The New Mr. Dollar

By George Russell

The office is ornate and spacious but nothing at all special by Washington standards. Yet the 27-ft. by 16 3/4-ft. second-floor sanctum in the marble- clad Federal Reserve Board building on Constitution Avenue has a unique feature: from behind its cluttered wooden desk, the occupant has a breathtaking view of almost every hazard that currently confronts the U.S. and world economies. In the foreground is the distressingly weak dollar, which threatens to push the inflation rate out of control once again. In the middle distance: sluggish levels of U.S. and world growth that could easily tail off into global recession, especially if American interest rates, already on the rise, should climb too high. In the background is the ugly accumulation of Third World debt, an unstable mass that if not properly managed could still crush the world financial system.

No wonder then that a wave of nervousness swept through financial markets last week when Ronald Reagan announced an epochal change at the Federal Reserve Board, the chief government authority for setting U.S. monetary policy. Political leaders, investors and currency traders in every part of the globe were understandably concerned that a new and untested man was being entrusted with the fate of the dollar, the course of U.S. interest rates and quite possibly the prosperity of the world economy. The change was all the more dramatic because it removed from the scene a commanding figure who in eight years has earned a heroic reputation and the profound trust of the international financial community as the world's foremost inflation fighter and its top central banker.

Just before leaving Washington for this week's Venice summit for leaders of the major industrial nations, the President said he had accepted with "great reluctance and regret" the resignation of Federal Reserve Chairman Paul Volcker, 59, effective in August at the end of his second four-year term. His successor, and thus the new Mr. Dollar, will be Alan Greenspan, 61, a highly regarded private economist (and longtime member of TIME's Board of Economists) who served as chairman of the Council of Economic Advisers during the Ford Administration. Said Greenspan last week, after revealing that it took him "milliseconds" to accept the President's job offer: "Under Paul's chairmanship, inflation has been effectively subdued. It will be up to those of us who follow him to be certain that those very hard-won gains are not lost."

Greenspan admitted that it would be a "major challenge to fill Volcker's shoes." By law, the activities of the Fed are insulated from White House or congressional interference, but Volcker's imposing presence (he is 6 ft. 7 in.) and his supremely assertive stance have over the years added more substance and clout to the Fed's famed independence. Indeed, in many foreign capitals, Volcker has been viewed as virtually the sole guarantee of sound American monetary policies, immune to political pressure. One commentator went so far last week as to describe him as a "financial demigod."

His successor, whose confirmation by the Senate should encounter no serious obstacles, also enjoys widespread respect in international economic circles, though he has no central bank experience. Moreover, his economic views are cut from essentially the same conservative, anti-inflationary fabric as Volcker's. As a Republican who has already served one Republican President, however, Greenspan is bound to face increasing pressure to bend his actions to political ends as the 1988 presidential election draws nearer. Indeed, some Administration critics argued last week that Greenspan's surprise appointment already amounted to just such political meddling. Said Pierre Rinfret, a former Nixon Administration economic adviser and now a Wall Street consultant: "It's a real watershed. President Reagan has now succeeded in turning the Fed into an arm of the Administration."

Most experts would consider that charge hyperbolic if not downright false. Still, the change at the Fed was unsettling enough to cause considerable zigzagging in world financial markets. Within minutes of Reagan's announcement, the Dow Jones average of 30 industrial stocks dropped 22 points, and bond prices suffered their worst one-day drubbing in more than five years. But the Dow bounced back by 42.47 the next day and closed on Friday at 2326.15, up 34.58 points for the week, while bond prices also recovered much of their loss. In Tokyo the U.S. dollar, which has lost about 30% of its value against the yen in the past 18 months, tumbled quickly from 145 to the dollar to 142.5 before rebounding to finish the week at 143.6. In Paris, the dollar dropped nearly 2% against the French franc in a matter of hours, but later gained back half of its lost value.

Verbal reaction followed the same down- and upbeat course. Nihon Keizai Shimbun, Tokyo's respected business daily, headlined an editorial VOLCKER'S RESIGNATION IS VERY REGRETTABLE. But Takeshi Ohta, deputy governor of Japan's central bank, said with evident satisfaction, "Mr. Greenspan is the best successor that the President could have chosen." British Chancellor of the Exchequer Nigel Lawson called Greenspan's appointment an "excellent choice." In the U.S., where Greenspan is much better known, most economic thinkers and money managers hailed the Fed newcomer -- once they had regretted Volcker's departure. Said Frederick Joseph, chief executive officer of the Drexel Burnham Lambert investment firm: "Volcker had credibility. Greenspan will have to grow into it." Agreed Alice Rivlin, director of economic studies at the Brookings Institution and a fellow member of TIME's Board of Economists: "Volcker had the confidence of the world. That will be the hardest thing for Greenspan to build."

Amid the welcomes there were a few voices of caution. Henry Kaufman, a partner at the Salomon Brothers investment firm and one of Wall Street's most famed Cassandras, warned that Greenspan's appointment in the short haul "is a negative both for the dollar and for interest rates." Allen Sinai, chief economist at the Shearson Lehman Brothers investment house, noted that Greenspan "does not have much experience in international finance."

To ordinary Americans, much of the fuss about the appointment may have seemed puzzling. Significant as the Fed chairman's actions have often been in U.S. monetary history, the management of the nation's central banking system is shrouded in obscurity. The chairman of the Board of Governors of the Federal Reserve System is one of seven presidential appointees who as a group oversee 25 branches of the central bank, which is organized into twelve districts nationwide.* Ordinary governors serve 14-year terms, while the , chairman is chosen for four years. One purpose of the board is to regulate the behavior of large bank holding companies. Numerically, those concerns make up only about 45% of all U.S. banks, but they account for more than 90% of all bank deposits.

By far the Fed's most important mission is to manage the supply of money and credit in the banking system. By controlling the amount of cash available to banks, the Board of Governors affects interest rates and ultimately influences the level of inflation. The discreet actions of the Fed chairman and his colleagues have an impact on everything from the price of bread to the interest rate on a home mortgage.

In Federal Reserve decision making the chairman's vote theoretically counts equally with those of the other governors. But in practice the board has traditionally tended to follow the lead of the chairman. In the past, figures like William McChesney Martin Jr. (chairman from 1951 to 1970) and Arthur Burns (1970 to 1978) have become nationally renowned monetary policymakers. Volcker may have earned an even mightier reputation for bringing the inflation rate down from 13.3% in 1979, the year he was appointed, to 1.1% in 1986. He consistently managed to persuade the other Fed governors to go along with tough and often unpopular policies. His skills with the board, the public and politicians inspired Economist Jack Albertine, vice chairman of Chicago-based Farley Industries, to call Volcker the "shrewdest bureaucrat in Washington since J. Edgar Hoover."

Another reason for Volcker's status, though, was the absence of any coherent U.S. fiscal policy during most of his tenure. While he presided at the Fed, the U.S. growing budget deficit steadily ballooned, eventually reaching a record $221 billion last year. This year the deficit is expected to shrink only to a still terrifying $175 billion. Volcker's great contribution has been to ensure that the Fed did not crank up the U.S. money supply -- and thus fuel inflation -- to accommodate the budget gap. Instead, the deficits have increasingly been financed by foreigners, chiefly Japanese, who in turn have looked to Volcker's continuing presence as a guarantee of the stability of their investments. From the Fed chairman's point of view, the loose budget policy of the White House and Congress put the job of inflation fighting squarely on his shoulders.

For all his authority, Volcker's celebrated powers have gradually been waning at the Federal Reserve. Populist supply-siders in the Reagan Administration have never been happy with Volcker's austere monetary views. Neither, until his own departure in February, was former White House Chief of Staff Donald Regan. As members of the Reserve Board have resigned, retired or fulfilled their 14-year terms, the Administration has gradually replaced them with appointees who have favored more expansionary policies. Reserve Board insiders insist that relations between Volcker and the newcomers never deteriorated into antagonism. But, says one, "he obviously didn't have the control he had before."

A sign of the change is that Volcker went along with a gradual reorientation of Fed policy toward pepping up economic growth. In 1986 the Reserve Board let the basic money supply grow at a 16% annual pace, far above Volcker's original target limit of 8%. That money spurt, along with the weakening dollar, has let inflation edge up this year and may have sown the seeds of future rises that could nullify part of Volcker's celebrated victory against spiraling prices.

Knowledge of the underlying tension at the Fed led many to speculate last week that Volcker had been squeezed out of his job. The outgoing Fed chairman tried to squelch the gossip at President Reagan's press conference announcing the Greenspan appointment. Said Volcker: "I had no feeling that I was being pushed." On the other hand, Treasury Secretary James Baker muddied the waters slightly with an assertion that several attempts had been made "at my level" to get Volcker to stay on for a third term. The implication could be -- and was -- drawn that Reagan himself had declined to ask Volcker to remain.

The process of Volcker's departure actually began in March, immediately before Washington's annual Gridiron Dinner for an elite roster of media figures and politicians. Newly appointed White House Chief of Staff Howard Baker, a longtime Volcker supporter, bumped into the Fed chairman at a reception. Said Volcker: "Howard, I guess it's about time I came over and talked to you and the President." Baker's reply: "That's fine." He invited Volcker to set an appointment anytime to discuss his future at the Fed.

Volcker called on May 19 to ask for a meeting that was set for seven days later. The get-together was originally scheduled for Baker's office in the White House West Wing, but the Fed chairman did not want to be spotted entering the building. Instead, he asked Baker to travel to his own Constitution Avenue headquarters, and to use the garage entrance. When the chief of staff arrived, Volcker quickly passed on the news: "I don't want to be reappointed." Baker's reaction was, "The President will be disappointed." He tried to get Volcker to reconsider. "Paul, you really ought to think about this. It's important for the President, and it's important for the country." Finally Baker suggested that Volcker, an avid fly fisherman, consider the matter further during a planned weekend fishing trip. Volcker agreed.

While Volcker fished, Baker, along with Secretary of State George Shultz (himself an international economist) and Treasury Secretary Baker pondered alternatives. Greenspan's name topped their list. Second came Deputy Secretary of State John Whitehead, 65, a well-known expert on international monetary matters; before joining the State Department he was a highly successful investment banker at the Manhattan-based firm of Goldman Sachs. Third on the list was Beryl Sprinkel, chairman of the Council of Economic Advisers. Shultz and James Baker discreetly sounded out the two top choices about their availability for the Fed job.

After returning to work, Volcker asked for an audience with Ronald Reagan. Both the Treasury Secretary and the chief of staff were in attendance as Volcker sat down last Monday afternoon with the President in his yellow-and- white sitting room on the second floor of the White House. Related Chief of Staff Baker afterward: "The President went into that meeting prepared to ask him to reconsider."

Reagan began briskly. Said he: "I understand from Howard that you don't want to be reappointed." When Volcker concurred, the President started to ask the Fed chairman to think yet again. But he was interrupted by Volcker, who pulled his letter of resignation from a pocket and began to summarize its contents. As President Reagan heard that some of Volcker's reasons were personal, he declared, "I've got a policy that I never try to talk anyone out of leaving Government for personal reasons." All four men then discussed Volcker's successor and, with the Fed chairman's approval, quickly settled on Greenspan.

Informing the economist of the decision took a little longer. When tracked down by the White House switchboard, Greenspan was in his Manhattan doctor's office and unreachable for 20 minutes. Commented Reagan, who has seen all too many physicians during his two terms: "There's no telling what they're doing to that man." Eventually Greenspan emerged. Would he accept the job? The immediate answer was yes.

As markets adjusted to the shock of Volcker's impending absence, a new Fed- watching game had already begun. Every recent utterance by Greenspan was being scanned for inklings of his current views on inflation, interest rates and the dollar's value. By and large, Greenspan kept mum in anticipation of his Senate confirmation hearings in mid-July.

Even so, some observers tried to make much of the fact that two weeks ago in Chicago Greenspan had remarked that "over the long run" the value of the battered dollar would go "significantly lower." At last week's press conference announcing his appointment, however, he noted cautiously that there was "evidence" that the dollar's fall had bottomed out. Observed Japanese Central Banker Ohta: "Mr. Greenspan made his remark about ((the falling dollar)) when he was an economist, not when he was chairman-designate. So we do not have any concern about it." In his new vein of bankerly circumspection, Greenspan also declared that the "economy, at the moment, looks reasonably strong and hopefully will continue so for the indefinite future."

For the immediate future, Greenspan is likely to follow Volcker's anti- inflation policies. Says Harry Kalberman, a broker at Merrill Lynch and a close Greenspan friend: "People who think he will allow inflation to come back are fooling themselves." Agrees Jerry Jasinowski, chief economist of the National Association of Manufacturers: "Philosophically, he may feel more strongly about reducing inflation than Volcker did."

Greenspan's lack of central bank experience does not bother experts like Salomon Brothers' Kaufman. Mindful of Greenspan's reputation in Republican and Wall Street circles, he says the chairman-designate "has the standing in Washington to deal forcefully with other Federal Reserve Board members."

Indeed, some Fed watchers think Greenspan may become more influential than Volcker has been, at least recently. Says Robert Hormats, a vice president of the Goldman Sachs investment firm and an economic adviser in four Administrations: "The markets have made a mistake if they think the White House may have more influence on the Fed. It will be the other way around." Hormats' reasoning: Volcker's commanding manner and banker's jargon may have been off-putting to Reagan. Greenspan, on the other hand, has a gift for rendering economic concepts in the kind of uncomplicated language beloved by the folksy President. Greenspan may try to coax Reagan, for example, to accept a tax increase in the fight to cut the federal budget deficit.

The strongest difference between Greenspan and Volcker is likely to be in the area of banking deregulation. Volcker was chary about tearing down regulatory barriers that divide U.S. commercial banks and securities houses, a distinction enshrined in the 1933 Glass-Steagall Act. Greenspan, on the other hand, is an enthusiastic deregulator. He also brings his free-market enthusiasm to the issue of Third World debt. Volcker pioneered in that area by promoting concerted action by government and international authorities, along with private banks. Greenspan is more likely to applaud such market-oriented maneuvers as swapping bank loans for equity stakes in the domestic industry of debtor countries.

More than underlining his differences with Volcker, however, Greenspan must stress his similarity in one major respect: unwillingness to be manipulated for partisan political purposes. Says John Heimann, vice chairman of Merrill Lynch Capital Markets and a former U.S. Comptroller of the Currency: "The most important thing he has to do is give the markets convincing evidence that he is free of influence from the White House." Without that evidence, foreign investment in U.S. securities, a crucial factor in underwriting the budget deficit, might well dry up. That in turn would undoubtedly lead to a vicious spiral of increased interest rates to woo back the creditors, resulting ultimately in a slowdown of economic growth and the doleful prospect of U.S. and possibly even global recession.

Greenspan, of course, is fully aware of all that. He knows that playing politics with the economy could be disastrous. Preserving financial stability during these uncertain and jittery times would have been difficult enough for Paul Volcker, and it will be doubly daunting for Alan Greenspan as he proves his mettle to anxious moneymen around the world.

FOOTNOTE: *The other governors: Kansas Banker Wayne Angell, 59; California Economist H. Robert Heller, 47; Manuel Johnson, 38, a former U.S. Treasury official; Houston Businessman Edward Kelley, 55; Martha Seger, 50, a former Michigan bank regulator. One board seat is currently vacant.

With reporting by Jay Branegan/Washington, Barrett Seaman/Venice and Frederick Ungeheuer/New York