JBIII Still the Problem
Jude Wanniski
November 16, 1987


In my pre-Black Monday FYI of October 16 I observed that Treasury Secretary James Baker III was the man on the margin, "holding together the world economy." This was my sense having met with him 10-13, believing he would fend off attacks on the President's economic program on taxes and trade and would defend the Louvre accord on exchange rates that was his baby. After the Crash, which was triggered by JBIII's signal 10-18 that he would not defend the accord and even preferred a weaker dollar, I wrote that he had gone over to the forces of austerity and if the bull market were to resume, he had to be won back to growth. He has not been and is still the problem.

A logjam exists in the world economy because W. Germany in particular is withholding monetary and fiscal expansion in exchange for cuts in the U.S. budget deficit, the deflationary D-mark weakening the European economy. JBIII should have taken the lead after Black Monday in persuading Bonn and Tokyo to expand in exchange for withdrawal of the trade bill, which threatens both of them, at the same time reaffirming the Louvre accord and pledging budget cuts through the Gramm-Rudman sequestering process or other spending cuts. Instead, he persuaded the President to swallow his campaign promise against tax increases in the interests of producing a successful budget summit and avoiding the $23 billion Gramm-Rudman sequestering. He has been behind moves to orchestrate a bigger package of cuts and tax hikes than Gramm-Rudman requires, and it seems clear he has been encouraging his counterparts in Bonn, Tokyo and London to keep up the international pressure. President Reagan agreed to put everything on the summit table but Social Security. His Treasury Secretary permitted it to be put back on. Finally, since the Crash, JBIII has continued to signal dollar weakness. It was RR who last week arrested its decline by saying he did not want it to fall. Granted the dollar has been stable against commodity prices and gold, indicating the source of the problem is tight monetary policy in Germany. But Baker certainly hasn't made that clear, which leads us to believe he still thinks devaluation will cut the trade deficit.

What worries us more as the weeks go by is that Baker is getting more and more committed to these austerity solutions to the trade deficit. The summiteers are having trouble producing a package that Congress will swallow, but JBIII seems determined to plough ahead and rig something to avoid sequestering. This week's "deadline" will be rolled over to buy time and cut deals. The tax components will almost certainly be egregious, House and Senate Democrats determined to put up marginal income tax rates through the back door. The 3% Medicare tax on all income is the worst of the elements we would see slipped in, but there would be others.

It seems incredible at this stage that JBIII has not pulled the trade bill from consideration. In the wake of the Crash, the Democrats are very nervous about it and would be relieved if it were withdrawn, as former Labor Secretary Brock recommended a few weeks ago (with no outcry from the AFL-CIO). Before the Crash most Democrats and many Republicans seemed to think tough trade legislation would be good politics. But the stench of 1929 and Smoot-Hawley is now everywhere. The Democrats see their point man for protectionism, Rep. Richard Gephardt, has slipped badly in the Iowa polls in his quest for the Democratic presidential nomination. Yet it is becoming painfully clear that JBIII wants a trade bill, that he considers it a matter of personal pride that he can get one out of the Congress that the President can sign, one he can persuade the President is not really protectionist. There isn't any other reason we can imagine why he isn't killing it as he could easily do. For too long we have focused on Howard Baker's publicly expressed sentiments for a trade-bill compromise. But he could not stop the Treasury Secretary for an instant if JBIII recommended to the President that he withdraw support for the trade bill. Instead, Baker played to the protectionist forces by clearing tariff sanctions against Brazil, in line with his dubious strategy of placating congressional protectionists in hopes of getting them to be more reasonable in the legislation.

As we have known all along, the Treasury Secretary is not a man of great conviction. His strength is his practical ability to get things done, through determination, personal political skills, pulling strings, dodging and feinting, maneuvering and manipulating. Anything it takes to get the job done. The problem for us at the moment is that he is determined to get the wrong job done. In 1982 he was in a similar position, as he and David Stockman, Bob Dole and Pete Domenici, Howard Baker and Ken Duberstein and Alan Greenspan cooked up TEFRA, the biggest tax increase in U.S. history, and sold it to the President.

He has of course been swept up by the incredible outcry from the Eastern Establishment for higher taxes, with Peter Peterson shouting at us from every possible TV talk show, old folks being terrified by talk of Social Security cuts to build support for tax hikes, announcements from The New York Times that the Reagan party is over, Jimmy Carter and Walter Mondale saying they told us so, and Senator Bob Dole announcing he will seek the GOP presidential nomination on a platform of "bitter medicine" (which Fritz Mondale instantly and publicly applauded).

It seems like a juggernaut, but if it were we would not be hanging around Wall Street at all. The growth forces are not yet entirely irrelevant. President Reagan still shows up at his desk in the Oval Office, not thoroughly paralyzed, still receptive to arguments against tax increases and trade protectionism. He hardly did more than raise his eyebrow last week and pulled the dollar out of its nosedive, which suggests world markets have not bought the going line that he has already been worked on by a taxidermist. Rep. Jack Kemp, who has always been Reagan's chief lieutenant of the growth forces, does not see the wisdom in a campaign of bitter medicine, and, as in '82 when he led the fight against TEFRA, is awaiting the monstrosity the Budget Summit will produce. He continues to insist neither the people nor the economy are yearning for higher taxes, regularly repeats his call for a withdrawal of the trade bill, and has not strayed from his campaign promise to deliver a gold-based monetary reform. It's anyone's guess where Vice President Bush will be on the summit deal, but his close friend, the Treasury Secretary, will have to take him into account when the deal is cut. How much bitter medicine can the Veep swallow with New Hampshire just around the corner?

JBIII is still the problem, the fellow we thought was going to hold the world together. But he has his problems too, and just might get tired of hanging around the austerity crowd as he did once before.