- The Washington Times - Monday, September 5, 2005

Selection of the Federal Reserve chairman has become the president’s most critical financial appointment.

This hasn’t always been so. Even today, the treasury secretary outranks the Fed chairman. But the role of Fed chairman has grown dramatically in the post-World War II years and often overshadows the treasury secretary.

This reflects several key developments. The Fed gained considerable independence from the U.S. Treasury starting in the 1950s when the U.S. government agreed to market rate financing in issuing its new debt. Moreover, the dynamic growth of U.S. financial markets and globalization of markets put the Fed in the center of warding off systemic risks and moderating extreme business cycle fluctuations. Increasingly, it was also recognized a very flexible fiscal policy that quickly adjusted to economic requirements was unattainable.

It is also easier for the president to replace a treasury secretary than it is to force a Fed chairman’s resignation. A treasury secretary serves at the pleasure of the president. But a Fed chairman can be removed only by Congress.

Once in office, Fed chairmen usually gain a broad constituency and are viewed as somewhat above the political fray. So most presidents have scrutinized very carefully the economic and monetary philosophy as well as the political leanings of prospective Fed candidates.

Since the early 1950s, all new presidential appointments to this position were of the same political persuasion as the sitting U.S. president. Once in office, however, Fed chairmen often have been reappointed by a president from another party.

This does not mean Fed chairmen necessarily became captives of the near-term political objectives of the presidents who appointed them. President Harry S. Truman, who appointed Chairman William McChesney Martin, in a later moment of anger called Martin a traitor when the Federal Reserve did not provide adequate funds to finance a new Treasury issue at below-market rates. Martin also attracted the ire of President Lyndon B. Johnson for raising interest rates. Johnson reportedly scolded him: “You took advantage of me and I just want you to know that’s a despicable thing to do.”

Paul Volcker also showed considerable independence from his political mentors. It is highly questionable whether President Jimmy Carter, who appointed him, realized the vigor and tenacity with which the new chairman would attack the skyrocketing inflation ravaging the economy. But Mr. Volcker stood his ground, even during the subsequent Reagan administration, when he opposed the Fed Board’s politically popular proposal to lower the discount rate.

For selecting a new Fed chairman, there will be a premium placed on professional and political experience. Bill Martin had been head of the New York Stock Exchange, president of the Export Import Bank, and assistant to the U.S. treasury secretary. He was even the son of the president of the Federal Reserve Bank of St. Louis. His academic background included an undergraduate degree from Yale and studies toward a Ph.D. in finance at Columbia University.

His successor at the Fed, Arthur Burns, was chairman of the Council of Economic Advisers in the Eisenhower administration. Burns was the most renowned academician to have been Fed chairman, having gained fame at Columbia University for his expertise in business cycles. History, however, will not put Burns in the pantheon of central bankers. Despite his vast academic training and knowledge, his monetary regime failed to head off or break 1970s’ dangerous inflationary momentum.

Business experience alone does not make for a strong and effective Fed chairman. William Miller — who ran a diversified industrial company when named by Mr. Carter — demonstrated this. Miller was not equipped to grasp the intricacies or fundamental issues of monetary policy. He came to the Fed job when the economy and financial markets were under duress, and left them in even poorer condition.

Mr. Volcker, in contrast, seems almost born and raised to be a central banker. With an education at Princeton University and the London School of Economics, his career moved from economist at the New York Fed and the Chase Bank, to two stints at the U.S. Treasury, to president of the New York Fed, then to the Fed chairmanship.

His dedication to public service is well known. When he became Fed Chairman, Mr. Volcker immediately confronted the task of halting a dangerous inflationary spiral. He pursued this relentlessly, though few cheered him on. Fed monetary easing is always more popular than tightening.

Alan Greenspan brought considerable background, including a Ph.D. in economics and prominence as a private sector consultant, as chairman of the Council of Economic Advisers, and as chairman of a government committee that significantly reformed Social Security. During his Fed chairmanship, Mr. Greenspan has navigated the political waters, demonstrating mastery in maintaining unity within the Federal Open Market Committee while maintaining unprecedented public visibility. Time will tell how he will rank among those who preceded him.

And only with the passage of time will the markets feel comfortable with the new chairman. Given our highly entrepreneurial and integrated markets, the new chairman’s success will depend largely on an ability to “take away the punch bowl just as the party gets going,” in the prophetic words of Bill Martin many years ago.

Henry Kaufman is president of Henry Kaufman & Co., an economic and financial consulting firm, and author of the book, “On Money and Markets, A Wall Street Memoir.”


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