A Chance to Stack the Fed

By Charles P. Alexander

Preston Martin, Henry Wallich, J. Charles Partee, Emmett Rice, Martha Seger. To most Americans, those names could be a random selection from a telephone book or maybe the supporting cast of the movie Revenge of the Nerds. But though they garner little recognition, Martin, Wallich & Co. are some of the most important people in America. They help determine how fast consumer prices rise, how many jobs are available and how difficult it is to get a car loan or mortgage. Obscure but powerful, they are Chairman Paul Volcker's colleagues on the Federal Reserve system's board of governors.

President Reagan will soon nominate two new members to this elite group and possibly change the course of monetary policy. Lyle Gramley resigned from the board last week to become chief economist of the Mortgage Bankers Association. In January Partee's term will expire, creating a second vacancy. When those two posts are filled, Reagan, who has already named Martin and Seger, will have picked a majority of the board. Since Federal Reserve governors serve 14- year terms, the board will bear the President's stamp long after he leaves office.

High-ranking Administration officials told TIME last week that one of the Federal Reserve posts will go to Manuel Johnson, 36, the Assistant Treasury Secretary for Economic Policy. He is a supply-sider: one of the controversial economists who were the main architects of President Reagan's program of deep income tax cuts. A former professor at George Mason University in Fairfax, Va., Johnson has also been at the forefront of the Administration's drive to reform the tax code and deregulate the banking industry.

Administration supply-siders, including Johnson, have often criticized Volcker's Federal Reserve for being too tight with the U.S. money supply and thus keeping interest rates too high. In addition, Martin and Seger, the two Reagan appointees to the Federal Reserve, have sometimes dissented from the board's decisions and called for less restrictive policies. The White House considered replacing Volcker, a Carter appointee, when his term as chairman expired in 1983, but then decided to reappoint him because of the respect he commands in the financial markets. Now, however, the openings at the Federal Reserve may give the Administration new leverage against Volcker. The chairman's reputation earns him enormous clout, and he can set the Fed's agenda, but his vote counts for no more than those of other board members, and he could be overruled by his colleagues.

The Federal Reserve's changing of the guard comes at a crucial time for the U.S. economy, which has been almost stalled. The gross national product, after expanding at a 6.8% pace in 1984, grew at an annual rate of only 1.2% in the first half of this year. Housing starts are falling, and industrial production is virtually stagnant. One sign that growth may be reviving, however, is a recent dip in unemployment. After being stuck at 7.3% for six months, the jobless rate dropped to 7% in August. The fall in black teenage unemployment, from about 40% to 35%, was particularly encouraging. Much of the improvement, though, came because many teenagers left the labor force at the end of the summer to go back to school.

Agriculture has been among the sickest sectors of the economy. Plagued by low grain prices and continuing high interest rates, farmers are sinking deeper and deeper into debt. Last week the Farm Credit Administration asked Congress and the White House to begin making plans for a federal rescue of the 37 farmer-owned banks and 797 local lending associations that the FCA oversees. The institutions are stuck with loans worth more than $11 billion that have been classed as nonperforming because borrowers are behind on their payments. Donald Wilkinson, governor of the FCA, said that the federal aid needed could ultimately amount to "multibillions of dollars."

In an effort to resuscitate the economy, the Federal Reserve has been letting the amount of money in circulation rise rapidly. During the first six months of the year, M1, the basic measure of the money supply, which primarily includes currency and checking accounts, grew at a 10.4% clip, far above the Federal Reserve's target range of 4% to 7%. That spurt helped interest rates fall a bit. The prime rate that banks charge on commercial loans has dropped from 10.75% to 9.5%.

In July the Reserve board voted to lift the 1985 M1 limit slightly, to 8%, but to restore the 7% target in 1986. If the board is to meet those goals, it will soon have to rein in the money supply. Martin and Seger voted against the 7% target for 1986, arguing that faster money growth may be necessary for an economic rebound. The Volcker-led majority, however, was worried that too much money would lead to an acceleration of inflation.

The departure of Gramley and Partee could possibly weaken the Federal Reserve's inflation-fighting resolve. The board during the past year has been divided into hawks, doves and owls. Gramley and Wallich were the hawks. They have been especially concerned about inflation and have occasionally voted for a more restrictive monetary policy than Volcker wanted. Martin, Seger and Rice have been doves, sometimes voting for faster money growth. Volcker and Partee were the owls in the center, favoring a moderate course. The appointment of Johnson and another Reagan loyalist might give the doves a stronger hand.

The White House seems eager, however, to avoid giving the impression that it has gone soft in the battle against inflation. So in addition to nominating Johnson, the Administration is considering monetarist economists for the other Federal Reserve vacancy. Monetarists have long advocated steady money growth as a way of guarding against inflation. A leading contender in this camp is Wayne Angell, an economics professor at Ottawa University in Kansas. Angell, whose nomination has been urged by Kansas Senator Robert Dole, has a firsthand understanding of the credit crunch in the farm belt. He is a part-time farmer, and, together with his brother, owns a small bank in Pleasanton, Kans., and a second in Hume, Mo.

Another monetarist candidate high on the White House list is James Meigs, senior vice president and chief economist at First Interstate Bancorp in Los Angeles. He has impressive credentials: a bachelor's degree from Harvard, a doctorate in economics from the University of Chicago, and experience as an economist for the New York Stock Exchange and the Federal Reserve Bank of St. Louis. Other names circulating around Washington as Federal Reserve candidates include William Dunkelberg, the chief economist for the National Association of Independent Businessmen; Alan Reynolds, a New Jersey-based economic consultant; and Lee Hoskins, a senior vice president of the Pittsburgh National Bank.

Presidents sometimes find that their Supreme Court nominees do not turn out to vote as expected, and Federal Reserve members are also frequently unpredictable. White House veterans doubt that Reagan will be able to dictate policy to the new Federal Reserve Board. Says Walter Heller, who served as President Kennedy's chief economic adviser: "Historically, many economists who have joined the Fed have shed their political stripes and shown a considerable amount of independence in their voting."

Other experts point out that many of the most important Federal Reserve decisions that affect the money supply and interest rates are made by its open-market committee. That body consists of the board of governors plus five presidents of the regional Federal Reserve banks. Since Volcker has several allies among the regional presidents, he may still be able to forge a majority in open-market committee deliberations.

Nonetheless, Volcker could face increasing dissent. His term as chairman does not end until 1987, but some Fed watchers fear that he will leave sooner if he faces serious opposition from the Reagan appointees. Says Rimmer de Vries, senior vice president of Morgan Guaranty Trust: "There has been a lot of bitterness in the past between the Fed and the White House. If Volcker finds himself outvoted on policy issues, he may resign." That would rattle financial markets, both in the U.S. and overseas. Since Volcker took office in 1979, investors have come to count on him as a bulwark against inflation.

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With reporting by Thomas McCarroll/New York and Christopher Redman/Washington