[Congressional Record Volume 140, Number 19 (Monday, February 28, 1994)]
[House]
[Page H]
From the Congressional Record Online through the Government Printing Office [www.gpo.gov]


[Congressional Record: February 28, 1994]
From the Congressional Record Online via GPO Access [wais.access.gpo.gov]

 
INTRODUCTION OF H.R. 28, THE FEDERAL RESERVE SYSTEM ACCOUNTABILITY ACT 
                                OF 1993

  The SPEAKER pro tempore. Under a previous order of the House, the 
gentleman from Texas [Mr. Gonzalez] is recognized for 5 minutes.
  Mr. GONZALEZ. Mr. Speaker, it is now abundantly clear in financial 
markets around the world--and it will become painfully clear to 
consumers all over America when they become priced out of the housing 
market or have trouble paying their bills because of rising interest 
rates--that the Federal Reserve acted with extreme malfeasance and 
tightened its vice grip on the American public when we needed it least.
  The Federal Reserve's recent actions have injured the Nation's 
economy and its ill-conceived notions will affect every one of us.
  According to an article in today's New York Times, the Fed is using 
its intuition to steer the Nation's economy. In other words, they are 
guessing that the economy needs an ice cold bath, even though no fever 
is evident. And the cover of this week's Economist has a large picture 
of Chairman Greenspan as a puppeteer pulling the strings of the 
administration with the headline, ``No wonder the markets are 
confused.''
  On Monday, January 31, Federal Reserve Chairman Alan Greenspan told 
the congressional Joint Economic Committee (JEC):

       A number of questions will have to be addressed by the 
     Federal Open Market Committee [FOMC]. Foremost will be when 
     is the appropriate time to move to a somewhat less 
     accommodative level of short-term interest rates.

  At the hearing, Chairman Greenspan also announced that the inflation 
rate for 1993 was far below the official 2.7 percent, below even 2 
percent and close to price stability. He agreed that the inflation rate 
was the lowest in nearly 30 years with the exception of 1 year, 1986.
  That was Monday. Three days later on Thursday, February 3, 1994, when 
the FOMC met in Washington, the Federal Reserve raised a short-term 
interest rate it had been keeping at 3 percent. Uncertainty shot 
through the bond markets although most experts speculated that the Fed 
would return to the 3 percent target it had held for over a year. But 
the next day, the Federal Reserve announced it would target a slightly 
higher rate of 3.25 percent.
  Chairman Greenspan's ambiguous language was quickly followed by 
equally confounding explanations from other Federal Reserve Governors 
and bank presidents. This left bond markets throughout the world in a 
state of panic because they were second-guessing each other while 
trying to decipher all the inscrutable rhetoric.
  On Sunday, February 20, 1994, The Atlanta Journal and Constitution 
carried a story with the headline, ``Fed Official's Comment Causes Rate 
Turmoil'' which recounts the previous Thursday's confusion:

     in the middle of the day, the Fed's Jerry Jordan [president 
     of the Cleveland Federal Reserve Bank] reportedly said the 
     Fed had backed away from a policy that would help keep rates 
     down. Jordan also said low rates and low inflation are here 
     to stay. The financial markets, which were already on edge, 
     seized on his comments as meaning the federal funds rate was 
     going to go up again soon.

  The panic the Federal Reserve started in bond markets caused long-
term interest rates to rise from 6.23 percent on January 31, 1994, when 
Chairman Greenspan made his vague threats about taking action at some 
unforeseeable future time, until they reached 6.75 percent on February 
24, 1994.
  Had the Federal Reserve announced a one-time move and flatly stated 
that was all for the foreseeable future, they may have at least avoided 
the extreme uncertainty that started to collapse world-wide bond prices 
and raise interest rates.
  It's time for this policy of obscuration to end. I urge the Fed to 
clearly state its intentions rather than trying to persuade us that 
nothing is happening when just the opposite is true. There is 
absolutely no reason to raise interest rates and even less reason to 
inject panic and uncertainty into bond markets. Chairman Greenspan's 
Fed-speak, which says little but causes everyone to guess which way the 
economy is heading, results in an onslaught of panic attacks up and 
down Wall Street and around the world as traders try to decipher what 
the Nation's monetary monks are really pushing. Are they putting the 
brakes on? Are they refilling the gas tank? Or are they lost without a 
map? No one knows, because the real policy has not been answered.
  My bill, H.R. 28, the ``Federal Reserve System Accountability Act of 
1993,'' would require Federal Open Market Committee members to disclose 
their monetary policy decisions promptly. H.R. 28 also requires that 
within 60 days of the FOMC meeting, the Fed release a detailed record 
of their decision because their actions affect the employment and 
purchasing power of every American. They should be individually 
accountable. The bill also calls for the General Accounting Office 
[GAO] to examine substantial parts of Federal Reserve operations which 
are now restricted from inspection.
  These provisions would force the Federal Reserve to be more 
accountable to the public. If its every move were scrutinized, the 
public would learn in advance that the Fed was trying to pull the wool 
over its eyes. With a decent public record, the markets would work 
better, and we'd know for sure if the Fed is driving the economy over a 
cliff or actually has a road map it can read.
  Madam Speaker, I include for the Record the article referred to in 
the issue of February 26, 1994, in the Economist.

                      No Wonder They Are Confused

       ``Come, children,'' wrote Thackeray, ``let us shut up the 
     box and the puppets, for our play is played out.'' If only 
     such advice were heeded in Washington, DC, for in that city 
     of budding economic puppeteers a play is under way that could 
     determine the course not only of the American economy but 
     also of economies elsewhere. For determine read damage, for 
     this is a play that is generating, and risks worsening, the 
     most harmful of all feeling sin the great audience of 
     financial markets and ordinary companies: confusion.
       At almost any moment in any economy some confusion is 
     unavoidable. Information even abut recent economic trends is 
     patchy and unreliable; information about the future is 
     nonexistent, and thus uncertainty about what might, or might 
     not, happen is ever-present. But one variable, at least, is 
     capable of clarification. That variable is the government's 
     use of the limited number of economic instruments at its 
     disposal. Those instruments--principally interest rates, 
     taxation and spending, and trade regulations--do not control 
     the economy but they do influence it, sometimes mildly and 
     sometimes powerfully. It is the direction of that influence 
     that is currently at issue in America, not overtly but 
     covertly. And the confusion is arising because different 
     puppeteers appear to want to use different instruments to 
     achieve conflicting ends.


       the anti-inflation policy that provoked fears of inflation

       On February 4th, when Alan Greenspan, chairman of America's 
     Federal Reserve, surprised everyone by raising short-term 
     interest rates by a quarter of a percentage point, the first 
     rise in official American rates for five years, the message 
     ought to have been clear. There was not yet any firm evidence 
     of a revival in inflation, but the Fed felt that the 
     experience of previous recoveries was that if you wait until 
     inflation punches you in the nose, the subsequent fight 
     (i.e., monetary tightening) will have to be nasty. This time, 
     the Fed seemed to say, we are determined to maintain price 
     stability without a bloody nose.
       Such a move should have reassured financial markets--
     particularly those for government bonds, since expectations 
     of future inflation play a big role in setting bond yields. 
     The Fed's new determination ought, in other words, to have 
     resulted in a fall in yields. The opposite has happened, not 
     just for American bonds but also for those in Western Europe 
     and Japan. Yields have risen (and prices have fallen) ever 
     since the Fed made its move, and equities fell sharply on 
     February 24th.
       Why? One answer, popular among market pundits, is that 
     investors now believe that the Fed knows something they 
     don't, and that that something is that inflation is about to 
     accelerate. But this is implausible. Central bankers' 
     knowledge about future inflation is no better than anybody 
     else's: it consists of guesswork based on publicly available 
     statistics, and on models, sophisticated or otherwise, of 
     past relationships. The only thing a central bank knows more 
     about than the markets do is its own attitude, which is why 
     evidence of a tougher attitude ought to have been reassuring.
       A better answer is that the Fed's policy is only part of 
     the story. Central banks always disagree with politicians 
     about inflation; that is their job. When Mr. Greenspan made 
     his move, the White House and Treasury were shocked. Quite 
     rightly, they had not been informed; quite rightly, they put 
     a brave face on the matter. It is no surprise that they 
     disagree with such early tightening. But the surprise has 
     been that their words since February 4th not only make that 
     disagreement clear, but also threaten to subvert the 
     tightening itself.
       Chief among those subversive words and actions has been the 
     administration's policy on trade. A week after the monetary 
     tightening, America threatened trade sanctions against Japan. 
     That would have been unsettling enough for financial markets 
     and businessfolk, since a trade war would certainly depress 
     growth in America and elsewhere, though it would not 
     necessarily be inflationary. But alongside those threats also 
     came hints that some administration officials favour a weaker 
     dollar, and are not worried that this could boost inflation.
       That is not a direct confrontation with the Fed. After all, 
     the Fed, not the administration, controls interest rates, 
     which are the only effective means of influencing the 
     dollar's international value in the medium term. Yet connect 
     it with the next fact and it becomes worrying: two of the 
     Fed's fiercest opponents of inflation, David Mullins and 
     Wayne Angell, have recently resigned from the board of 
     governors, and Mr. Greenspan himself has only two years of 
     his term to run. In his semi-annual report to Congress on 
     February 22nd Mr. Greenspan appeared to acknowledge worries 
     about the loss of Mr. Angell by stressing that he, too, 
     favoured one of Mr. Angell's favourite inflation-spotting 
     tools, the gold price. No matter: the Clinton administration 
     has a chance to appoint three new governors, perhaps more to 
     its taste than the old ones. One candidate for Mr. 
     Greenspan's job is likely to be Larry Summers, the Treasury's 
     top official for international affairs (see page 32).
       All this means that the markets are right to think that 
     policy makers in the world's largest economy are in a tangle: 
     some want to be tough on inflation, some want to be tough on 
     Japan, some want a weaker dollar, some want to raise public 
     spending (and perhaps taxation) to pay for reform of 
     America's health care. These things cannot all be done at 
     once. And in the case of the currency there is the added 
     complication that other countries are unlikely to co-operate.
       Japan does not want a stronger yen, for its recession is 
     deepening. Germany does not mind a strong D-mark, but since 
     its Bundesbank is trying to lower interest rates while the 
     Fed is raising American ones, the opposite is likelier to 
     transpire. When finance ministers from the seven big 
     industrial countries meet this weekend, they will doubtless 
     discuss all this and may even produce a communique calling, 
     as usual, for greater policy co-ordination and free holidays 
     for all. But it will mean nothing until the confusion at the 
     heart of American economic policy is removed. With the 
     American economy now enjoying strong growth, with Britain 
     tagging along behind, and with some signs that even Western 
     Europe's economy may at last be picking itself up off the 
     floor, it is the sort of time when governments ought to be 
     able to help rather than hinder. But they cannot resist 
     tugging at the strings.
                                  ____


                        The Riddle of the Bonds

       Bond-buyers on both sides of the Atlantic are panicking. 
     America's fear higher interest rates and faster inflation. 
     Europe's have little reason to turn tail.
       Not even the carefully chosen words of Alan Greenspan, 
     chairman of America's Federal Reserve Board, have convinced 
     investors that the six-year-long bull market in Treasury 
     bonds is not heading for extinction. In his testimony before 
     a congressional committee on February 22nd, Mr. Greenspan 
     suggested that further increases in interest rates were 
     likely but hardly imminent; there was little evidence, he 
     said, that inflation was accelerating. The bond markets 
     believed him for a bit and, forgetting its massive sell-off 
     of February 18th, moved the price of long-dated Treasuries 
     higher. But he proved king for only a day: over the next two 
     days, the long bond fell again.
       Such unease makes a certain sense in America, where 
     stronger-than-expected economic recovery provided the 
     backdrop for the Fed's first tightening of monetary policy in 
     five years on February 4th and the dollar's weakening against 
     the yen has made dollar-denominated assets less appealing. 
     The puzzle is Europe. Bond prices there plummeted on February 
     24th--as did equities--having already fallen earlier in the 
     week. Few markets can have failed so spectacularly, and so 
     quickly, to live up to earlier expectations.
       At the end of last year European bonds seemed certain to 
     shoot skywards. The heady mixture of low inflation, slow 
     growth and declining interest rates looked irresistible. No 
     matter that America's strengthening economy was unnerving its 
     Treasury bonds. Though European bonds had tracked them 
     closely for most of 1993, the markets seemed likely to become 
     detached in 1994. As inflationary pressures subsided in 
     Europe (especially in Germany), the next movements in 
     interest rates would be downward, so bond markets there would 
     rise.
       Like most dead certs, this one fell at the first fence. 
     American and European monetary policies have diverged, as 
     expected: an increase of a quarter of a percentage point in 
     America's federal funds rate on February 4th was followed by 
     small cuts in Britain, France and Belgium and by a half-point 
     cut in Germany's discount rate. Bond markets, however, have 
     stayed together. The yield on ten-year German government 
     bonds (Bunds) has risen to well over 6%--an increase of more 
     than a quarter-point in February alone. Indeed, since the 
     start of this year German bond prices have fallen even 
     further than America's. And the yields on German Bunds, which 
     set the floor for long-term European rates, have risen faster 
     than those in Europe's other government-bond markets. Why?
       Foreign--particularly American--investors have been dumping 
     Bunds, and they have plenty to sell. Last year foreigners 
     scooped up DM163 billion ($94 billion), or 70%, of Germany's 
     net new issuance of government and government-guaranteed 
     bonds. That was roughly double the amount they had bought in 
     1992. German investors buying through Luxembourg accounted 
     for some of the foreign purchases, but probably not much more 
     than 5%. Genuine foreigners concentrated mostly on long-term 
     federal bonds, buying half of those issued last year.


                           on second thoughts

       Their change of heart this year was prompted by two things. 
     The first was growing disappointment over the glacial pace at 
     which the Bundesbank is cutting short-term interest rates. In 
     January the three-month German interest-rate futures contract 
     on London's futures market sold at a price which predicted 
     that interest rates would drop to 4.5% by September. Now it 
     predicts that rates will have fallen only to 5% by then.
       German inflation and money-supply growth have remained 
     stubbornly high. Although the Bundesbank admits that these 
     figures are distorted, it has been slow to lower its most 
     important interest rates. The repo rate--at which the 
     Bundesbank promises to repurchase securities from banks--has 
     been stuck at 6% since December 2nd. That has had profound 
     implications for bond investors. The repo rate, by defining 
     the short-term cost of money, determines how much those who 
     borrow to finance purchases of government bonds must pay to 
     do so (most American hedge funds, for example, pay at least a 
     quarter-point more than the repo rate).
       Since the repo rate has been higher than longer-term rates, 
     investors who borrow have had to pay more on their loans than 
     they were collecting in interest on their bonds. They were 
     willing to do that as long as they expected borrowing costs 
     to decline quickly or, more importantly, the price of bonds 
     to go up, as they did from 1990 until 1994. But the snail's-
     pace fall in short-term rates has made investors increasingly 
     nervous about incurring running losses, or ``negative 
     carry'', on their bond investments.
       The second reason for investors' change of heart was 
     concern at the downward drift of American Treasury prices in 
     January. Though there is no reason why the two markets should 
     move in tandem, with little more than speculation about 
     domestic interest-rate movements to divert them, investors in 
     European bonds have been transfixed by the actual movement in 
     American prices.
       Those who leveraged their European bond positions, either 
     by borrowing to buy in the cash market or (more often) of 
     loading up on futures, have been especially worried by 
     persistent ``negative carry'' and wavering bond prices. Both 
     hurt more when positions are leveraged. So hedge funds and 
     the proprietary trading desks of American investment banks, 
     in particular, have been selling, mainly through the futures 
     markets; daily trading volumes in ten-year Bund contracts in 
     London are running this month at twice their average last 
     year.
       As foreigners retreat, domestic investors have not stepped 
     in to buy German's cheapening government bonds. They have 
     better alternatives, for one thing. These include bank bonds, 
     which offer yields 50 basis points higher than those on 
     Bunds; at the start of 1993 the spread was three basis 
     points.
       And bonds have become less attractive to German investors 
     since the tax authorities started to crack down on tax 
     avoidance. Many domestic investors dodged the 30% withholding 
     tax imposed in 1993 on interest payments by setting up 
     Luxembourgh bank accounts. In January 1994 the taxmen started 
     to investigate Dresdner Bank for allowing clients to do it.
       Despite all this, European bond prices are still more 
     likely to move up than down. Once investors' current bout of 
     nerves has calmed, the Bundesbank's slow easing should boost 
     bonds. Most economists expect both consumer-price inflation 
     and money-supply growth to fall in Germany this year. By 
     cutting its discount rate, the Bundesbank has signalled that 
     it wants interest rates to fall further. If money-supply 
     figures due to be released on February 28th show less growth, 
     it may decide to cut the repo rate, too. European bonds might 
     then, belatedly, live up to expectations.
                                  ____


                       Debunking the Yellow Peril

       Like Arab investors' alleged speculation in gold, it is one 
     of the financial world's old chestnuts. When yields on 30-
     year Treasuries rose to 6.64% on February 18th (up from their 
     low of 5.77% in October), Wall Street worried that the 
     Japanese were dumping the bonds in retaliation for America's 
     threatened trade sanctions. What a waste of worry.
       First, the Japanese no longer hold anything like as many 
     Treasury bonds as they once did. They owned $106 billion-
     worth at the end of 1992, according to the latest Federal 
     Reserve data, only about 3% of the total outstanding.
       Second, America no longer needs to rely on foreigners to 
     finance its budget deficit, for during the 1990s the deficit 
     has fallen and domestic savings have become available. Edward 
     Hyman, chairman of New York-based International Strategy and 
     Investment, says that borrowing by government, companies and 
     consumers rose by more than $900 billion a year in the mid-
     1980's. In 1993, however, it increased by only $575 billion. 
     Meanwhile their savings has risen from $600 billion a year in 
     the mid-1980's to around $800 billion last year, resulting in 
     net savings of about $225 billion. True, much of it is 
     financing investment (one reason that the OECD expects 
     America's current-account deficit to increase this year). But 
     if bond prices are attractive, there is money at home to buy 
     them.
       That point may now be at hand. Mr. Hyman reckons that 
     underlying inflation will be 2% this year, which means that a 
     30-year bond offers a respective real yield of 4.5%. Such a 
     return might also appeal to Japanese investors, who currently 
     receive a nominal yield of only 3.5% at home (though prices 
     there may actually fall this year). Another reason to be 
     bullish is that most professional money managers are bearish. 
     Less than a third of bond-fund managers think bond prices 
     will rise, according to a survey published by Market Vane on 
     February 22nd.
       Still, the surprise is that yields have risen as far as 
     they have, given the lack of any real inflationary pressures. 
     One explanation is that the ubiquitous trend-following hedge 
     funds have sold the market short in recent months. In an 
     attempt to make up the considerable losses they have 
     sustained elsewhere, however, they will probably now cover 
     their profitable shorts by buying Treasury bonds. Who needs 
     the Japanese.

                          ____________________