In an Uncertain World (26 page)

Some saw a tension between my basic stance in favor of a strong dollar and our action on rare occasions to spur a market correction of what seemed an undue rise in the dollar against a particular currency. But when we took this action, we were operating within the context of our strong-dollar policy. I was skeptical about the efficacy of currency “interventions” per se—that is, of governments trying to influence the exchange rate of a currency by buying and selling large quantities in the open market. My experience with foreign exchange markets at Goldman Sachs led me to believe that trading flows were simply too vast for such interventions to have more than a momentary effect, except in very unusual circumstances. Basically, currency levels reflect the market's expectations—and the realities—of a country's fundamental economic situation relative to the economic fundamentals of other countries: fiscal conditions, interest rates, inflation, and growth.

In any case, whatever my views were about whether the dollar at any given moment was too strong or too weak relative to economic fundamentals, I virtually always said exactly the same thing: “A strong dollar is in our national interest.” A lot more thought went into that small phrase than was evident from my boring repetition. The repetition reflected not only my belief in a strong dollar, but also my belief in leaving markets to market forces. The slightest shading, such as going from “I believe a strong dollar is in our national interest” to “I believe it's in our national interest to maintain a strong dollar” could have market effects, even if no change in view was meant.

At press conferences at home or on the road, reporters from financial publications would try to engage me in a cat-and-mouse game. They would ask the same questions about the dollar and the stock market again and again, each time with some new twist, hoping to elicit something different from my standard response—a response that was always true on its own terms but not necessarily a complete answer relative to the circumstances at any given time. I had said a strong dollar was in our national interest when one dollar could buy 120 yen. Now the yen was at 130—was the stronger dollar better? How strong was too strong? Wire service reporters kept their cell phones on to broadcast my remarks directly to their news desks, in case I disgorged some unexpected nuance. But I became very adept at simply repeating my mantra—except in those rare instances when we deliberately used a slight shading, always built around commitment to a strong dollar, to convey a message. For example, my saying “A strong dollar is in our national interest, and we have had a strong dollar for some time now” created great excitement at a press briefing, as it was construed to mean that we wouldn't mind seeing the dollar remain strong but soften somewhat. However, I would never give any explanation for such a change beyond my prepared phraseology.

A good illustration of how sensitive markets can be is what happened when I was testifying before the Senate Finance Committee in June 1998. At that point, the Japanese yen had fallen to 141 to the dollar, its lowest level in eight years. The weak yen seemed to have reached a troubling extreme and was exacerbating our trade deficit by making Japanese imports cheaper in the United States and American exports more expensive relative to Japanese products in overseas markets. Of even more urgent concern at that moment was that the falling yen could worsen the economic crisis that had then been afflicting Asia for nearly a year, by putting pressure on the currencies of the troubled Asian countries and by motivating China to devalue its currency. When Senator Frank Murkowski asked me about the possibility of U.S. intervention to support the yen, I said that intervention was “a temporary tool, not a fundamental solution.” Weakness in Japan's currency, I said, reflected the underlying weakness in Japan's economy. In order to raise the value of the yen, the Japanese would have to address their fundamental economic problems.

That was all correct, but in focusing on Japan, I mistakenly discussed intervention in an intellectually serious way. Larry, who was sitting next to me, passed me a note that read, “Bob—Yen has moved to 143.20 in last 15 minutes. I think we need a little more saber rattling.” In other words, the foreign exchange markets were interpreting my remarks to suggest I had made the possibility of intervention to support the yen less likely, and were selling yen against the dollar. In fact, my policy views had not changed at all: I was never enthusiastic about currency interventions, but I didn't rule them out as an occasional tool.

After reading Larry's note, I hastened back to my normal level of opacity, offering the clarification that I didn't want anyone to infer that I was suggesting that intervention was not an appropriate tool to affect the short-term direction of currencies. “We have often said in the past, Mr. Chairman, that we will intervene when appropriate and not intervene when it's not appropriate, but it is always a tool that is available for the kinds of impacts that it could have.”

This was not especially useful guidance, a point Senator Moynihan picked up on immediately. “And you will always know when it is appropriate and when it is inappropriate?!” he interjected.

But my clarification was unavailing. The yen continued to fall that day, to 144.75 to the dollar. We hadn't adjusted our policy on the yen-dollar relationship or on currency intervention in the slightest. But currency traders were reading nonexistent meaning into my comments, even after I said that I hadn't meant what they'd thought I'd meant. An episode like that demonstrated the value of discipline and, on exchange rates, of avoiding interesting discussions and sticking to carefully wrought stock phrases.

Having said all that, currency intervention can make sense on rare occasions. Just a few days later, with the yen continuing to fall against the dollar, I felt the conditions that can make a currency intervention effective might well be present. The first was that the yen-dollar exchange rate, now at 147 yen to the dollar, seemed to have gone to a real extreme—the yen was approaching free fall. American manufacturers, who were always worried about the level of the dollar, were becoming truly alarmed. The second condition was that the intervention would be supported by policy changes. Japanese officials were prepared to make a series of statements supporting economic reforms we were encouraging, such as closing insolvent banks. (Whether they would follow through with such promises was another question, but their going on the record seemed like progress.) The final condition was the psychological element of surprise. If the markets expected you to act, that would already be reflected in market positions and prices and tend to vitiate the impact of the action. My well-known bias against currency intervention—and even my unintentionally direct Senate hearing remarks—were helpful here. For this kind of move to be successful, surprising the market can be key.

But despite propitious conditions, I still felt that the odds of success might not be good enough to warrant intervention. Alan, Larry, several top Treasury officials, and I debated the pros and cons at length. Japan's economic slide urgently required economic reform that the government seemed unable to accomplish. How much reform commitment had to accompany the intervention for the market to react? And I was concerned, as usual, about the effect that an unsuccessful intervention might have on our credibility. But Larry and Tim Geithner made a strong case that intervening in support of the yen was a risk worth taking, largely because of what was happening elsewhere in Asia. After many, many hours of discussion, they persuaded me.

That decision illustrates another point about decision making. While keeping your choices open for as long as possible—a proclivity of mine that Larry termed “preserving optionality”—is desirable, the markets don't wait for you. As we continued our discussion into the early evening, in the Far East the new day was under way and we had to decide before the Tokyo markets opened. When the markets opened the next morning in New York, we would be too late. So rather than continuing our deliberations in the hope of new information or new insights, I had to make a decision without further delay.

In this case, the intervention worked—which is to say that the psychology of the foreign exchange markets was clearly affected. When the Federal Reserve Bank of New York, which acts as the Treasury's agent in the foreign exchange markets, converted $2 billion into yen, currency traders were caught by surprise and the exchange rate moved all the way back to 136 yen to the dollar. Although the larger issues related to Japan's economic weakness remained, the yen never again reached the lows of that summer. We intervened very seldom, and each of our interventions was successful.

   

ANOTHER CONSTANT FACTOR in the life of a Treasury Secretary is the stock market. As my time at Treasury went on, my personal view was that excesses were probably building. The U.S. bull market had begun in 1982. By the second half of the 1990s, investors were asking much less of a risk premium for investing in equities than they had historically. People had come to believe that stocks would bounce back reasonably quickly from any decline, as they had from the sharp drop in October 1987; that stocks always outperform bonds over the long term; and that stocks involve minimal risk if you hold on to them. The proliferating financial news on television and book titles such as
Dow 36,000,
published when the Dow was around 11,000, exuded financial market euphoria. The attitude of people who grew up in the 1980s and '90s was the mirror image of people I had known who grew up during the Depression. Whereas many people of my parents' generation never lost their wariness about investing in the stock market, many people of my generation and younger were equally conditioned toward complacency.

My view was that nothing had changed to reduce the substantial risk that has always been associated with stocks. From the last day of 1964 to the last day of 1981, the Dow Jones Industrial Average fluctuated a great deal, but the closing price was roughly unchanged—meaning it had declined substantially when adjusted for inflation. We were now in the midst of a bull market of similar duration that could potentially be followed by a long period of underperformance. In Japan, in admittedly different circumstances, the Nikkei average lost roughly three quarters of its value between 1989 and 2003.

Many new investors weren't knowledgeable about stocks and were investing based on theories that were oversimplified and, at worst, simply incorrect. Take the popular hypothesis that stocks outperform bonds over the long run. This has been true historically, though the assumption that the future will resemble the past remains exactly that—an assumption. Moreover, stocks might have ceased to be undervalued in relation to bonds once investors became aware of the phenomenon and priced it into the market. Leaving that issue aside, what's true of market aggregates is not necessarily true of any one portfolio, which is subject to the performance of particular companies. A preference for stocks in general doesn't help you understand valuation or choose investments wisely. Moreover, while buying stock index funds and holding shares for a couple of decades or longer may provide a good likelihood of a distinctly higher return than bonds, history also indicates that markets can provide subpar returns for lengthy periods. Even if the stocks-versus-bonds thesis is correct, not all investors have a time horizon of sufficient duration to benefit from what might be a very long run—for example, if you're planning to retire on your savings in five or ten years or don't have the psychological staying power to withstand a long drought. All of this was relevant—but ignored—in the subsequent political debates, at the height of the bull market, about reforming Social Security by creating individual equity accounts.

As it seemed more and more likely that stock prices were excessive—and that the NASDAQ was almost manic—I became increasingly concerned that a sudden return to historical valuation levels could do harm to the economy. My considered view was never to say anything about the level of the stock markets, but with possible serious overvaluation posing larger risks to the economy, was there anything I could do about it? Alan, Larry, and I talked about this issue as the Dow broke 5,000, 6,000, 7,000, 8,000, and 9,000. Warning off the investing public might have seemed tempting, but I thought, and still think, that public officials ought not to comment on the level of the stock market—and that applies when stocks seem undervalued relative to historical trends, just as when they appear overvalued. A Treasury Secretary serving as a market commentator and hoisting a green, red, or yellow flag depending on his current view is a genuinely bad idea for four reasons. First, whatever our opinions might be, nobody can say what the “correct” level of the stock market is—or whether the market is overvalued. My personal alarm bells started ringing thousands of Dow points below the peak, and I know very shrewd people who were bearish at many points during the great bull markets of the 1980s and '90s. Having been wrong then, I was reminded that I could well be wrong now.

Second, I think any comments I made probably wouldn't have had any effect. An object lesson occurred on December 5, 1996, when Alan Greenspan posed a rhetorical question in a speech: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions . . . ?” I'm not sure Alan was even intending to express a view about stock prices. But markets thought the “irrational exuberance” phrase was deliberate and the Dow declined the next day, from 6,437 to 6,382. Then the bull market resumed its run—for another 5,000 points. The only lasting effect of Alan's comment was to win him a probable future entry in
Bartlett's Familiar Quotations.

Third, I believed that attempts to influence financial markets through words not only would be ineffective but would harm the credibility of the individual making the effort—because knowledgeable people will understand that he has no special insight, and because he'll almost surely be wrong a good bit of the time. By undermining the credibility of policy makers, such attempts could erode confidence and damage the economy itself. Finally, a gradual decline of an overvalued stock market can be readily absorbed. But if an official's comments, for whatever reason, precipitated a rapid and substantial market decline, that could be economically disruptive.