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January 18, 2009
David Warsh, Proprietor


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Looking Forward: a Semaphore

Here at the outset, let’s set out a possible goal for the US Treasury. Nobody forecasts eight years ahead. Yet in terms of human aspiration, of planning, of envisaging the state of affairs to be brought about, of considering which paths to follow (and those to avoid), that span of years is no time at all. So what’s the best we dare to hope for by the beginning of 2017, if Barack Obama serves eight years as president and proves to be a steady hand at the helm?

 

Could the nation find itself in the happy situation that obtained eight years ago, with the federal budget in surplus?  The entries, that is, on the present unified ledger – never mind the off-budget obligations of Social Security and Medicare. Even with bringing into balance those entitlement programs, much progress probably could be made.

 

Why not? Granted, the massive stimulus now in the works is going to make the hole that much deeper. But as far as taking office in the vicinity of a recession, it’s déjà vu all over again. All three of the last two-term presidents – Ronald Reagan, Bill Clinton and George W. Bush – have taken office in or just before or after an economic downturn. Each blamed the hard times on his predecessor and claimed the recovery as his own, with varying degrees of success.

 

In 1993, Bill Clinton’s economic team inherited a situation similar to today – less severe, certainly, but bad enough. At 7.8 percent, the jobless rate in June 1992 was higher than it was last month — 7.2 percent. (Unemployment is expected to hit 8.0 percent this year.)

By the end of the 1990s, the federal deficit had been eliminated.  The rubbed-raw focal point of acrimonious debate throughout the 1980s simply disappeared. Much adroit maneuvering had been required, especially in 1995 and 1996, when the White House and the Republican-controlled Congress engaged in a prolonged spell of brinkmanship, including two short-lived episodes in which government employees were sent home.

 

But the macroeconomic results were inarguable:  low inflation, falling unemployment, rising productivity by the end of the decade and, thanks partly to capital gains taxes stemming from the stock market boom, soaring tax receipts. Alan Blinder, of Princeton University, and Janet Yellen, president of the Federal Reserve Bank of San Francisco, both former Fed governors who also had a hand in producing it, summed it up as “the Fabulous Decade” in a little book that appeared in May 2001.

 

A key architect, perhaps the key architect, of the technical success, which continued the fiscal tightening that had begun in 1990 and combined it with a loose monetary policy carefully negotiated with the semi-independent Federal Reserve Board, was, Lawrence Summers, protégé throughout the Clinton years of Robert Rubin, the former Goldman Sachs executive who served a director of the National Security Council, then as Treasury Secretary, before turning the job over to Summers in 1999 – the same Larry Summers who is now heading the National Economic Council, with an office in the West Wing of the White House. So why not balance the budget again?

 

To put is slightly differently: has the Starve-the-Beast (or Two Santa Claus) strategy that dominated Republican Party thinking for much of thirty years been discredited as an electoral strategy?  Probably so. Big deficits, perpetuated by frequent tax cuts, designed to serve as a straitjacket with which to restrict government spending were an explicit centerpiece of presidential policy under George W. Bush.

 

Granted, Bill Clinton faced a different set of problems with a different kind of team in the ’90s. Former Democratic vice-presidential candidate Lloyd Bentsen, as Treasury secretary for two years, and Rubin together smoothed the rough edges off Summers’ plans and manners.  They enjoyed good relationships with Fed chairman Alan Greenspan. Especially important were two major new developments in the real economy, the rapidly growing US interdependence with the Chinese economy and the Internet boom.

 

But the skills that Summers developed then – caucusing among the many interested parties in order to devise acceptable and productive policies – are potentially even more valuable today.  Market participants, experts, regulators, counterparts of every sort in other countries:  all must be consulted and kept informed.

 

This president, too, has a good team shaping up, with Timothy Geithner at Treasury, Christina Romer at the Council of Economic Advisers, Peter Orzag at the Office of Management and Budget, and former Fed chairman Paul Volcker hovering in the wings as a special adviser. Obama is much less likely to provoke the same antagonism as did Bill Clinton.

 

And it is entirely possible there will be another good leg of international development in the years ahead, though the teens seem unlikely to be as wild and wooly as the decade that followed the end of the Cold War. Growth, when it resumes later this year or early next, will proceed slowly for many quarters. Remember the famous “jobless recovery” from the ’90-’91 recession?

 

So here, at the beginning of things, it is important to raise a semaphore. There is one thing President Obama ought to rule out.  He should not switch Fed chairmen when Ben Bernanke’s term expires in January 2010.

 

More to the point, he should not seek to appoint Summers to the position, even though Summers’s desire for the job is “thinly disguised,” according to Financial Times Washington bureau chief Edward Luce, who also happens to have been Summers’s Treasury Department speechwriter in 2000-2001.  It is a bad idea on several grounds.

 

For one thing, a failure to reappoint Bernanke would undermine the central principle of central bank independence – a hazy enough concept to outsiders, but one that market participants know well, especially when they don’t see it. True, the former Princeton professor and one-time Bush adviser had a rough start, but settled down and he has performed admirably under pressure.

 

For another, Summers probably wouldn’t be very good at the chairman’s job, for all of his technical acumen and love of spirited argument. His five-year stint as president at Harvard showed him to be ill-accustomed to the exercise of the sort of soft power that is the essence of leadership at the Fed. The very way he has returned to Washington, bruiting about his desire to turn the incumbent out of his job, suggests a bull who still hasn’t learned about china shops.

 

Finally, Summers probably couldn’t be confirmed by the Senate – not this autumn, anyway. The nature of his failure at Harvard are too little understood; his role in the US embarrassment over the university’s failed advisory mission in Moscow in the ’90s too little examined. A messy battle is the last thing the administration needs or wants next autumn. (Would monetary policy expert Christina Romer fare any better after a few months as chair of the Council of Economic Advisers?  Probably not; she’s just too new on the job to be a serious candidate in this thundery situation.)

 

There is nothing abstract about these calculations. The matter of Bernanke’s reappointment will be coming to a head by July, when leaders of the Group of Eight industrialized nations meet in La Maddalena, a town in northeast Sardinia, where Italian Prime Minister Silvio Berlusconi will be host. Economists who follow central banking closely are already parsing the matter, very carefully, and only among themselves. If the decision is taken to move Bernanke out, they’ll be ever more thoroughly ventilated.

 

What is the alternative?  Summers is not just highly talented. He hankers for redemption after his bruising experience at Harvard. Yet it is possible that he is already in exactly the right place, as principal economic counselor to a president who probably has much to teach him in return.  As the Talking Heads’ David Byrne put it once, “The laws of chance, strange as it seems/take us exactly where we most likely need to be.”

 

Suppose that Summers decides to stay where he is for a few years?  Recommends the reappointment of Bernanke and actually runs the Economic Council, where department and agency heads meet regularly to coordinate their policies and plans? Perhaps puts some of his abundant energy into writing a book about this new economic era? Relaxes and enjoys Washington, where he is clearly at home?

 

It’s not the sort of job where you get your portrait painted. But then Summers portrait already has been painted twice. To serve for a time as its eminence grise would be a pretty good way to enter history, if this administration were to live up to anything like its advance billing. There’s the chance that sustained good behavior would earn him the job at the Fed in 2014, when Bernanke’s second term would be up; Summers would only be 59. And if he were to write that book well enough, he could earn the title in the wider world that Obama recently bestowed on him, and become “thought leader” to a generation.

 

                                        *****

 

Enough people have asked so that I should explain to those who haven’t:  I am no relation to Federal Reserve Board governor Kevin Warsh.  I never heard of him before he was appointed in 2006, and he probably never heard of me.

 

He’s been doing a good enough job to be prominently mentioned, along with fellow governor and Fed vice chairman Donald Kohn, as a possible successor to Tim Geithner as president of the Federal Reserve Bank of New York.  So related or not, I am proud of him.

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