In an Uncertain World (27 page)

On the other hand, I did, in speeches and television interviews, what seemed appropriate and useful, namely advise investors to focus adequately on risk and valuation, and express concern that these disciplines had flagged. That seemed to me a sound approach no matter what the state of the market might be and carried with it none of the disadvantages of comments on the level of the markets.

By mostly refraining from comment, Alan and I differed greatly from our Japanese counterparts, who tended to take the view that markets should be managed by policy makers. I remember one bilateral meeting with a Japanese finance minister where the issue arose of whether our stock market was too strong. The Japanese official said to me, “Why don't you bring the stock market down?” Obviously, government actions, including fiscal and monetary policy, do affect equity markets. But the Japanese view was that government can affect markets by providing guidance or, in the case of currency rates, through intervention. My view, and that of most American economists and policy makers, is that the impersonal judgment of a vast number of participants guides markets. Over the longer term, stock markets, like currency markets, tend to reflect fundamental economic conditions, although they often diverge from those averages and go to excess in one direction or the other, sometimes for extended periods. In any case, in the long term as well as the short term, markets are going to go where markets are going to go—with jawboning by government officials unlikely to have more than the briefest effect, at most. As I often put it to others in the Clinton administration, “Markets go up, markets go down.” Some people viewed this as a profound observation. To others, it was the most obvious of truisms.

All that notwithstanding, in rare instances a Treasury Secretary probably does have to say something about unusually dramatic movements in the stock market. On October 27, 1997, the Dow Jones Industrial Average fell 554 points, its largest-ever single-day point drop at that time. The precipitating factor was a decline in foreign markets brought on by the Asian financial crisis, which created widespread concern in U.S. markets that the problems might spread to us. Adding to the psychology of the situation was that, just ten years and one week before, the Dow had suffered what was then the largest point drop in history, the 1987 stock market crash. People started referring to “Black Monday II.”

Now, 554 points in 1997 was a 7.2 percent decline, far less significant than the 508-point, or 22.6 percent, drop on Black Monday in 1987. Moreover, ten years earlier, the crash had overwhelmed the systems that processed and cleared buy and sell orders. As a result, the New York Stock Exchange had temporarily ceased functioning in an orderly way. This time, the market's order-clearing and protective systems had worked much better. Trading had been halted before the end of the trading day by the so-called circuit breakers put into place after the 1987 crash. Nonetheless, the fall worried us, in the context of large declines and growing market volatility at home and abroad, and had been receiving intense media attention throughout the day.

I was torn about whether to say something publicly. On the one hand, I did not want to be in the position of cheerleading the stock market, since that is intellectually dishonest, very unlikely to work, and potentially counterproductive with respect to confidence. On the other hand, the great nervousness and uncertainty in the U.S. financial markets seemed to call for a reassuring presence. Larry Summers, Alan Greenspan, Gene Sperling, and I decided, after much discussion, that I should make some statement. We didn't want or expect to affect the market's direction, but we did want to try to diffuse a panicky environment. Our hope was simply that whatever was going to happen would happen in a calm, orderly fashion, as opposed to what had occurred in 1987.

With Greenspan at the Treasury, the four of us spent more than an hour with other Treasury officials constructing a brief statement. It said that I had been in touch with other officials, that we'd been monitoring developments closely, and that these consultations indicated that market mechanisms, such as the systems for settling trades, were working effectively. The statement continued, “It is important to remember that the fundamentals of the U.S. economy are strong and have been for the past several years.” As a final note, we added that the prospects for continued growth with low inflation and low unemployment remained good.

The delivery of this statement was a dramatic moment. I walked down the steps of the Treasury Department and read the statement we'd worked out to a vast number of television cameras. Then I turned around and, ignoring the questions being shouted by members of the press, walked back inside. This was treated as a major news event; the networks broke into their regular programming to carry it live.

The next day, the stock market recaptured some of its losses, and the news media expressed a general view that my comments had served a useful purpose. Having somebody who is viewed as possessing some measure of credibility with respect to markets and economic matters speak in a calm and thoughtful fashion, even if he says nothing that is relevant to the immediate market phenomenon, probably does contribute positively to the psychology of a volatile situation. One advantage of avoiding frivolous market commentary is that one builds and maintains a credibility that can be drawn upon when it is really needed.

Given the remarkable rise in the Dow following Clinton's election in 1992, political people in the White House often wanted the President to take credit for the strength of the stock market. I argued that for Presidents to validate their policies by pointing to the stock market's performance was always a mistake. The stock market could fluctuate for all kinds of reasons and could overstate or understate reality for extended periods. I sometimes dissuaded Clinton's advisers by using the argument that if the President took credit for the rise in the stock market, he'd get the blame for the fall as well. Live by the sword, die by the sword.

   

BECOMING SECRETARY of the Treasury greatly increased my interaction with the Federal Reserve. At the NEC, I had always supported the Fed's independence with regard to monetary policy, and I continued to do exactly that at Treasury. The basic logic here is familiar: the head of a country's central bank has the job of acting countercyclically—prompting growth during economic slowdowns and constricting the money supply when strong growth threatens to produce inflation. The latter task is intrinsically unpopular. As the longest-serving Federal Reserve chairman in history, William McChesney Martin, famously said, the Fed chairman is the fellow who takes the punch bowl away just when the party is getting going. That's why the chairman should have a fixed term, which he does, rather than serving at the pleasure of the President. This helps insulate him from political pressure.

Before 1993, Presidents and Treasury Secretaries had sometimes opined on what the Fed should be doing with regard to interest rates and sometimes tried to lean on the Fed chairman in various ways. Bill Clinton, by contrast, always adhered to the principle of not commenting publicly on Fed policy. Whenever the contrary suggestion was made inside the White House, I argued that commenting was a bad idea for several reasons. First, and most fundamental, the Fed's decisions on monetary policy should be as free from political considerations as possible. Second, evident respect for the Fed's independence can bolster the President's credibility, economic confidence, and confidence in the soundness of our financial markets. Third, the bond market might be affected by any belief that the Fed chairman was under political pressure that could affect the Fed's actions. There was also another factor I came to recognize after moving to Treasury: we advised other countries around the world, such as Mexico during the peso crisis, that their central bank governors should be insulated from political pressure. Attempting to put political pressure on our own central bank could undermine that prescription.

Whatever a President's philosophy about publicly commenting on the Fed, every President probably complains about it privately from time to time. There's a natural tendency to second-guess any decision not to let the economy grow faster, especially when such a decision comes in advance of an election. Even with President Clinton, who respected the Fed's independence both in principle and in practice, behind-the-scenes discussions sometimes grew rather heated. In 1994, a few people in the White House suspected—totally wrongly—that Alan Greenspan, a Republican, might be raising interest rates more than necessary out of some kind of political bias. I responded that Greenspan seemed to me to be trying to extend the recovery by preventing the economy from overheating. That would ultimately benefit the President politically when he ran for reelection in 1996.

Greenspan's actions in 1994 were vindicated by subsequent economic developments. But such suspicions of political motivation, though not warranted in this case, leave nagging questions. What should be done if the Fed chairman is consistently wrong or ineffective or politically motivated, and who should make those judgments? We obviously never had to face those quandaries with Greenspan, but they have no easy answer.

At Treasury, my personal relationship with Greenspan also grew much more familiar. The Treasury and Fed staffs work closely together on a range of issues, despite what has historically been some degree of institutional competition. There is a tradition, maintained by Lloyd Bentsen before me, that the Treasury Secretary and Fed chairman meet on a regular basis. So I now got together with Alan at least once a week for breakfast either at my office or at his, and before too long Larry Summers also joined us.

Our discussions ranged all over the place. Sometimes we were dealing with issues of crisis, such as Mexico or Asia. Other times we would be preparing for one of the several different international meetings of finance ministers and central bank governors or considering some issue expected to arise in Washington. But many times, we simply debated and explored issues about the U.S. and world economies. These meetings were a cross between a graduate seminar in economics and a policy-planning meeting, with bits of gossip thrown in. We were looking at intellectually complicated issues in the context of immediate, practical issues and decisions. While these discussions were serious, they could also be very funny—assuming you shared Alan's taste for jokes about the yield curve.

One of the issues the three of us returned to again and again was the strong performance of the American economy. By mid-1996, the expansion was well established and still going strong. The growth rate was higher, and unemployment lower, than prevailing views would have said was possible without igniting inflation by putting upward pressure on wages and prices. People were throwing around the phrase “new economy,” suggesting that advances in technology had revised the familiar rules and limits. Some investors appeared to be falling prey to the timeless boom-era temptation to believe that the business cycle had been tamed, that companies would never fail in their earnings, and that the next economic slowdown would never come.

Yet amid such indicators of what Alan called irrational exuberance, real signs suggested that something had indeed changed for the better. With unemployment so low, a Fed chairman's normal instinct would be to raise rates to prevent inflation. But there were no signs of increased inflation. The question was whether—as Clinton had intuitively argued in our internal discussions in 1994—the American economy could safely grow faster than during the previous few decades. Though there was no real evidence at the time, Clinton's instinct turned out to be correct.

This apparent change in the so-called speed limit of economic growth strongly suggested that productivity growth—which had greatly slowed from the early 1970s through the early 1990s for reasons not fully understood—had now picked up again. Productivity increases work wonders on an economy, allowing faster growth without inflation. Understanding why productivity growth first faded and then apparently returned would help us estimate future growth and develop policies to promote it.

Most economists were initially skeptical about increases in productivity. But as time went on, Alan said that the data he was poring over didn't reconcile unless productivity was substantially higher than was generally thought. One of Alan's great strengths is his wide-ranging focus on data and his insight in drawing inferences from it. He'd show up at breakfast and ask what I thought about the latest railcar shipments of some type of wheat I had never heard of. “Alan,” I'd say, “I don't know how I missed that figure in the paper, but I did.” He would have worked out a whole hypothesis around it. Greenspan was the first of the three of us to reach the tentative conclusion that productivity growth did explain the absence of expected inflation. That meant that the speed limit on economic growth was higher than we'd thought. Larry and I followed in agreement somewhat later.

In my view, a critical factor in the return of productivity growth was the restoration of sound fiscal policy. That helped catalyze productivity-enhancing investment by contributing to lower long-term interest rates, increased business and consumer confidence, and greater foreign capital flows into the country. Another key factor was advances in technology, which raised an interesting question. Europe and Japan had access to the same technologies we did in the 1990s but did not experience increased productivity growth. I think the explanation for the difference lies in a third factor: America's cultural and historical disposition to take risks and embrace change. That inclination helped to explain why American companies invested much more heavily in new technologies than companies in other countries. A fourth factor, related to the third, was our more flexible labor market, which meant that companies could more readily benefit from productivity-enhancing investment, and our greater availability of risk capital. Japan and Europe were and are far less change oriented, more mired in structural rigidities, and shorter on risk capital.