The fed handoff is done. Now what? In taking over from legendary Alan Greenspan, Ben Bernanke has his work cut out for him. CFOs are among those who aren't quite sure what to expect. Opinions are divided about whether Bernanke's talk about "inflation targeting" is a good thing or potential trouble.

As the iconic Alan Greenspan was leaving the Federal Reserve chairmanship at the end of January, an unaccustomed spate of criticism appeared in the press, reminding one of the Reverend Dr. Parr's comment about posthumous attacks on the great writer Samuel Johnson: "Aye, now that the old lion is dead, every [fool] thinks he may kick at him." Yet

even the backhanded fare-thee-wells to Alan Greenspan had to grant that he held the Fed's helm longer than any other chairman except the colossal William McChesney Martin, whose tenure ran from 1951 to 1970.

Interestingly, Greenspan and Martin had something else, less noted, in common: both were succeeded by career academics, Greenspan by Benjamin Bernanke and Martin by Arthur Burns.

Ouch! Burns' watch featured the worst period of inflation in U.S. history, and he managed to astound the economics profession when his policies created the unprecedented phenomenon of simultaneous rises in inflation and unemployment--until then theoretically unthinkable. It took Paul Volcker, double-digit Fed funds rates and one of the worst downturns since the 1930s to clean up the mess Burns' tenure created.

So will history repeat itself? In fairness to the new Fed chair, both Bernanke skeptics and Bernanke champions seem to doubt it. "Another Burns? No, it's a whole different personality," says Laurence Meyer, former Fed governor and, like Bernanke, a champion of inflation targeting. Even the U.S. Chamber of Commerce's chief economist, Martin Regalia, who has some reservations about Bernanke, says, "Is it unfair to look back at Burns? It's neither fair nor unfair. It's a fact. But is it a fact that provides predictive information? I'm not sure that it does."

That said, anything is possible--and there's the rub. The Fed chair has enormous power and authority. History (see the sidebar) shows that the men at the helm of the Fed (so far, they've all been men) have taken it in wildly different directions. Bernanke is a relative newcomer to the Fed system. He was a Fed governor from 2002-05 and became chairman of the President's Council of Economic Advisors last June; prior to that, he was chairman of the Economics Department at Princeton University. One of the biggest challenges he will face is to make changes in the Fed chair a non-event, supporters suggest. If he has his way, his own handoff to a successor will be only a little more significant than a change in engineers on the Amtrak Metroliner.

In that scenario, the Fed train will run on time to a destination everyone knows, no matter who is at the controls. Everyone will understand what the Fed does and why, and no one will have to wonder about what the new chairman might really be thinking, or whether he has the guts to face down the White House if he has to.

But we're not there yet. "The first time we have a crisis and Bernanke does not act the way Greenspan did, and gets a lot of pressure, it will be interesting to see if he has the toughness to stick [it out]. The worst thing is to withdraw and not stick with one philosophy," says G. William Evans, CFO of LandAmerica Financial Group, a Richmond, Va.-based title insurance and real estate transaction services company. Blythe McGarvie, president of the Leadership for International Finance and member of the boards of Accenture, St. Paul Travelers Insurance, the Pepsi Bottling Group and Wawa Inc., also wonders, "How aggressive will new Fed chairman be about inflation? I think pretty aggressive, but we don't know, and that leads to some uncertainty."

What to Expect

To be sure, the decisions of a Fed chairman usually affect businesses only indirectly, and more or less over the long term--at least outside of such interest-rate-sensitive sectors as finance and housing--and it's safe to say that few executives have been losing sleep over Greenspan's departure.

Says John Bachmann, senior partner of Edward Jones and former chairman of the U.S. Chamber of Commerce: "I think the changes you'll see will be subtle. The traumatic change was when Volcker came in and changed the Fed's fundamental policy from managing interest rates to managing the money supply. It almost destroyed industries like autos and housing that depended on heavy doses of credit to sell the products. Now, look for a period of relatively low interest rates and low inflation--but a concern that inflation may be on the horizon."

Bachmann speaks for many. At Computer Sciences Corp., CFO Lee Level says, "Everyone I talk to is assuming business as usual from the Fed."

Others are less sanguine. The U.S. Chamber's Regalia says he thinks "this may be a bigger change than most people think." Noting Bernanke's advocacy of inflation targeting, more transparency and greater collegiality in Fed decision-making, Regalia says, "I don't know if this is an improvement or not. If it ain't broke, don't fix it."

Regalia also cocks an eye at Bernanke's lack of political experience. Both Volcker and Greenspan had spent most of their careers before chairing the Fed working in policy or political posts where they learned Washington gamesmanship. Greenspan was so political that, when he came to the Fed, some worried that he would not be independent enough to run the monetary system. He proved the skeptics wrong by going against the wishes of the first Bush White House and refusing to open the Fed's easy money spigots to help re-elect Bush senior.

But Greenspan's political savvy was one reason why he played his cards so close to his vest with respect to the Fed's inflation goals. In practice, Greenspan adopted an implicit inflation target but did not tie the Fed publicly to it. Even Laurence Meyers, one of the earliest and most prominent advocates of inflation targeting, says there was a good reason for caution.

Why? The Fed has a dual mandate from Congress to address both unemployment and inflation, and although the Fed is independent, Congress did create it and could--one way or the other--wreck it. "One of the great fears of the skeptics and some of the proponents of inflation targeting is Congress," Meyers explains. "What the Fed doesn't want is Congress reopening the Federal Reserve Act, because God knows what mischief might occur." For example, Congress might ask the Fed to establish an employment target, too.

Bernanke doesn't seem worried about that. His proposal for what he calls "best-practice inflation targeting" calls for announcing an inflation target and publicly communicating the bank's progress in meeting it. He professes to leave room for some flexibility, an approach he refers to as "constrained discretion," so the Fed can respond to short-term shocks.

But in a speech he delivered in 2003, he clearly put the accent on constraint, saying: "The intuition that more flexibility is always better than less flexibility is quite fallacious, a point understood long ago by Homer, who told of how Ulysses had himself tied to the mast so as not to fall victim to the songs of the Sirens. More recently, the notion that more flexibility is always preferable has been pretty well gutted by modern game theory."

It would be a mistake, though, to think of Bernanke as a hawkish inflation fighter, as many do. He has studied the causes of the Great Depression extensively, and is at least as concerned about the effects of deflation. With an eye to the Japanese example, he warned about the risk of deflation as early as 2002. One reason why he wants to set a target of some inflation instead of no inflation is to allow a "buffer" for the Fed to act against deflation.

Charles Plosser, John M. Olin Distinguished Professor of Economics and Public Policy at the Simon Graduate School of Business, University of Rochester, praises Bernanke for being open, transparent and willing to say "we're not inflation fighters, we're inflation creators, and we commit to the public to keep inflation within a fairly narrow range." Bernanke and his supporters have taken pains to stress the point that this kind of inflation targeting would merely institutionalize what Greenspan has been doing for years.

"If we measure Greenspan by what the economy and inflation did during his time, he was successful. The problem is with the institution," Plosser says. "I think he could have and should have provided an institutional commitment that would perhaps prevent another Arthur Burns from happening, or reduce the probability." Plosser thinks Bernanke's inflation-targeting idea could do that.

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Interestingly, however, Bernanke has also staked out a distinct position from Greenspan on some other issues that have subtle but real implications on business. Greenspan pounded his bully pulpit about the federal budget deficit, for example, but in a March 2005 speech, Bernanke said, "I disagree with the view, sometimes heard, that balancing the federal budget by itself would largely defuse the current account issue."

He called the U.S. current account deficit the "tail of the dog," the product of international financial conditions that have led to a "global glut of savings." He concluded that "even if we could balance the federal budget tomorrow, it wouldn't do much to solve the current account deficit problem."

That could be good news for companies that report to their shareholders in dollars. Charles Smithson, managing partner of the risk management consultancy Rutter Associates and one of the world's great authorities on financial risk management, says a weak dollar would be consistent with Bernanke's views on the current account deficit. "You could easily see him being willing to accept a weakening dollar," Smithson says.

"He believes that part of the reason we're running this deficit is not only overspending, but that there is a lot of savings floating around the world looking for a home. Since we don't have a way to control the savings that's out there, the one thing we can do is try to increase our exports, and when the dollar is cheap, we export a lot more."

All of which worries some observers greatly. "I think we're at a very precarious moment in the financial cycle," says Paul Kasriel, senior vice president and chief economist for The Northern Trust. "I think that Bernanke is inheriting a very risky hand to play. If you're dealt bad cards, it's hard to win, and I think he was dealt some bad cards."

Among those bad cards: a highly leveraged economy with a vulnerable housing sector that could cause serious damage to the banking system. Kasriel fears that if banks take big losses because of a bursting housing bubble, the U.S. could echo the experience of Japan, where broke-back banks collapsed under a mountain of bad real estate loans and could not stimulate the economy even when the central bank took interest rates to zero.

On the flip side, if the banking system stays sound, Kasriel sees Bernanke's commitment to inflation targeting creating still more asset bubbles. Global sourcing and technology are working to push prices of goods and services down, so Kasriel says it's natural for them to fall. "If you target inflation in this country, you're likely to repeat the Greenspan mistake, print more money to keep prices from falling and lead to inflated asset prices," he concludes.

Financial Strategy for the Times

Financial executives in a number of industries are already watching prices warily. Staples Inc. CFO John Mahoney says that "in the last year, a lot of the things related to commodities--such as electronics, resin-based products and so forth--were impacted by rising commodity prices." With rising demand from China and recent evidence of the supply disruptions caused by tsunamis, hurricanes and political instability, Mahoney says, "Risk management has become a much bigger issue and affects your financial strategy very much."

He sees a need for companies to allow a little more slack in their "just in time" supply chain management practices. "With respect to financial strategy, it means you may have to use more working capital," he says. "And reshaping the balance sheet is something companies have to think about. We try to think about what our balance sheet will look like long-term, what we need in terms of a strong credit profile, while at the same time not having a bunch of excess cash that's not earning much money for shareholders."

On the other side of the commodity price table, Roger Plank, CFO of independent exploration and production company Apache Oil, should be smiling. But his pleasure in higher oil prices is tinged with caution. "The threat of inflation is real, because energy prices are high and so are a lot of commodity prices, and after an era of underinvestment, we're undersupplied," he says.

"I think you have to be very careful and not assume that today's conditions will last forever. We tend to have very lean debt on our balance sheet, less than 20 percent of total capitalization. Investors are strongly encouraging us to take what appears to be excess cash flow and invest it in buying our own shares. Our view, again, is one of caution."

G. William Evans of LandAmerica also says, "My own philosophy is to remain nimble and watch carefully to see how the market is reacting." Evans's financial strategy for LandAmerica reflects that cautious flexibility. When rates were low, LandAmerica did two bond issues, one at a seven-year maturity and one at 10 years, to lock in low rates. On the asset side of the balance sheet, LandAmerica has a long-term investment portfolio to address future claims, but Evans says he has "kept investments a little on the short side, so as rates go up, we can capture increased yield."

Operationally, he stresses that the "number one [thing] is to make sure we remain nimble and lean in our cost structure as business volumes go up and down." LandAmerica is looking to develop opportunities in real estate markets abroad. Evans says, "If we do have some flattening here in the U.S., we can look globally for growth opportunities."

Yield Curves and Interest Rates

Dennis Ling, senior vice president, global finance and treasurer of Avon Products Inc., is watching the yield curve carefully as an indicator of future economic performance. He cites evidence that "a flat yield curve, as we have now, is a 60 percent accurate predictor of a slowing economy. And, if we end up with an inverted yield curve, that's a 90 percent indicator of slower economic growth or, indeed, of a recession."

Avon has been benefiting from rising interest rates as returns on its cash holdings have neatly hedged its short-term borrowings. But Ling has an eye on the currency markets. "So much of our business is in foreign currencies that the movement of exchange rates is very important," he says.

Ling notes that interest rate differentials over the past year have driven investors to hold dollars, but with inflation differentials and interest rates converging around the world, he expects less incentive for investors to hold dollars this year. "The dollar was stronger than we expected in 2005, but we are looking at it to weaken in 2006."

After the horrendous Burns inflation of the Seventies, and Volcker's hard-fought battle to restore monetary stability, Alan Greenspan came to the Fed to preside over a decade and a half of prosperity. "Greenspan was an outstanding Fed chairman, and I'm not sure that the most outstanding thing about him wasn't his timing," quips Apache Oil's Plank.

In the 1980s, currency and interest rate moves took whole industries by surprise, and the Rust Belt remains as a monument to how unprepared executives were. Now, companies have learned to manage the risks of currency and interest rate moves with both financial and operational hedges. As far as the bond markets are concerned, the new Fed chair will institutionalize what Greenspan has done, and we indeed should get smooth and stable times ahead.

"The war against inflation is over because we won," says Paul McCulley, managing director of PIMCO, a fixed-income manager with $590 billion in assets. "Volcker had been the general in the war against inflation, but Ben Bernanke will be the constable of price stability."

Yet in operating businesses--where global demand for commodities is sending prices continually up, where supply chains are stretched tight and vulnerable to every threat from fickle dictators to high winds--executives who learned a lesson from the financial history of the 1980s are watching--and waiting--carefully.

Gregory J. Millman (gj.millman@earth link.net) is a New Jersey-based business writer and author who contributes regularly to Financial Executive.

RELATED ARTICLE: How to Change Drivers While Moving, Or a Brief History of Fed Chairs

Benjamin Bernanke would like to put the Federal Reserve car on rails, with an inflation-targeting regimen that reduces discretion. That could be a good thing, given that the Fed's history is one of more or less unpredictable driving.

The Fed chairman is immensely more powerful than anyone else on the Fed, and the chair's views set the direction. Says the U.S. Chamber of Commerce's Martin Regalia, who served as staff economist in Volcker's Fed: "We used to joke that Volcker could win votes 11 to one--when he was the one."

History shows that Fed chairmen have set very different directions. The Fed traces its roots to 1913, but the Banking Act of 1935 created the modern Federal Reserve System. Only recently has research made it clear how much responsibility the Fed bore for the Great Depression.

One of the most prominent contributors to that research was former Princeton University professor and current Fed Chairman Bernanke, who faults the Fed of that era for "allowing persistent declines in the money supply and in the price level." Through the operation of the international gold standard, the depression spread through the world--sparing only those countries that, like China, had never joined the gold standard.

The first Fed chair of the modern era was Marriner Eccles, who took the chairmanship in 1936 and continued the deflationary policies of his forebears in part because he and the other Fed governors of his time didn't believe that monetary loosening could help reverse a downturn. Instead of loosening, he tightened in an attempt to prevent speculation and inflation.

During the 1940s, other issues than Fed policy were front and center on the national agenda. William McChesney Martin's chairmanship (1951-70) showed commitment to price stability but, according to University of California at Berkeley economists David and Christina Romer, "he also believed that policy should be made by consensus ... when the Kennedy and Johnson administrations and other FOMC [Federal Open Market Committee] members adopted the 'New Economics,' Martin acquiesced." The New Economics saw a tradeoff between inflation and unemployment and maintained that the country could buy employment with a little inflation.

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Arthur Burns succeeded Martin in 1970. "To most economists, Arthur Burns was a big disappointment," says the Simon School's Charles Plosser with some understatement. "Whatever inflation-fighting reputation and credibility the Fed had gained under Martin was quickly squandered by Burns." Although the inflation rate was already almost 6 percent when he took the chair, Burns loosened further, expanding the money supply in a mistaken attempt to generate employment. Inflation hit 9 percent by 1974 and kept going up.

G. William Miller, former CEO of Textron, came to the Fed chairmanship in 1978 and lasted just over a year. He was perplexed by the fact that the U.S. was experiencing both inflation and unemployment simultaneously, but allowed real interest rates to go into negative territory and inflation to 12 percent.

Then Paul Volcker took the chair and radically changed the fundamental assumption that had guided the Fed since the 1960s. Instead of a tradeoff between inflation and unemployment, Volcker saw price stability as the only way to ensure long-term economic prosperity. In order to wring out inflation, he sent nominal interest rates into the double digits and kept them there, despite a severe recession in the U.S. and global economic consequences that included a commodity price collapse and debt crises in Latin America and Africa.

Greenspan replaced Volcker in 1987, and with a combination of extraordinary good judgment and (perhaps) extraordinary good luck, managed to preside over the longest peacetime economic expansion in U.S. history--yet kept inflation under control.

Now, we have Bernanke. One of the strongest arguments in favor of his proposal to put the Fed car on rails is the fear that some future Fed chairman might veer from economic sanity as wildly as Burns did. Says Plosser, "Chairmen Martin and Burns, no doubt, had the best of intentions. But to varying degrees, both succumbed to the political pressure to inflate."

Although even politicians now oppose inflation, no one knows what political winds might blow in the future, and history suggests it's risky to bet all of the economic chips on the Fed chairman's backbone.

--Gregory J. Millman

RELATED ARTICLE: takeaways

* The transition from Alan Greenspan to Ben Bernanke has produced a variety of reactions, from yawns to expressions of concern, especially over the notion of how well Bernanke might respond to a crisis.

* Bernanke seems to be suggesting publicly that he wants to put the Fed's monetary policy on a narrow track that would help contain inflation. But he has also voiced worries about the dangers of deflation.

* Financial executives generally expect little obvious change in Fed policy. Some worry about rising commodity prices. Others are positioning their companies to capture any further increase in short-term rates.