I spent 40 minutes Tuesday afternoon, 5/5, with Treasury Secretary Baker. He had called 5/1, upset at my recent criticisms of him for lack of leadership on monetary/trade issues. The meeting was disappointing, though, Baker several times asserting that my action recommendations were "politically" impractical. I noted with satisfaction that Commerce Secretary Baldridge was quoted in the WSJ that morning, saying he would recommend a veto of the House trade bill even without the Gephardt amendment. I said I thought this had buoyed the markets in time to benefit the refunding, but that he, Baker, should be taking the lead on free trade. I argued, as I did with him 5/1, that the Fed had gotten cold feet in defending the dollar and the bond market collapse since late February was due to the failure of either Volcker or Manley Johnson to boost short rates when trouble first appeared. It was now up to him to lead, I said, my idea being that he should call for the lifting of the chip sanctions against Japan immediately, this being the chief barrier to Nakasone's ability to swing the Bank of Japan behind a discount-rate cut. The Fed won't hike the discount rate because Manley Johnson insists on a coordinated move with Japan, and Nakasone, who seemed to promise a cut last week (producing a quick 2 ½ pt rally in long bonds), pulled away when he got no relief on the sanctions (knocking bonds back). Baker said he opposed the chip agreement to begin with, but had to stick with it because Japan had violated it and we couldn't be seen as being weak. Bobby Byrd would be furious, he said, if the sanctions were lifted now. It's a matter of timing, he said, and perhaps this could be done before the June economic summit in Italy. I protested that this will delay until June a coordinated interest-rate move to defend the dollar, that the Fed will do nothing on its own. Volcker won't move without Manley, I said. He said Volcker could do it at the next FOMC meeting, May 19, without Manley. But why should PV stick his neck out on a discount-rate hike with no encouragement from the Treasury Secretary, especially given renomination politics? JBIII said he supported the snugging up, but clearly wasn't interested in sticking his neck out, pointing out the Treasury advisory committee of bond dealers recommended against a unilateral discount rate hike. Selling gold was politically impractical. The budget deficit was driving up interest rates, he said! Yes, I said, because the Treasury Secretary is not defending the dollar, especially its future value, interest rates were climbing, thereby adding greatly to the cost of financing the $2 trillion national debt. He also denies that he favors a cheaper dollar, but clearly believes it will have beneficial trade effects, and seemed astonished when I said it has had the opposite effect on our trade balance. He's also getting advice from monetarists inside the administration who are pointing out that M-1 is sluggish, an argument against tightening short rates. I came away thinking he believes he is operating at optimum, given his sense of political realities, but has boxed himself in with the strategy of a little bit of protectionism to prevent a lot of it, i.e., Bobby Byrd would be furious. It's hard to see help coming from him. We're back to hoping Manley will take the lead, but as his reported remarks of 5/5 indicate, he still has cold feet.