Cheer Up, A Bit
Jude Wanniski
October 16, 1987


The market slide in stocks and bonds reflects a variety of anxieties about U.S. monetary, tax and trade policies that is not entirely warranted, based on assurances I have had this week from senior Administration officials. I met Tuesday with Treasury Secretary James Baker, Wednesday saw Chief of Staff Howard Baker Jr., Trade Rep. Clayton Yeutter, and House Majority Leader Tom Foley at the Evans & Novak Forum, and yesterday morning met with Fed Gov. Wayne Angell. My sense is that the markets fear the trade deficit will either tempt the Fed to let the dollar slide or increase chances of enactment of a protectionist trade bill, with or without the President's support. The President seems pitifully weak, losing the Judge Bork fight, the Democratic Congress seems ferociously strong. We can have no confidence that Howard Baker will stand and fight for anything, although he says he sees little chance of a trade bill and no chance of a tax bill ~ that the President would take defense cuts sooner than swallow the $12 billion tax hike that the House Ways & Means Committee is preparing to savage "the rich" and Wall Street. Baker's mindset is to run out the clock, hoping to lose as little as possible.

But Jim Baker is still in fighting form, although his happy talk on inflation yesterday afternoon was a mistake, inviting fears that he will let the dollar slide further. But he was emphatic there will be no protectionist deals cut with Congress. I told him there were grave suspicions of this, when he was quoted Sunday as saying that if the non-trade items such as plant closings are kept out, a compromise might be worked on trade. He said there's small chance the Democrats will separate out the non-trade items, that they are in a political box. But supposing they might, I gave him a list of provisions of the House and Senate bills that could not be in any trade bill the President could sign, which he read, and said "Do not worry about any of this!", waving it at me. He believes it will be next spring before a bill is produced and that the longer it takes, the more likely no bill will be enacted. Yeutter thinks there's a 50-50 chance of a bill by Christmas, but seemed more emphatic than usual about the likelihood of a sustained veto. Yeutter still believes in J-Curve devaluations, although I reminded him that a year ago I told him the yen and D-mark appreciations would worsen our trade deficit. But he is clearly under instructions to avoid talking down the dollar further.

Jim Baker seemed extremely pleased with the reception he's gotten thus far on his gold initiative, with the U.K. and France as well as the domestic audience. He even seemed sanguine about bringing West Germany along. In his press conference yesterday he was openly critical of Bundesbank tightening, which seemed to occur in reacting to Bonn's new withholding tax on securities, a foolish move in itself. JBHI is talking to financial reporters about the gold/commodity basket being an "anchor" and "reference point," The Washington Post's Hobart Rowen told me. I warned JBIII that the structure he's achieved at this point would soon be tested, not realizing it would come so soon in the next days. As in the past, I urged him to consider, in addition to Fed interventions, some gold sales (2 or 3 million ounces, or 1% of our stocks) to "scald the speculators," to use Mundell's words, and at least he was attentive. Fed Governors Manuel Johnson and Angell are known to favor such a move at the right time, which would occur with gold rising and the dollar/yen ratio about to bump 140, I told JBIII. He was poker-faced, but I'm absolutely positive he understands his achievement to date or this framework of monetary reform would be blown away if he can't meet this test. I'm sure the reason for his press conference was to convey concern about the DM closing in on 1.80, the other key floor in the Louvre agreement, although he left the poor impression that he might lower the floor rather than bash the speculators at the floor. There's at least a small chance there would be a gold sale at this point, but the idea may not have cooked quite enough as yet. Angell is making the solid argument that the central bank should not hold any reserves in its portfolio, including gold, unless it is prepared to use them. Of course, this would be very bullish for bonds, clarifying the tremendous uncertainty about Fed policy in this Greenspan era. Greenspan, by the way, was a key supporter of the Baker gold initiative in the infighting that preceded the IMF speech.

Greenspan has been pushing his pet idea of selling gold bonds, and I urged JBIII to reject the idea, that it is always seen as an act of desperation by the markets. If he wants to send a signal of his confidence, I suggested they not issue long bonds at these high rates, or issue them with call provisions. JBIII says the Treasury staff opposes gold bonds. So, by the way, does Wayne Angell.

Other points I raised with JBIII: That he make clear when he urges Germany and Japan to expand that they do so by cutting marginal tax rates, not simply pumping up demand. That if they did so, neighboring countries would be forced to emulate, just as Canada followed our reform. He said he does privately urge tax reforms on Germany, especially. It would help if this were made clearer. Also, I urged him to learn the tax-rate structures of the Third World and urge his counterparts from those nations to bring them down, that this has always been the missing ingredient of the "Baker Plan." He expressed great interest in this, seeming astonished at some of the high rates in various countries I mentioned.

My meeting with JBIII was extremely reassuring, ending all worry that he might be lax on trade or insincere on pushing forward on monetary reform. Given the collapse at the White House, JBIII is the best thing we have going for us. He is holding together the world economy. I advised him I am pushing for a "Kemp-Jim Baker ticket" in '88, and he asked, "In what order?" Then, "Why would I want to be V.P.? You get more done in this office!" He's clearly not on the defense, counting the days till he can go home, as Howard Baker obviously is.

A few other odds and ends: Democratic Majority Leader Foley also believes it will be next spring before a trade bill emerges from Congress and that it's likely it will be vetoed and sustained. He's a free trader, but believes the issue is a winning one in many parts of the country. I suggested the early presidential primaries will then have an impact on the trade bill. If the more protectionist candidates like Gephardt do well, the Democrats will be more ardent in pushing a tough bill to the President, knowing he'll veto and they will have an issue. And vice versa. Foley said he didn't think much of a trade message will be drawn from those primaries.

Wayne Angell will make public his "index" of commodity prices in about two weeks, an extremely important milestone. It will have heavy weights of gold, oil, metals, food and fibers. Angell will present it for discussion, but it could immediately become the proxy for JBIII's "basket," given the fact that Treasury hasn't been working on one. It could become critical for the bond markets and exchange markets, seen as a central policy target, from which deviation by other central banks or other Fed governors would require explanation or excuse.

Certainly the dangers to the world economy are greater now than they were a few weeks ago. But as long as JBIII hangs on, we'll get through this bubble and avoid a new world stagflation. If I'm right, we are on the threshold of major policy breakthroughs that will cheer the sagging bull. Hang on.