The Fed in Fact and Fiction

...The decisions of still another esoteric agency, the Fed's Open Market Committee (the seven governors of the Federal Reserve Board plus five rotating presidents of the Federal Reserve banks strewn across the land) set targets for new monetary growth...

...Governors eager to be reappointed will display themselves as cooperating with liberal administrations just as now they ally themselves with conservative presidents...

...If America today "stands tall," as Ronald Reagan used to say, it is because thriftier foreigners are propping us up...

...Perhaps easier said than done...

...Responsive both to the continental size of the United States and to apprehensions that presidents or Congresses might manipulate it for political purposes, the Congress deliberately designed the "Fed" as an independent agency...

...In the Reagan era, high American interest rates have induced Japanese and other foreign investors to buy tens of billions of dollars of Treasury securities...

...In England and France, it is plain to all parties that executive control covers both taxing and spending (fiscal policy) and interest rates and credit creation (monetary policy...

...Almost certainly, the new bad-debt reserve understates risks of default...

...Elsewhere in the more or less civilized world, the chancellor of the exchequer or the finance minister possesses statutory authority to issue instructions to the central bank...

...No president cares to hear a mere banker described as his country's second most powerful official...

...Usually it has faithfully adjusted itself to White House inclinations...

...That overvaluation, in turn, enlarged underpriced Japanese and German exports to the American market, imposed high, uncompetitive prices on our exports, and created massive trade deficits only now beginning to shrink slightly after two years of American action to talk down the dollar's value and correspondingly to increase that of the yen and mark...

...In 1914 the Federal Reserve System came into operation...

...The myth of independence, reinforced from time to time by Fed action against the wishes of unpopular and therefore vulnerable presidents, has served to shield men in the White House from blame...

...It finances its operations, invariably with a sizable surplus, from the fees it charges the commercial banks that depend upon the Fed to clear checks, make loans to replenish depleted reserves, and in a pinch rescue a failing operation...

...Martin defied Truman and Johnson...

...Practically every respectable soul graced the departing Volcker with lavish praise for his prowess as a slayer of inflationary dragons, as the savior of the banking system, and as a light unto the heathen in lesser lands...

...Almost certainly, gentler restraint upon money growth within the context of OPEC's disarray would have brought inflation down at the cost of much less punitive general contraction, unemployment, and lost output from shuttered factories...

...In December 1982 unemployment peaked at 10.7 percent, the highest figure in three decades...

...The Volcker era ended in 1987 under appropriately murky conditions...

...In the 1960s and 1970s, 6 or 7 percent unemployment signified, by general agreement, recession conditions and accordingly alerted the White House and Congress...

...Our federal deficits and defense extravaganza have been substantially financed by foreigners...

...Volcker's cold-turkey therapy entailed severe, enduring side effects...

...Congress acted just in time to exacerbate the woes of idled workers...

...In the topsy-turvy universe of high finance, low unemployment is bad news, for the Fed might interpret it as a sign of renewed inflationary pressure and as reason to push interest rates higher...

...Paul Volcker's legacy is a more powerful corporate sector, banks protected from their own follies, a badly damaged labor movement, and unaddressed Third World debt burdens...

...When congressional control is divided, as it was during the initial six Reagan years, this model insures frustration and policy drift...

...Worse still, the shock of the 1981-1982 downturn has significantly changed public expectations...

...In this antiunion environment, Paul Volcker has served as a discreetly silent partner of a Reagan agenda all but explicitly directed to the reinforcement of corporate power...

...The mystique of the Fed is enormously enhanced by the secrecy that surrounds its machinations...

...Volcker's strategy contributed to the overvaluation of the dollar against the yen and mark during the first half of this decade...

...Volcker warmed up in 1980 when his slowing of monetary growth and acquiescence in consumer credit controls caused a brief recession that contributed to Reagan's victory over the hapless Carter...

...By the end of his first term in 1983, Paul Volcker had acquired such global prestige that the president with almost visible regret felt compelled to reappoint him...

...Congress craftily arranged that this crucial post fall vacant in the middle of a presidential term...

...In its quiet way, the Reagan administration encouraged Fed policy...

...Those who operate in them apparently prefer accounting fictions to honest bankruptcy...

...Such claims merit close inspection...

...President Nixon, nobody's bleeding heart, imposed wage and price controls, clapped 10 percent surcharges on imports, and increased federal spending all in reaction to a mere 5 percent figure...

...Neither the White House nor Congress exerts budgetary control over the Fed...

...Did he genuinely resign, gratified that his work was done, or was he nudged out by an administration that was never confident of its ability to control Fed policy and too naïve to realize that Volcker's Fed shielded the administration from the consequences of its own reckless tax cuts and furious Pentagon escalation...

...If the Fed is at heart political, no justification exists for the fourteen-year terms of members and the staggered four-year term of the chairman...

...Nowadays the employed public, encouraged by economists who mumble about WINTER • 1988 95 high "natural" rates of unemployment, accepts 6 or 7 percent idleness as tantamount to full employment or at least necessary to keep inflation low...

...Just to complicate matters, there are twelve Federal Reserve banks headed by presidents who earn considerably more than the head of the system...

...When, under pressure from the International Monetary Fund, lesser Volckers in countries like Egypt and the Dominican Republic impose higher food prices and more unemployment on their citizens, riots more than once have broken out and compelled governments hastily to reverse course...

...He will do his best in 1988 to continue Republican control of the White House...

...Major banks, like Chicago's Continental Illinois, must be rescued lest financial markets panic...

...Thus it was that Ronald Reagan inherited Paul Volcker, originally selected by Jimmy Carter...

...In times past, the president of the New York Fed has contested power over credit policy and money creation with the Board of Governors...

...Dimly recalling freshman economics, college graduates are aware that the Fed's variation of the interest rate it charges needy commercial bank borrowers (the discount rate) and its purchases or sales of government securities (open market operations) raise or lower the interest cost of buying a car, house, or major appliance...

...Moreover, other banks in weaker financial condition than Citicorp have, in following Reed's lead, exposed the fictions upon which bank accounting has been allowed to operate with Fed indulgence...

...In so doing, he tacitly conceded that substantial portions of Citicorp's Latin American portfolio were at risk...

...As a congressional creation, the Fed might report to Congress...

...Thus the supply-siders in the Reagan administration were able to evade 96 • DISSENT responsibility for the minidepression in 1981 and 1982 by claiming that it was the fault of Paul Volcker and his colleagues...

...There is merit in transforming the Fed into an executive agency...

...They also know how to stifle the inflations often promoted by their own earlier decisions...

...Presidents routinely take credit for good economic news...

...Alan Greenspan, who bills himself as a shorter Volcker, will no doubt continue if he can the Volcker charade...

...They ought in equity get the blame for slow growth, high unemployment, unfavorable trade balances, and other maladies...

...So covertly political an agency cries out for a clear, public definition of its role...

...Major bank failures early in this century compelled congressional recognition, under the urging of Woodrow Wilson, that central banks could play an essential stabilizing role in guaranteeing the solvency of the country's credit...

...The Fed in other words is approximately as ideologically neutral as William Rehnquist and Robert Bork...

...It was John Reed, Citicorp's head man—not Volcker—who introduced a note of realism when last year he dramatically enlarged his institution's bad-debt reserve...

...This means that during the Reagan years many hundreds of billions of potential output of goods and services have been unnecessarily lost...

...In conservative America, the natives are quiet...

...L sum, Volcker has been true to the tradition of central banking: Protect the strong and sacrifice the weak...

...The good news of the Volcker regime is the absence so far of a total collapse in the inflated structure of international debt...

...When and if the White House shifts to Democratic control, the Fed should neither sabotage ongoing economic policy, nor should it refrain from stimulating the economy in an election year on an equal-opportunity basis for liberals and conservatives...

...Volcker sabotaged Carter...

...Only in 1987, the fourth year of recovery, did unemployment drop below 7 percent...

...If ever the time were appropriate to transform the Fed it is now...

...Central bankers are conservatives more alarmed by inflation than by unemployment...

...Acclaim for Volcker attests to his capacity to endure stoically the misfortunes of his fellow citizens conscripted, all unwitting, for service in the war against inflation...

...But the main event was the mini-depression of 1981 and 1982...

...No wonder the man commands veneration from respectable financiers...

...In 1987, implausibly for better or far more probably for worse, Ronald Reagan encumbered a new administration with Alan Greenspan, of whom more subsequently...

...The bad news concerns Federal Reserve participation in a blatant bank scam...

...Commercial banks as large as Citicorp and as small as regional players in the Midwest and the South have been allowed to list as assets loans to the Third World as likely to be repaid by Brazil, Argentina, Mexico, and smaller debtors as the Soviet Union is to redeem Imperial Russian bonds...

...Throughout its history, the Fed has been a political institution...

...Seldom enjoyable, unemployment has become more painful as the result of major cuts in welfare, food stamps, rental assistance to low-income families, Medicaid, and other social programs...

...The financial community greets calmly news of layoffs, small-business failures, plant closings, and farm foreclosures...

...Central bankers can stimulate inflation by printing more money and pushing interest rates down...

...In blunt language, the art of central banking is infliction of financial damage upon freshly unemployed workers, overextended farmers, precariously financed small enterprises, and the communities that depend upon them...

...Imbued with a salutary populist distrust of bankers, Americans only grudgingly and belatedly accepted the public need for a central bank analogous to the Bank of England and similar institutions in Western Europe...

...Burns's arrogant persona, his adept deployment of the professorial pipe and somber dark suits, and his grudging disclosure of Fed intentions, all contributed to a reputation for rocklike nonpartisanship belied by the great man's actions...

...All that the monetary authorities need do is slow the printing presses, shove interest rates up, discourage business and consumer borrowing, compel layoffs—in short, administer the painful but efficacious medicine of recession...

...Nothing signals more dramatically the shift of power from workers to employers than the following statistic: in 1986 large corporations locked out 55,000 men and women and promptly replaced them with far lower-paid substitutes...

...The White House happily collected credit for taming demon inflation and absolved itself of complicity in the sharp contraction which, in combination with falling energy and food prices, achieved this nonmiracle...

...In 1972 Arthur F. Burns performed a conjurer's trick by pumping up the money supply and simultaneously inveighing against inflation, all in aid of his patron Richard Nixon's reelection campaign...

...Liberals must take note of the Fed's tilt against Democratic administrations...

...The seven governors of the Federal Reserve Board are nominated by the president for terms of fourteen years, subject to confirmation by the Senate...

...Even in a new environment of cheaper dollars and more expensive marks and yen, American producers are encountering grave difficulty recapturing markets lost earlier this decade...

...Fed chairmen inevitably acquire an almost gurulike aura...

...Worse still, the Fed encouraged banks to lend new money to these bankrupt countries so that they could pay interest on loans and American banks could continue to record the loans as "performing...

...Until 1985, unfavorable exchange rates stimulated export of factory jobs, inflicted heavy losses on American manufacturing, and, not least, severely damaged trade unions...

...Since 1945, central bankers in Europe and Latin America have repeatedly, if as a rule temporarily, halted and reversed price escalation...

...His eight years are a convenient occasion to sketch the importance of the Fed's policy-making role and to ask the inescapable question: Should the Fed be put under the authority of Congress, the president, or both...

...WINTER • 1988 • 97...

...It scarcely aids comprehension that pundits squabble incessantly over the definition of the very word "money...

...On the record, they have also been willing in election years to submerge their anxieties about inflation in order to enhance the victory prospects of Republicans after the fashion of Arthur Burns in 1972...

...Alan Greenspan is a Republican loyalist, a soldier under Nixon, Ford, and Reagan command...

...There is every reason to make 1988 the last presidential election in which the Fed can quietly promote the conservative cause...

...The chairman of the Fed from 1951 to 1970, William McChesney Martin, 94 • DISSENT defied Lyndon Johnson in 1966 in order to raise the discount rate as a check upon an economy overheating from the escalating Vietnam war...

...The president designates one of the seven for a four-year term as chairman—the world's most powerful central banker...

...On the "covert action" model, the chairman might seek the approval, say, of the Joint Economic Committee before it undertook any significant policy change...

...11 et us begin with the obvious...

...A clean resolution of the accountability issue might be the appointment of all members of the Board of Governors, not just the chairman, for four-year terms coinciding with the dates of presidential elections...