POTHOLES ON ROAD TO RECOVERY

The U.S. economic engine is starting to hum. When the Arkansas mechanics get to Washington in January, presumably they will realize the machine ain't broke. Hopefully, they will be careful about how they try to fix it. However, to mix a metaphor, there are still plenty of potholes in the road to the promised land.

Senior Democrats in the House have threatened to cut the salaries of top Federal Reserve officials by up to 50 percent and sharply increase the political oversight of monetary policy. There is little chance that such ideas - most of which have been floating around Capitol Hill for 30 years or more - will ever become law.Still, it remains to be seen whether a young and pliable president will spend much political capital defending the integrity of the central bank. Without strong support from the White House, Fed officials will find it difficult to increase their 3 percent target for the federal funds rate, no matter how fast the money supply grows. Should money growth run out of control, this would have major implications for the economy - particularly the risk of renewed inflation.

At present, demand for credit in the private sector appears to have stabilized and may even be increasing. To push the funds rate down to 3 percent and then keep it there, the Fed had to pump more than $100 billion in new spending money into the economy - a near-record rate of gain. The longer the Fed holds rates down, the more money growth will increase.

For the time being, this is fabulous news for financial markets. The supply of fresh liquidity far exceeds the needs of the real economy. These surplus funds have obviously played a key role in supporting financial asset values over the last 12 to 18 months.

Sadly, good times, like bad, come to an end. The bigger the climb in money growth, the sharper will be its eventual fall. Meanwhile, the huge jump in spending money has kept inflationary expectations high, despite the modest rate of price change in recent months. As a result, long-term rates are above optimum levels for the current stage of the expansion.

Henry Gonzalez, the maverick Texas Democrat who heads the House Banking Committee, is leading the latest charge against the Fed. Mr. Gonzalez is following a grand tradition of populists from the Lone Star State. His predecessor, Wright Patman, developed Fed baiting into a high art during almost 50 years on Capitol Hill. Many, if not most, of Mr. Gonzalez' ideas are warmed over versions of proposals that Mr. Patman failed to enact into law. Hope springs eternal.

Mr. Gonzalez said he would introduce legislation to require Senate confirmation of the presidents of the 12 regional Federal Reserve banks. By tradition, the president of the Federal Reserve Bank of New York is vice chairman of the Federal Open Market Committee, the Fed's key policy body. The other 11 presidents serve in rotation as members of the FOMC.

Under the Gonzalez plan, the White House would select Fed bank presidents from a list submitted by the board of directors of each bank, subject to the same confirmation process as the seven members of the Federal Reserve board and other presidential appointees. No more than a simple majority of the Fed bank presidents could be members of the party controlling the White House.

The proposal would limit salaries of employees of the Federal Reserve Board and the federal reserve banks to that of Fed Chairman Alan Greenspan, who currently earns $129,500. All the Federal Reserve bank presidents earned more than that amount in 1991. Gerald Corrigan, president of the New York Fed, got $245,000.

Mr. Gonzalez has a limited reputation as a stand-up comic. Even so, he claimed the Fed bank presidents had no reason to fear his legislation. Mr. Gonzalez argued that the reserve bank presidents should find Senate confirmation "to their advantage" because it would "put them in a stronger position on the Federal Open Market Committee." As an alternative, other Democrats in Congress would simply abolish the FOMC by removing the reserve bank presidents.

Mr. Gonzalez also wants congressional oversight of Fed operations in the foreign exchange market. Scrutiny of foreign exchange intervention is justified, he said, because it is "also used in certain cases to make the equivalent of loans to foreign countries."

Among other things, the Gonzalez bill would stiffen provisions designed to prevent conflicts of interests on the Fed bank boards, give Congress the right to review the budgets of the Federal Reserve Board and the Fed banks, require release of complete minutes of FOMC meetings instead of summaries and extend the General Accounting Office's audit authority to all Fed operations.

In the meantime, the Fed is pumping high-powered money into the credit markets at an extraordinary pace. Total bank reserves, the raw material for the money supply, rose at an annual rate of 51.14 percent in October from their September average.

The Fed cannot increase the money supply at this rate forever. Investors should focus on what happens when the Fed closes its money faucet. The drop in money growth in 1984, for example, pushed the yield on Treasury bonds to 14 percent. In 1987, bonds got to 10 percent and the stock market crashed. Another stock market meltdown is unlikely. However, investors should anticipate higher prices for gold and lower prices for bonds on Mr. Clinton's watch.

For the full story: Log In, Register for Free or Subscribe