The title of Bob Woodward's first, most celebrated book, All the President's Men, played off the old Humpty Dumpty nursery rhyme. The book revealed how "all the king's horses and all the king's men" could not put Richard Nixon back together again. It was a dark, riveting melodrama in which two very young reporters, Woodward and co-author Carl Bernstein, discovered the high crimes at the pinnacle of American political power. Woodward's subsequent books also shocked and illuminated with many insider revelations, but Woodward himself has steadily progressed toward a more wholesome and respectful view of those who govern, depicting them as cool, tough-minded leaders who make the hard choices of history. His latest book, one could say, returns to the story of Humpty Dumpty. Only, Humpty is still sitting on the wall. There has been no great fall, and Woodward celebrates the man's wisdom and awesome power.
The subject of Maestro is Alan Greenspan and his thirteen-year tenure as chairman of the Federal Reserve Board. Greenspan, who will preside over the next meeting of Fed decision makers on December 19, is at the apogee of public esteem and celebrity, since the robust economy and booming financial markets of recent years have been widely attributed to his skillful management of money and credit at the central bank. Woodward goes a step further and engages, uncharacteristically, in a literary flourish that resembles a rite of apotheosis. Father Greenspan is portrayed as a strong and trusted parent who supervises the children's interests; he loves us all, notwithstanding the dour expression. Indeed, he is seen as a godlike Olympian who does the hard thinking on our behalf, worries constantly for us and makes unpleasant decisions for our own good.
"Although his words are almost unbearably opaque, he appears to be doing something rare–telling the truth," Woodward reports. In an epilogue, Woodward suggests that the Fed chairman even embodies the American spirit. "With Greenspan, we find comfort. He helps breathe life into the vision of America as strong, the best, invincible. The fascination with Greenspan has become one of the ways in which the country expresses confidence in itself and its future."
Wow. Is Woodward in love? I cannot remember an important public figure who has enjoyed such adulation, not while he's still alive, still in office. "Outside the Fed," the author observes of Greenspan, "hardly anybody can muster the courage to criticize him anymore." That's true enough in the high realms of Washington politics, but some of us dissenters are still around, still talking back to Father Greenspan though not at his dinner table (most critical voices are far beyond the view of establishment media, some of us dismissed as cranks). In the "good times," conventional wisdom can safely ignore contrary critiques of power. When the "good times" turn sour–an unwinding process now under way in both financial markets and the real economy–a more substantial dialogue may develop about Greenspan's stewardship of monetary policy and the insulated, unelected governing power he represents.
This piece is not a review of Woodward's book but an argument against the shallow, self-protective mythologies the Federal Reserve promotes about itself, which are fully reflected in this book. A review would be improper, given the personal associations (Bob and I are former colleagues at the Washington Post and remain distant friends; we also both write books for the same publishing house and editor). But since I wrote my own book about the Fed more than a decade ago (Secrets of the Temple: How the Federal Reserve Runs the Country, 1987), I do feel entitled to quarrel with the conventional wisdom's celebration of the Greenspan era–the triumphalist interpretation that reigns unchallenged not only in Washington and on Wall Street but also in Bob Woodward's book.
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The most compelling quality of a Woodward narrative is the authoritative sense of intimacy. The reader is right in the room with high officials, listening to the spirited back and forth among important players. Often the reader feels inside their heads, hearing their unexpressed doubts or hunches. Intense digging is required to pull this off, and Woodward is without peer for his daring and his meticulous style of cross-rough reporting among numerous unnamed sources. In newsrooms, this dramatic form of storytelling is known as a "ticktock"–reconstructing pivotal events hour by hour, day by day–and it implicitly relies upon the "great man" approach to history, focusing almost entirely on who said what to whom behind closed doors.
The problem with the great-man approach is that not only is the reader confined to the insider's version of reality; so is the storyteller. The Federal Reserve described in Woodward's book is a near-perfect fit with the institution's longstanding self-image and, indeed, with the standard version taught in Economics 101 or typically portrayed in news stories. The central bank is described as an island of disinterested technocratic expertise–sober thinkers who are surrounded by the federal government's messy, sometimes barbarous political swamp. The Fed, it is said, must be cloistered from the usual pressures–the accountability and openness required of elected government–so Fed governors are free to focus on the long-term consequences. Thus, the core conceit sustaining this institution is the claim that good government requires the absence of politics–a high-minded notion inherited from the Progressive Era, which created the Fed in 1913.
In reality, with few exceptions over nine decades, the governors all come from the same club–banking and finance, with a sprinkling of academic economists who share the same values and operating assumptions. When staff economists graduate from the Fed, they go on to very lucrative careers in the same fields. I am not questioning personal integrity or intelligence, but the insularity that allows them to evade the deeper implications of their work. They argue endlessly over what the numbers mean, but remain elegantly oblivious to brutal class conflicts inherent in their decisions. They vigorously espouse competing theories but do not in fact regard every element of economic life as equal in status. When farmers or homeowners tap out on their debts, they forfeit homes or farms and the Fed regards their liquidation as a natural event of market economics. When major banks and brokerages face the same fate, the Fed comes to their rescue, in the name of defending "the soundness of the system."
The technocrats at the Fed, we are told, essentially have one principal function–setting interest rates to keep the economy running on an even keel (Woodward tracks this decision-making process closely across more than a decade). By limiting or expanding the availability of credit, raising or reducing short-term interest rates, the Fed attempts to curb price inflation or perhaps to stimulate sagging economic activity and avert recession. Not too hot and not too cold, but just right. The Goldilocks economy was the basis for Greenspan's central accomplishment–the unprecedented length of the current business cycle, now in its tenth year. Trouble is, the conventional view of monetary policy leaves out the hard parts–the many contentious issues that authorities consider too complicated (and explosive) for frank public discussion. For one thing, institutional lore mystifies the Fed's central role in inducing recessions, intentionally or otherwise, for justifiable reasons or for wrong reasons. Every US recession, since World War II and before, has been caused directly by the restraining force of tight monetary policy–the Fed pushes short-term interest rates above long-term rates (an unnatural condition known as the inverted yield curve) and holds them there until the real economy of producers and consumers is driven into a contraction. The justification is always the need to brake price inflation and defend the currency's value.
But sometimes the recession is induced by mistake. That was the case in the one Fed-generated recession that has occurred on Greenspan's watch, in 1990-91. The chairman's private expectation (well documented in Woodward's account) was to slow the economy but not sink it, a so-called soft landing. But he overdid it, held tight too long and produced a relatively brief but nasty contraction. Greenspan never acknowledged his momentous error. The causality and the blame are strangely unmentioned in Woodward's storytelling.
The mistake has special relevance for the present moment because, despite the absence of inflationary pressures, Greenspan launched another vigorous campaign of interest-rate increases in 1999 and continued them into this year (the economy was growing too fast–dangerously so–we were warned). The yield curve became inverted once again last summer, and that ominous condition continues today, like a flashing warning light. It means the Fed is still actively suppressing economic activity, even though the economy is rapidly losing strength. The chairman, in my judgment, ought to be cutting interest rates right now–and aggressively–if he wishes to avert another hard landing, that is, full-blown recession. I am not alone. According to an unnamed source of mine, Wall Street influentials are peppering the chairman with the same message. "It looks ugly," he confided.
As my source suggests, the real context of monetary policy involves a rich, continuous, seldom-visible interplay of politics–coming not so much from politicians but from sectors of business and finance contending to influence the Fed policies and discreetly "lobby" the governors (an unseemly term that is never used). I want to be clear about this: There's no conspiracy involved; the Fed is simply surrounded by the normal, inevitable exertions of political interests–politics in the generic meaning. Contrary to the mythical image, the Federal Reserve is inescapably a political institution, deeply conservative by nature but above predictable partisan ties (as Woodward vividly illustrates). The Fed does deep politics, whether people can see it or not, because its governors must regularly choose among competing interests in the society, deciding which bad outcome has to be avoided at the risk of inviting another bad outcome somewhere else in the economy. Some citizens and interests will be directly injured by the Fed's interest-rate choices; others expect to benefit from them. Fiendishly complicated trade-offs are always embedded in monetary-policy decisions and, I note respectfully, pose an extraordinary burden for the decision makers.
Yet most Americans don't have a clue–even though roughly half of them are net financial debtors and their interests are vitally affected by the Fed. The conflicting fortunes that underlie monetary policy are purposefully obscured by the institution–never discussed very directly even among the officers and never acknowledged in ways that ordinary citizens might understand. But the policy contests are well understood by the elites who engage in them. Woodward, like most commentators, starts from the assumption that everyone shares roughly the same stake in "sound" monetary policy, and he affirms that the public is wise to trust in Father Greenspan. The opacity is one reason the dissident claque, myself included, persists unfashionably in assailing the Fed. Sequestering this great power in an unaccountable governing agency subverts democracy itself by treating citizens as children.
During the past twenty years, the Federal Reserve has utterly dominated the national government–no meaningful opposition exists to its conservative supervision–and the sorry consequences for politics were on display in Election 2000. Neither major-party candidate dared to question any aspect of Father Greenspan's wise reign, nor could they admit that it is Greenspan who rules over the US economy, regardless of who winds up as President. Albert Gore's campaign was particularly handicapped by the silence. As a Democrat, he had to rally a base of voters who had not actually prospered very much during the nineties. This might explain why Gore was reluctant to brag about the boom–his own principal constituencies were the losers. He comforted them with a few lame swipes at the "powerful"–though not a peep at the much-admired father.
A Dubious Miracle
For the past two decades the Federal Reserve has been an engine of inequality. Its policies and long-term strategy have steadily generated greater disparities of wealth and income. It was not the only engine, of course, and certainly did not set out deliberately to achieve the growing inequalities, but that was the ineluctable result. The campaign began in 1979, when runaway inflation engulfed the economy. Fed Chairman Paul Volcker induced a long, harsh recession to break it. When the recession ended in 1982, financial markets rallied explosively–the beginning of the "superbull" stock market–but Volcker continued to restrain growth in the real economy, keeping interest rates above normal. His purpose was to keep ratcheting down increases in the price level during the recovery cycle–gradually, in stair-step fashion, until the inflationary fears of capital investors could be fully extinguished. Greenspan took up the task after he became chairman in 1987 and continued roughly along the same path of slow, steady disinflation (albeit with occasional setbacks). Eventually, he achieved the goal–low and stable inflation rates, as near to zero as plausible. In the annals of central banking, this was a great victory. But it was not pretty.
The long process of disinflation–measured by the falling rate of increases in the Consumer Price Index–meant the Fed was gradually "hardening" the value of America's money. A dollar, for example, was losing 10 or 11 percent of its value when the CPI was briefly rising in double digits during the 1970s inflation. But with the inflation rate steadily subsiding, moving downward in most years, the dollar's value was growing, particularly if it was invested in the future through stocks or bonds. Thus monetary policy effectively delivered a discreet dividend, year after year, to the wealth-holders. Not surprisingly, they felt good about this (even if they didn't understand why it was occurring). Their stocks and bonds or other financial assets would automatically be worth a bit more when they sold them because they would be paid in harder dollars–currency that had more purchasing power than the dollars they had originally spent to purchase the stocks or bonds. The silent, annual bonuses and the revived optimism among investors together fueled the soaring stock market that has stretched across the past eighteen years.
Industrial workers, on the other hand, felt lousy, as did a majority or more of all wage earners, because their wages were being discreetly depressed, in real terms, by the same process. With the slower growth and higher unemployment artificially induced by Fed policy, wage increases were naturally subdued or nonexistent, especially among those in the bottom half with little or no bargaining power. In fact, for most of Greenspan's tenure, average wages did not keep up with inflation. Many families experienced the paradox–their purchasing power seemed to be shrinking, even though inflation rates had fallen. Confused people sometimes blamed this squeeze on rising prices when the real problem was stagnant or falling incomes.
The Federal Reserve was in fact explicitly targeting the wages of the American work force as a principal threat to economic stability. Greenspan articulated the connection less elliptically than Volcker, but one still had to parse his sentences carefully to get his meaning. Neither media nor politicians bothered to explain it very directly. This subtext of "winners and losers" helps explain why opaque technical verbiage surrounds the conduct of monetary policy. Who wants to tell the workers their own government is holding down pay? It also explains why, even after four years of accelerated growth, lower unemployment and rising real wages, so many American families refuse to join the celebration. Either the "good times" never got to them or they are still trying to get well from the Fed's old medicine. Despite the boom, hourly wages in manufacturing remain mired, in real terms, at 1970s levels. For families at the median household income level, it has taken nine years to get back to where they were in 1989 (before Greenspan's 1990 recession hammered their incomes).
Among financial types, Greenspan's logic was sometimes called "the 2 by 2 economy"–2 percent growth, 2 percent inflation–better known as Goldilocks. As Greenspan repeatedly proclaimed, it was impossible for the US economy to grow faster than 2-2.5 percent a year without reigniting fierce inflation, a ceiling he derived from expected growth in productivity and the labor force. The operating corollary (the theorem known as NAIRU) translated this growth ceiling into a somber rule: The unemployment rate must not be allowed to drop below 6 percent. Such rules were invoked regularly to justify Greenspan's "pre-emptive strikes" against inflation and faster growth–raising interest rates when prices were subdued or even falling, slowing the economy when its productive capacities (plants and people) were still vastly underutilized. The danger that most spooked the governors was the threat of rising wages.
Spirited critics from left and right did challenge this logic (futilely, since Clinton and both parties passively adhered to Greenspan's dictum), and the supposed threat of inflationary wages proved to be nonexistent. As some of us argued, globalization and the competition from cheap labor overseas were imposing a most effective brake on both US wages and consumer prices (global influence on US markets is among the economic realities the Federal Reserve steadfastly ignores in its calculations). Corporate downsizings added to these pressures. For the record, the critics' arguments have been spectacularly confirmed by events and, ironically, by the Greenspan boom itself. Once the Federal Reserve relented in early 1997 and permitted faster growth to unfold, wage increases picked up smartly and started making real gains against inflation, while the CPI held steady. The unemployment rate fell below 6 percent, then 5 percent, then even 4 percent, yet the calamity predicted by the Fed in such circumstances never occurred. Woodward describes Greenspan as puzzled by the absence of wage inflation. Is the "traumatized worker," he wonders, afraid to ask for more?
Actually, the only visible price inflation was in the stock market–a developing bubble in asset prices that began to worry Greenspan too. In late 1996, when the Dow Jones Index was above 6,000 (the long rally had started at 900 back in 1982), Greenspan famously called it "irrational exuberance." Yet he did nothing to interfere. The Fed had launched the giddy run-up in financial markets and sustained it for many years, but the Fed has disclaimed any responsibility for what would happen on the downside. Greenspan waved away critics urging him to use the Fed's regulatory tools to curb the easy credit available to Wall Street's high fliers. The chairman essentially does not believe in regulation–not when it applies to his own constituency. The Dow peaked last year at 11,800 and is returning to earth. One of the reasons the stock market lost its luster is that the Fed's annual disinflation bonuses ended. Financial rates of return are subsiding back to normal ranges, and there's nothing Greenspan can do to stop the pain.
The standard claim that occasional "pre-emptive strikes" kept this long-running expansion going ignores all that was lost–the huge volume in output and income that would have helped achieve a more widely shared prosperity (leave aside the obvious political injustice of rewarding one class of citizens while injuring others). Greenspan was indulging in the very sin that conservatives used to attribute to liberal economic managers–attempting to fine-tune the economy according to abstract theory that did not match the realities. Dean Baker of the Center for Economic and Policy Research has estimated that an additional $1 trillion in economic output has been gained since the Fed backed off its rigid limits on wages and employment–ten times more economic benefit than the supposed gains claimed for deficit reduction. Economist L. Randall Wray of the University of Missouri, Kansas City, goes further: "If the Fed had simply left the economy alone for the past six years, I believe overall economic performance would have been better, but Greenspan's chances at sainthood would have been severely reduced."
The dramatic turning point in Woodward's narrative comes down to this: Greenspan changed his mind. This story has been told before, and it fits splendidly with the mystique of central banking: the soulful commitment to rigorous, disinterested intellectual inquiry. The chairman patiently noodles around in the data over several years, convinced something doesn't add up, and discovers the key–productivity is actually rising rapidly, thanks to heavy business investment in the new technologies of the Information Age, though not yet reflected in the government's data. Hurrah, there it is–the New Economy, computers and such. These efficiency-promoting tools, he decides, are invalidating the Fed's ceilings on growth–so he can stand back and let 'er rip. Greenspan has to persuade skeptical colleagues inside the Fed not to insist on further rate hikes, but when he succeeds, the boom is born. This makes a nice, uplifting story. But is it true?
Let me offer an alternative version of what may have occurred, based on informed supposition, not insider information. Greenspan, I think, was shrewd enough to understand that like it or not, the Federal Reserve had no choice but to back off. Because if it persisted in following its own stern dictates for curbing growth, the Fed might very well drive the economy over the cliff into a full-blown price deflation–falling prices. That would swiftly put many sectors under water, not to mention millions of debt-burdened families. The real value of debts increases ferociously in that situation while wage incomes fall because of rising joblessness. The intellectual detective work was doubtless genuine, but he was searching for a way out of the trap the Fed had constructed for itself. The 2 by 2 logic that he had applied for years was now dangerously successful, with a chance event threatening to push price levels below zero. He was flirting with a catastrophe far worse than any inflation.
In other words, the turning point that Woodward and others have lovingly described was, in fact, an inevitability that Greenspan could not escape. If he didn't change policy and relent, he was going to commit a monumental error–the kind of mistake that would put him in the history books not as saint but as blind fool. The chairman needed to find an acceptable rationale for relaxing the Fed's restraint–one that did not require him to trash orthodox principles. Miracle of miracles, he hit upon the talisman of productivity, and it's good that he did. But the motivation, I suggest, included a strong dose of old-fashioned fear.
The heroic version of Greenspan's brilliant discovery is already quite tattered. A growing circle of economists and other critics has been punching holes in his analysis–the supposed productivity miracle created by New Economy hardware–and they started well before tech stocks swooned. John Cassidy in the November 27 New Yorker gave a lucid tour of the statistical jokers in Greenspan's deck. He pointed out that if Germany adopted the same dubious accounting methods the United States started using in the 1990s, it could claim a productivity miracle too. Others note that the miracle may belong to Asia and other foreign producers, since computers and components are largely manufactured abroad.
In truth, productivity is a kind of "black box" in economic thought–a measure with manifold meanings that can be invoked to scold the work force or to claim a company's improved efficiencies. In practice, the gains can be achieved just as readily by suppressing labor costs–less spent for workers' input means greater productivity in the output. The investment boom was real, but the labor factor–getting more from workers without paying them for it–is centrally implicated in the miracle Greenspan attributes to technological innovation. For instance, economist David Friedman, senior fellow at the New America Foundation, cites a Fed study showing that the use of temp workers doubled in manufacturing during the 1990s. The practice of mandatory overtime is now commonplace, since it's much cheaper than hiring additional workers. Corporate restructuring dumped boatloads of expensive white-collar employees.
If the rise in productivity is real, it was accomplished at the expense of the work force. In conventional economic theory, workers are supposed to gain wage increases in step with employers' rising productivity (and only then are they supposed to expect it). But wage earners have not been rewarded. Their increases remained quite modest, even tepid, during this boom–sustaining long-term inequity, further widening income inequalities. While manufacturing productivity has been growing at 5 percent a year or more, real wage growth has averaged only 0.3 percent, according to Friedman. This gap between rising wages and rising productivity is now the widest in forty years, he observed. Anyway, since Greenspan began slowing things, trying to restore his 2 by 2 economy, the growth in real wages has stopped. The boom was already over last spring for many folks, and if they haven't paid off their credit cards, they are headed for trouble.
The subject cries out for critical public argument: Was productivity boosted by New Economy innovations, or was it mainly extracted from the work force–the practice that in the olden days, before computers, was described as "sweating" it out of the workers? This is not an esoteric matter for scholars alone but a pivotal political question for establishing a different economic policy direction. When the boom is over, should government keep on favoring capital or start supporting the wage earners? If this country had an alert, focused political party (alas, it doesn't), it would launch its own spirited examination. At least it wouldn't leave the inquiry to the Fed, which is anything but disinterested in protecting its own reputation. Last July I got a phone call from Bob Woodward, who said he was at work on a book about Greenspan and asked what I thought of him. Bob seemed startled to learn I was not on board for the celebration.
Humpty Dumpty Sat on the Wall…
When Alan Greenspan was younger, he was devoted to the bellicose individualist Ayn Rand and hung out in her brainy circle. In those days, he wrote his own fierce essays in defense of free-market capitalism, and he still espouses contempt for government interference with the economy. "The welfare state," he wrote in 1966, "is nothing more than a mechanism by which government confiscates the wealth of the productive members of society to support a variety of welfare schemes." This sounds laughable today because Greenspan presides over one of those schemes himself: Only the Fed takes money from us productive citizens and dispenses it to troubled banks or financial firms that have fallen on hard times. Meanwhile, the chairman uses his influential status to urge on the politicians whacking away at the tattered old welfare state.
In his view, it is necessary to save the bankers from their mistakes, but it would be wrong to help people with theirs. Greenspan's distinctions are so precious, one suspects they are grounded not only in conservative ideology but in his interest-group loyalties. The chairman expressed no public embarassment (indeed, he never told the public) when he engineered the discreet bailout of Citibank and other major banks threatened by default in the early nineties. Or when the huge financial rescue was required for Mexico in 1995 so that Wall Street investment houses could get their millions out without huge losses. Or when Southeast Asia melted down a couple of years later and required even larger assistance. Or when the wonder firm of Long Term Capital Management–managed by his old friend and former Fed vice chairman David Mullins–went bust.
Greenspan is a player, after all, who has long operated at the intersections of business, finance and politics. He is the same shrewd analyst who, as a private consultant in 1985, gave federal regulators his prestigious endorsement of Charles Keating's notorious Lincoln Savings and Loan–just before it went belly up and dumped huge losses on US taxpayers. As Fed chairman, Greenspan actually set out to lend $100 million to rescue his former client, but he thought better of it when he saw the rising public wrath about the S&L bailouts. Ayn Rand might have winced for her protégé.
But meanwhile, in true Randian fashion, Greenspan has repeatedly weakened or stripped away the Fed's existing regulatory powers so as to liberate financiers and bankers. Commercial banks are more profitable today because Greenspan greatly reduced their obligations to deposit stabilizing reserves with the central bank. The financial deregulation he champions has led directly to the predatory, usurious lending practices that afflict the working poor. He single-handedly repealed the Glass-Steagall Act before Congress got around to doing it, by opening a dubious loophole permitting the creation of Citigroup and other financial conglomerates (mastodons the Fed may well have to rescue if the worst occurs). The point is, financial deregulation and Greenspan's laissez-faire enforcement have created the time bombs that may explode; if they do, he will run to the rescue, in the name of the soundness of the system.
Despite the stock market bubble, Greenspan refused to raise the margin requirement on lending and, in fact, tried to repeal this regulatory lever enacted after the 1929 crash. Woodward informs us that the chairman's current tight money is actually a belated attempt "to defuse the bubble" slowly –"a kind of soft landing for the stock market." But that's not what Greenspan tells the public. "We do not and have not been targeting the stock market," he has insisted. One of them is not telling the truth (I pick Humpty).
Truth does still matter in a democracy. In Maestro, Chairman Greenspan repeatedly boasts about achieving "balance" and "stability," but the truth is quite different in the real world. His tenure has led the US economy and society deeper into a condition of profound imbalance, one that now threatens bloody instability that would batter the "losers" once again. To restore a genuinely balanced prosperity will require new politics and great reforms, including overhaul of the Federal Reserve. In a perfect world, banking and the financial systems would be reregulated along different lines. The Fed would at last be subjected to concrete political accountability–either by making it a subdivision of the Treasury Department or by establishing a process of regular Congressional directives that force it to restore a more rational and equitable monetary policy. Ideally, politics would pursue all these and other propositions, but reform is obviously a long way off. In the meantime, I would settle for a genuinely honest public debate, because I do not think the central bank could stand it.