A Delicate Balance

By Stephen Koepp

It was quiet, maybe a bit too quiet. America's economic problems seemed to be taking a summer vacation last week, as if to give the incoming Federal Reserve chairman, the new U.S. money czar, a few moments to plug in his computer terminal and sharpen his pencils before the first crisis. To a remarkable degree, everything was going Alan Greenspan's way, as the nominee prepared for the Herculean job of succeeding the retiring Paul Volcker. The Dow Jones industrial stock average zoomed to a new peak of 2572.07. The dollar, which had spent much of the past two years in a free fall, seemed to be holding its own. After hearings that Wisconsin Democrat William Proxmire described as a "love feast," the 20 members of the Senate Banking, Housing and Urban Affairs Committee voted unanimously to recommend Greenspan's confirmation. The full Senate is expected to approve the nomination before Volcker completes his term this week. Even Proxmire, who voiced philosophical differences with Greenspan, concluded, "I think you are a remarkable man."

Indeed, Greenspan, 61, will need to be one. The summer's respite can last only so long before the Fed nominee will have to deal with a flare-up among the many long-term economic woes the U.S. faces. America's giant twin deficits, in trade and the federal budget, are improving slowly but remain daunting. Their persistence could help send the dollar plunging again and pressure the Fed to bolster the currency with higher interest rates. Inflation has returned as a potential threat, while the Third World debt dilemma refuses to go away. America's aging economic expansion, now in its 56th month, is entering a precarious stage, increasing the odds that a recession could strike in 1988.

Greenspan's first goal is to reassure the financial world that he will be as politically independent-minded as Volcker was. During Greenspan's confirmation hearing July 21, a questioner asked the conservative nominee whether he might succumb to "muscle" from the White House to stimulate the economy with an easy-money policy as the 1988 elections drew near. Greenspan responded that he "obviously would reject" any such pressure and declared the Fed's political independence to be "terribly critical." He has little choice, moneymen say. "His life will be very difficult if he is perceived as someone who will play politics. He has got to impress ((central bankers)) abroad, and the way to do that is by being a tough guy," says John Makin, director of fiscal policy studies at the American Enterprise Institute, a conservative think tank.

Yet Greenspan's closeness to the Reagan Administration could give him more influence over fiscal policymaking than Volcker possessed. Says Henry Kaufman, chief economist for the Salomon Brothers investment house: "Alan has a greater intimacy with people in the Administration and can argue his thoughts with them."

Greenspan aims to leave no doubts about his toughness as an inflation fighter. That quality is especially important now to the financial markets, which have been jittery about rising prices this year. Because of increased oil and food costs, the U.S. Consumer Price Index jumped at an annual rate of 5.4% during the first half of the year, up from just 1.1% during 1986. Declared Greenspan: "It is absolutely essential that ((the Fed's)) central focus be on restraining inflation." While most economists expect price hikes to ease to a relatively mild 4% for this year, a surge beyond that level is possible and would force the Fed to rein in the money supply -- even at the risk of a recession. Says Economist Rudolph Penner, former director of the Congressional Budget Office: "Greenspan has to somehow walk a very narrow path" between sustaining the recovery and restraining inflation.

Volcker has been tiptoeing along a similar line all year. In April the Fed felt compelled to tighten the money supply slightly in a show of support for the sinking dollar. Taking care to avoid spooking the financial markets, Volcker conjured a warm-sounding euphemism for the Fed's action, which he described as "snugging." At the same time, inflation fears helped drive interest rates higher, which put a damper on the housing industry and created turmoil in the bond markets. Since then, the Fed's course has been close to neutral as the board waits for signs of the next economic turning point.

To some extent, Greenspan comes into his job as a caretaker, charged with the tricky task of preserving what Volcker has wrought: moderate growth and low inflation. While Volcker's crusade to hold prices in line gave him a mandate to use strong-arm tactics at times, Greenspan will be expected to maintain the delicate balance that his predecessor had achieved at the end of his tenure. "Greenspan will be inclined toward fine tuning, not the sledgehammer approach that Volcker initially used," says David Hale, chief economist for Kemper Financial Services. Says Byron Wein, portfolio strategist for Morgan Stanley, the investment-banking firm: "I hope Greenspan will not be too creative."

He will have to be careful because the economic expansion he inherits is less than robust. After posting a healthy 4.4% growth rate during the first quarter of 1987, the economy slowed to 2.6% in the second period. Some economists see as much as a 50% chance of a recession next year because of stagnant spending by consumers, businesses and governments. Greenspan sees a downturn as a possibility, but a more remote one: "All I can tell you is that there is nothing visible on the horizon. But our horizon is rarely more than a year, and sometimes a good deal less than that," he said in testimony. Greenspan's sanguine view was supported last week by the Commerce Department's Index of Leading Indicators, an important barometer of future economic trends. It rose a healthy .8% in June, the fifth monthly increase in a row.

Foreign moneymen, who now hang on Greenspan's every word just as they did on Volcker's, are happy with what they hear from the new Mr. Dollar. In Japan and West Germany, where rising currencies have throttled export income and economic growth, central bankers commended Greenspan's assertion that the dollar has fallen far enough to bring a "very significant" improvement in the U.S. trade gap. After plunging by 47%, to a low of about 138 yen in late April, the dollar has now edged back up to the 150-yen range and has posted similar gains against the mark.

Greenspan plans no radical new formula for dealing with the menacing $1 trillion debt load of less-developed countries; he believes current strategies have improved the situation "really quite dramatically." Greenspan said he endorses the increasingly popular "market solutions," in which debtor nations are encouraged to boost their growth by loosening the government strictures on their economies. Said he: "The centrally planned, socially oriented type of government that existed in so many of the less-developed countries for so many years is now becoming an increasingly less acceptable way to function."

Probably the most significant difference that is emerging between Volcker and Greenspan is their approach to banking deregulation. While Greenspan favors lifting the ban on securities underwriting by commercial banks, Volcker has been leery of such a step. Greenspan is far more enthusiastic about allowing nonfinancial companies, such as automakers and retail chains, to operate limited-service banks. His testimony on this position drew a sharp rebuke from Proxmire: "That shocks this Senator, and I think it should shock many others."

Greenspan pointed out that he is no deregulatory zealot, but believes commercial banks need more latitude in order to compete against freewheeling foreign institutions and Wall Street firms. In fact, banking's rules could go through historic upheaval during Greenspan's tenure. Last week Congress and the Administration tentatively agreed on the first major banking-reform bill since 1982. In addition to providing a $10.8 billion industry-financed package for the ailing Federal Savings and Loan Insurance Corporation, the bill will ban the creation of any more limited-service banks and will prohibit banks from entering any securities businesses until next March. Congress will thus have more time to consider giving banks new privileges.

While Greenspan drew little criticism during his testimony, Proxmire staged a pointed attack on the economist's forecasting ability. During Greenspan's years as chairman of the President's Council of Economic Advisers in 1974-1977, Proxmire said, the economist's record of accuracy was "dismal" compared with previous and successive chairmen of the council. Greenspan pointed out that his record as a private forecaster was better, but he took the comments in good grace. "All I can suggest to you, Senator, is that the rest of my career has been somewhat more successful." Last week his Manhattan-based consulting firm, Townsend Greenspan, which he had run for almost 30 years, closed because it was unable to find another chief economist of suitable stature before a July 31 deadline for putting Greenspan's assets into blind trusts.

Volcker, 59, who has been in Government for nearly 30 of the past 35 years, currently at a salary of $89,500, will now have the opportunity to earn millions of dollars a year working on Wall Street, dispensing advice and giving speeches. So far, however, he has announced only that he will become chairman of the National Commission on the Public Service, a new nonprofit group that aims to foster respect for Government service.

Despite Volcker's legendary success, his own service was fraught with long- term frustrations that his successor will inherit. The primary one is that the money czar lacks the power to change America's most fundamental economic problem: the federal budget deficit. Only the Congress and the President can cut spending or raise taxes, and, laments Volcker, "the political impasse over doing something about it apparently remains." For that reason and more, he says, "my very able successor . . . will have challenge aplenty."

With reporting by Gisela Bolte/Washington and Frederick Ungeheuer/New York