Quit Now, Al

By Daniel Kadlec

Alan Greenspan should have quit. Instead of accepting renomination as chairman of the Federal Reserve two weeks ago, he should have said, "No, thank you" and bowed out on top. Michael Jordan did it. So did Jerry Seinfeld. Babe Ruth didn't--and finished feebly in Boston. I'm not saying Greenspan will go down in flames. In 12 years, he's steered us through a stock-market crash, banking crisis and emerging-market disasters and hasn't gone soft. But as the wild gyrations in stock prices so far this year suggest, the Fed's job is getting tougher, and that raises odds that the Great One will mess up.

For investors, this is a good time to contemplate such a turn. Tech stocks have repaired their millennial meltdown, giving you another chance to sell high, and you've seen that a "diversified" portfolio of Intel, Microsoft, Cisco, Lucent and Yahoo doesn't offer much panic protection. Tech remains a great place to be long term--but not exclusively.

Running the Fed is an ever more complicated chore these days. Greenspan has to wrestle with whether he should curb stock-market inflation, not just consumer-price inflation, and whether he should tolerate rapid growth, hoping productivity gains keep wage and price inflation in check.

His biggest problem may be a bond market that has stopped doing the heavy lifting for him. You've heard of bond vigilantes? Those are traders who set long-term interest rates in the open market. Long rates are critical. They govern the pace of home building and most other debt-financed activity. Greenspan controls short rates, which influence long rates but imprecisely.

For most of his time at the Fed, Greenspan hasn't had to do much more than jawbone. The bond market has taken his hints and moved accordingly. A couple of years ago I ran into Greenspan's predecessor, the aggressive inflation fighter Paul Volcker, and asked him what he thought of Greenspan's performance. Volcker, a financial heavyweight, wouldn't grade Greenspan, but he voiced a mock complaint that Greenspan was getting a lot of credit for prosperous times without having to break a sweat. The vigilantes were doing it for him. When traders whiffed inflation, they chased long-term rates higher to curb borrowing power and cool the economy.

But it's not working anymore. Long-term rates are up sharply, yet the economy won't chill. That's why the stock market is jumpy. After a decade of the bond market's preventive medicine, it may be time for surgery. Greenspan may have to step up with a bold, unpopular plan for higher rates.

Why have the bond vigilantes lost their effectiveness? John Manley, a market analyst at Salomon Smith Barney, traces it to the stock market's wealth effect. "People have money," he says. "Why wouldn't they spend it?" If you're sitting on stock worth twice your dreams, it's unlikely that higher rates will keep you out of the mall. And consider: more folks can sell stock and pay cash for a boat, a car, even a house. If they don't have to borrow, interest rates are immaterial.

So how can Greenspan dampen spending? Raise rates until stocks fall, chipping away at the country's wealth? That isn't much of a legacy.

See time.com/personal for more on interest rates. Dan appears regularly on cnnfn. His e-mail address is kadlec@time.com