Even if he did not plan it this way, Federal Reserve Chairman Alan Greenspan is still brilliant.

Over the past two years, Greenspan and company have pulled off a breathtaking monetary policy coup. The process has been so successful that it is hard to believe Mr. Greenspan could have foreseen all of the pieces of the puzzle fitting so neatly into place.

Of greater significance, the Fed may have established a situation where rising interest rates could lead to recovery.

Brink of Disaster

U.S. banks stood at the precipice of disaster in January 1991, shortly after the failure of Bank of New England.

While the unwinding of that bank could be managed, the dysfunctional status of at least four U.S. money-center banks, a number of large regional banks, and countless local institutions was not so manageable.

For a brief time, these troubled banks suffered a rapid and uncontrolled deterioration in asset quality, resulting in hits to both earnings and capital. Core funding sources, such as commercial paper, were drying up.

Also their ability to participate in certain markets, including foreign exchange and derivatives, was seriously impaired because of declining international perceptions of their creditworthiness.

At this time, the Fed started to ease aggressively.

Inflation Fears Eased

The trigger for the process was the Fed's easing of inflationary expectations, which increased the slope of the yield curve. This made it feasible for banks to short-fund their activities by substantially increasing their volume of short-term liabilities in relation to longer-term assets.

But active short-funding was only half the story. The other part was that U.S. Treasury securities held by banks have a risk weighting of zero under the new capital requirements.

This gave banks a powerful incentive to short-fund an investment portfolio of Treasury instruments, and a disincentive to lend money. Accordingly, banks increased their U.S. Treasury security holdings by 31.1% over the past 18 months, while reducing their commercial and industrial loans by 14.0%.

With the banks on a totally free ride to capture a spread of 75 to 150 basis points, the Fed was racking up benefits with little side.

Savers Pay for |Bailout'

First, this practice "bailed out" the banking system, supplying it with enough profits to provide for bad loans without depleting capital. Taxpayers no longer faced an S&L-type debacle on a bigger scale. Instead, savers picked up the tab.

And if savers worried too much about low yields, they could find solace in the capital gains on stocks and bonds that they enjoyed as interest rates declined.

Second, low interest rates prevented defaults by a large number of overleveraged companies. Since interest rates on highly-leveraged-transaction and other corporate loans were periodically adjusted to reflect market conditions, lower rates meant less interest expense.

Accordingly, the long-anticipated HLT debacle never happened. In fact, banks are now participating in new HLT deals, syndicating these loans at a pace that should easily exceed 1991's total.

A Lid on Money Supply

Third, inflation rates, which normally rise in the face of sharply declining interest rates, never rose - consumer price index inflation is now around 3% and dropping.

Because of the yield curve arbitrage - which created a closed system through which money passed from banks into government securities, thus bypassing the private economy - the money supply did not increase as rapidly as would normally have been the case.

While the Fed's annual growth target calls for 2.5% to 6.5% M2 growth, the 1992 M2 growth rate is only 1.7%. With money supply stable, even stagnant, inflation ceased being a problem.

Fourth, private debt, one of Mr. Greenspan's "headwinds," has steadily declined. Banks, after all, had easier ways to earn money than by lending it to their customers - namely, by buying risk-free U.S. Treasuries.

Installment Debt Falls

Total consumer installment credit has fallen about 2.5% in the past two years, at a time when, based on growth in gross domestic product, it should have risen at least 3%. Although some may still consider personal debt too high, the process is taking the economy in the right direction.

Fifth, banks were in fact financing the U.S. budget deficit by purchasing Treasuries. This was particularly important, since foreign financing sources had started to dry up.

Sixth, Fed policy weakened the dollar, enabling the United States to unintentionally, though successfully, "beggar its neighbors." The weaker dollar has reined in domestic demand, confining American purchases mainly to U.S. goods and services. By the same token, it has made American goods more competitive on world markets.

But the penalty one normally pays for employing such a policy - namely, higher prices - may be averted since inflation has been wrung out of the system as a consequence of the static money supply. When global recovery takes hold and the J-curve lag has been taken into account, this will substantially improve the trade deficit.

You need more than one hand to count up the benefits. Greenspan painlessly saved the banking system, stabilized corporate America, eliminated inflation, reduced private debt, financed the national debt, and cured the trade deficit.

Recession Prolonged

The downside of all of this has been a prolongation of the recession. Since the lowering of rates did not result in a meaningful expansion of money supply, the private economy remained stagnant.

Some might suggest, however, that this period of austerity may be good in the long run, since it improves productivity.

Besides, the real pain in this recession was not macroeconomic. It was largely secular, resulting from corporations permanently cutting staff, including middle management, for the sake of future competitiveness.

That is why the recession is perceived to be so painful, even though the numbers looked good compared with past recessions. The pain has little to do with the business cycle - it is "Perestroika, American style," the Reagan revolution without fiscal stimulus.

What is next for Mr. Greenspan and company? Naturally, it is all up in the air. I have a suggestion: The Fed should tighten by raising short-term interest rates.

Given the already low rate of inflation, such a move would squeeze out whatever inflation is left. With inflationary expectations low, the yield curve would flatten out, eliminating the benefit to banks of short-funding.

This would force banks to do what they are supposed to do: lend money. Accordingly, money would at last be allowed to make its way into the economy.

At the same time, rising rates would cause the dollar to strengthen. Right now, recession is enveloping Japan and just catching up to the Germans. If the Fed tightens while they ease, international capital would flow to the United States and help finance the deficit.

Fed Chairman Looks Ahead

For years, technological changes have been accelerating the rapidity with which payments are made and securities transferred in the United States and around the world.

More and more countries are installing, or increasing the effectiveness of, electronic large-value transfer systems. Proposals are increasingly heard for cross-border multicurrency payment and settlement systems.

All of these developments bind world financial markets ever more tightly and thereby increase the need for central bank cooperation in these areas.

Efforts to Control Risk

In the United States, we recognize the risk implications of these developments and have considered how markets will think about the units of time over which payments are due and made, and what the effect will be on the conduct of monetary policy....

Other G-10 countries are also devoting substantial efforts to controlling risk in both the private and public sectors. All of us need to be sensitive to this issue and think carefully about the implications of certain difficulties and the development of contingency plans needed to address them.

A generation or so ago, one-day money meant just that - close of business to close of business, or 24 hours. Now, most one-day credits are really overnight, with the borrower receiving funds late one day and repaying them early the next. The true value of money is beginning to become evident in less than one-day units.

Intraday Funds Market Moves Nearer

The U.S. decision to price intraday credit accelerates the inevitable development of an intraday market for funds. We have just proposed opening our funds-transfer service two hours earlier, a first step toward what I suspect eventually will be 24-hour, or near 24-hour, operations.

These changes will affect the way we conduct monetary policy. As [previously free] intraday credit becomes explicitly of value, the 24-hour rate will have at least two components: the overnight and daylight rates.

We central bankers thus must be cautious, as intraday interest rates develop, that we do not inadvertently disrupt financial markets by thinking that the overnight rate will provide the same indication of market conditions that we had become accustomed to.

Inevitably, we will discover that this change, too, has other implications that we had not perceived but to which policy must nevertheless adjust.

Mr. Phillips is president of HP Corporate Communications Inc., New York, a consulting firm that specializes in financial disclosures.

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