers, from the treasury secretary to the Federal Reserve chairman, spend a lot of time talking to the Japanese – reassuring them that U.S. economic policy will not do it to them again. Therefore, the Japanese Ministry of Finance and the network of Japanese financial institutions have a lot of potential leverage over the U.S. government right now. But the reality is quite the opposite of what people might expect. Instead of using their clout to push America around, the Japanese and other foreign lenders are actually propping us up.
Unlike the United States, the Japanese government has extraordinary informal power to direct the decisions of the country’s private capital – and Japan’s Ministry of Finance is telling investors to stay in American stocks and bonds, at least until after the election. That keeps American financial markets stable for now – but it also adds suspense to the question of what the Japanese will do after November 8th.
Indeed, the cooperative atmosphere that has prevailed in the campaign season has led some financial observers to suspect a deal between the Reagan administration and Japan’s financial leaders. “Let’s put it this way,” says Albert M. Wojnilower, the senior economic adviser to the First Boston Corporation, “the Japanese are trying to help Bush get elected, whether they know it or not, but Bush isn’t going to allow them to succeed.”
David Hale, chief economist at Kemper Financial Services, satirically suggests that Bush may be the first real ‘Manchurian candidate’ to run for the White House – a candidate programmed by a foreign power to do certain things for its benefit. Government officials naturally deny the suggestion, but it’s not totally far-fetched. Back in 1986, amid the congressional elections, the secretary of the treasury, James A. Baker III, worked a trade-off with Japanese politicians on dollar policy – designed to help Republican candidates here and the ruling party’s ticket in the Japanese elections. Yoichi Funabashi, economics editor of Asahi Shimbun, the major Tokyo newspaper, revealed the political deal in a recent book.
“It’s a confluence of interests,” Funabashi told me, “rather than a specific raw deal between the Bush camp and the finance minister of Japan.” Both sides have a large stake in keeping the American economy stable – and averting another global breakdown of financial markets. But the Japanese are also extremely nervous about being accused of manipulating American politics.
“Even though Japan now has some leverage over the policy-making process in the U.S., they have to be very cautious in using it,” Funabashi continued. “It’s sort of like the nuclear bomb – you cannot use that money power to threaten or even to remind the Americans that you hold this card.”
Still, Funabashi has no doubt that Japanese leaders would like to see Bush win the election – mainly because they know the incumbent conservative Republicans and understand how to deal with them, especially James Baker, who would be secretary of state in a Bush administration. “There is a weird sort of symbiosis,” Funabashi said. “Even though they have been burned a lot by Baker, the Japanese now know Baker very well, and they know how he plays the game. It’s much better to deal with him than with someone unknown.”
In any case, the really tender moment comes after the election – with or without Bush winning. Funabashi thinks the Japanese government will be able to hold restless investors to their commitment to stay in the American markets perhaps until the end of the year. “But after that, we will be heading toward a very dangerous course,” he said. “It’s a very, very fragile situation and might trigger uncertainty in markets around the world.”
A few analysts like Wojnilower think the critical moment may come even sooner – and it won’t be just nervous foreigners dumping stocks and bonds. “My hunch is that the period after Labor Day will be rough,” Wojnilower says. “The markets will figure that investors are going to sell off and rearrange their portfolios right after the election. Then people will decide that ‘if there’s going to be a bandwagon, I want to be in front’ – so they sell off, before the election. Japanese private investors will be part of that. Whether the Japanese government can slow them up is the question.”
Most Americans will never become experts on finance, but they can grasp the bottom line of this political situation: What Wall Street really wants – and foreign investors as well – is an American economy that never grows very fast. Every time the economy begins to expand more vigorously than at the mediocre rate of two percent, the financial markets scream that the Federal Reserve must slow it down. Both Paul Volcker and Alan Greenspan, despite their differences, have embraced that logic – a conservative conviction that too much prosperity will be bad for us.
That’s a good deal for the spoiled owners of financial wealth – a fail-safe system to protect them from inflation and to ensure exorbitant returns on their capital. For the rest of the country, especially young people just starting out in life, it is like a hammerlock on their aspirations for the future.
Money is power in politics, but it is not all-powerful. Though it seems most unlikely, the only real answer to Wall Street’s excessive influence is a chorus of reasoned protest from across the democratic landscape, declaring enough is enough. Capital is entitled to a fair return on its wealth; it isn’t entitled to outrageous excesses that year after year slow down the economic engine for everyone else.
The next president might begin, figuratively speaking, by smacking the greedy investors on the snout – and telling the Federal Reserve to do the same. The executive branch ought to enact new controls on the financial system – legal ceilings on interest rates and special taxes that penalize unproductive game-playing in the markets. The Fed, meanwhile, could learn how to say no to Wall Street’s constant whining. Unfortunately, neither Bush nor Dukakis has the dimmest understanding of how to deal with this fundamental imbalance.
As long as Wall Street has its way, the economy will remain stuck on a dreary plateau of slow growth. Genuine prosperity, equitably shared, is impossible as long as the Federal Reserve enforces its conservative order. High real interest rates compound debts, and financial weaknesses deepen. Slow growth ensures that real wages for most workers will continue to fall. This gradual erosion is a large part of what’s creating two Americas – one fabulously prosperous and secure, the other steadily losing ground and desperate.