The American Spectator

President Bush reappointed Alan Greenspan as chairman of the Federal Reserve Board last May. The board is made up of seven members nominated by the president and confirmed by the Senate to fill 14-year terms (even the chairman must fill one of these seven seats). Members may serve only one full term. If a member is appointed to fill an unexpired term, he may be reappointed to a full term.

Most members of the Fed do not serve a full 14 years. Greenspan, however, was first appointed in 1987 to fill a seat that had a little less than five years remaining. He was then reappointed in 1992 to fill a full 14-year term. As a result, despite the fact that he has now been reappointed to a fifth four-year term as chairman, he must step down as a member when this term expires on February 1, 2006.

At that point, the president will be forced to appoint a new chairman. This will be a huge decision. Chairman Greenspan has depths of experience rarely seen in Washington. He has become one of the most effective politicians the capital has ever seen. He has cultivated relationships in every nook and cranny of government. Queen Elizabeth made him an honorary Knight Commander of the British Empire.

What few detractors he may have accumulated cannot find a toehold for support. World leaders seek his advice on topics that have nothing to do with monetary policy, and it is reported that he has a virtual veto on any appointments to the Fed Board. No other chairman has garnered so much power.

A NUMBER OF GREAT things have happened during his tenure. He ended years of frustrating secrecy and began an era of transparency at the Fed. In the mid-1990s, the Federal Open Market Committee (FOMC) — a group that includes all Fed governors and a rotating group of five regional bank presidents — started to release a statement following each meeting. This statement informs the market of the Fed’s thinking.

On the economic side of the ledger, it is hard to find fault in the overall picture of the economy during the reign of Sir Alan. During his 17 years, the economy has been in recession for just 16 months (8 percent of the time). In the previous 17 years, between 1970 and 1987, the economy was in recession for 49 months (24 percent of the time). Inflation, which averaged 6.5 percent annually in the 17 years before Greenspan, has averaged just 3.1 percent during his tenure.

Former Fed Governor Wayne Angell once said that he would judge his tenure on the Fed a success if the price of gold were no higher when he left than when he arrived. Judged on this Angell standard, the chairman is a winner. Gold was selling for $457 an ounce in August 1987 when he was first appointed. Today it is trading near $385 an ounce, a drop of roughly 1.0 percent per year.

With an economic performance like this, it is easy to see why so many politicians refuse to question Fed policy. But even more impressive is how the Fed has evaded any serious inquiry into its mistakes. The real Teflon-Man in Washington, D.C. is Alan Greenspan.

WHILE GOLD PRICES HAVE fallen during the Greenspan era, this long-term trend misses some dramatic movements in the past eight years. The price of gold was $410 an ounce in 1996, but fell to $256 an ounce in 2001. While many Fed officials insist that the price of gold is not a good indicator of general inflationary pressures, falling gold signaled the onset of deflationary pressures between 1999 and 2002.

Deflation can only be caused by one thing — excessively tight monetary policy. Yet, the Fed was able to avoid any blame for deflation, with most members of the financial press blaming it on China, productivity growth, and 9/11.

Since bottoming in 2001, the price of gold has climbed sharply. Those who watch gold and commodity prices have not been surprised that inflationary pressures are on the rise. So far this year, the consumer price index has climbed 5.1 percent at an annual rate, while the “core” CPI has climbed an annualized 2.9 percent. Inflation rates like these in the early '70s led the Nixon administration to impose wage and price controls.

As a result of the sharp increase in inflation this year, the Fed shifted gears quickly. Just last March, the Fed was still arguing that deflation was a greater risk than inflation. It also thought that the upside and downside risks to economic growth were equal. In other words, the Fed was worried that both a recession and deflation were still possible. As a result of these statements, investors drove interest rates down dramatically and assumed that the Fed would not hike rates until 2005.

But job growth accelerated sharply (adding 947,000 in just three months) and inflation jumped. These developments were in direct contradiction to the Fed outlook. In a few short weeks, the markets have responded dramatically. Ten-year Treasury yields surged by more than a full percentage point and the markets now expect the Fed to double the federal funds rate by the end of the year — to at least 2.0 percent.

Such abrupt shifts in the direction of monetary policy send shockwaves through the financial system that can cause a great deal of damage. Following a period of excessive accommodation in monetary policy in 1992 and 1993, the Fed pushed the federal funds rate up sharply (from 3 percent to 6 percent) in 1994. Financial market problems snowballed. The Mexican peso crisis, the Orange County bankruptcy, huge losses at the investment bank Piper Jaffray, and incredible stress on the financial system all occurred in the wake of those Fed rate hikes.

In 1999 and 2000, despite falling gold and commodity prices, an inverted yield curve, and a very strong dollar, the Fed boosted the federal funds rate. The result was a stock market crash, recession, and deflation. Bankruptcies spread rapidly and the financial system seized up, even before 9/11. The Fed responded by cutting rates 11 times in 2001 — one of the most dramatic series of rate cuts in U.S. history.