Trade and Money
Jude Wanniski
May 3, 1988

TRADE: Senate Majority Leader Bob Byrd insists there won't be a new trade bill if the President vetoes the one he has. Senator Howard Metzenbaum says he'd filibuster any trade bill that doesn't contain a plant closing provision, which also suggests the legislation is doomed this year. But don't count on it. Jim Baker wants a trade bill and seems to think he can get one as long as the President doesn't tamper with the trade items in the bill in his veto message. Protectionists want the Super 301 provision so badly they'd shift heaven and earth to get it into law. Their game is to transfer trade authority away from the President to the trade bureaucracy, a "Trade Powers Act." This, in essence, is what Congress did in passing Gramm-Rudman, transferring budget powers to non-elected bureaucrats a dodge the Fifth Circuit Court of Appeals found unconstitutional. We've been urging the free traders in the Administration to concentrate all their efforts into requiring a Presidential signoff on all 301 actions before they go into effect, allowing the Chief Executive to kill trade actions passively. CEA Chairman Beryl Sprinkel, OMB Director Jim Miller, and, to some degree, Secretary of State George Shultz are leading the efforts to get the trade measures into the veto message, making the case to George Bush as well, but Jim Baker seems in control. There's no sign the President has been adequately briefed on the implications of Super 301.

Secretary Baker and Senator Bill Bradley (the most free-trade Democrat), insist the bill is much improved. They argue the bill will clear the way for GATT negotiations and will also spring the Canada trade pact, being held hostage by Senator Byrd. Bradley is at least unhappy that Super 301 survived, but thinks the language on authority transfer is ambiguous. I don't. It's my belief the transfer of authority in Super 301 overwhelms all other considerations. It would, even as The New York Times observed April 29, shift the U.S. Government into a decidedly protectionist stance. Both Baker and Bradley know White House insistence on retaining authority would doom any chance of getting the trade bill enacted this year, which underlines the real importance of the provision.

MONEY: In my August 3, 1987 client letter, "A Reagan Rebound," I warned that the Fed, in permitting the price of gold to rise to $450 from $400 "as if the climb meant nothing," had "bought higher consumer and producer prices in 1988" along with "higher wage demands." Further, "By next spring, after the horse has long gone from the barn, [Greenspan] will be pointing to the GNP, M1 and CPI signals and urging his fellow governors to lock the door with a monetary squeeze. Democrats will be demanding that he squeeze in order to demonstrate his independence from the White House and the Republican Party."

All this is unfolding at the moment, with a quiet panic in the Administration and at the Fed as the economy booms, the unemployment rate continues its decline, and all the indicators that lag the gold signal show up as "inflation." Every obsolete Phillips Curve economist on Wall Street is now "predicting" the Fed will tighten soon. ["I expect the Fed to tighten policy," perhaps as soon as Friday if the employment number is as strong as is widely expected, Manny Hanny's Charles Lieberman told The Wall Street Journal May 2].

Unhappily, the Phillips Curve lives on -- the idea that too many people working is inflationary. What we're seeing is an economy boomed by tax reform, plus creeping inflation derived from last year's unnecessary additions to liquidity by the Fed, which sank the dollar on the exchange markets. Happily, the Fed has been steady since then, more or less, with gold twice jumping on expected or actual easing of policy, and gold is back around $450. This means the lagged inflation signals we're seeing do not suggest things will get out of hand. But it does mean there will be arguments at the Fed, especially by the regional Presidents, to nudge the Fed funds rate up to 7%.

It would be quite all right for the Fed to do so as long as it made clear to the markets that it was fine-tuning. That is, that a snugging to 7% Fed funds, which would send gold down and the dollar up, would not be another in a series of tightening moves in reacting to strong statistics on the economy and employment. This was my constant plea to Paul Volcker in the early '80s, arguing that the bond market would react positively to a tightening of short rates when gold was above $400 as long as it knew it wasn't one of a series of moves constituting a general policy of deflation. That is, it wouldn't cause many problems now if gold was chipped down to $425 or even $400, reversing last year's move. But because Chairman Greenspan is known to the markets as a sometimes Phillips Curver, even a minor tightening move now would lead to expectations of more to come, another "planned recession."

The problem for Vice Chairman Manuel Johnson, and Governors Heller and Seger as well, is that if they now vote to tighten as Wall Street expects, what will they give as reasons? It's not very likely they'd say they would prefer gold at $400 or the dollar back at 150 yen (which they should have been watching but were not in '87). They'd have to say they worry about the economy being too strong or the producer price index showing signs of inflation. If they do, they are stuck, committing themselves to react next week and next month to the inevitable results of what they did on money last year and what has been achieved on taxes. That is, if you tell the world your inflation signal is the PPI, what do you say when it rises and you do nothing about it? As for Greenspan, unless he can slip off the Phillips Curve, he'll have to get louder and louder warning of inflation as the economy gets stronger and stronger going into the November elections. The Democrats will cheer him all the way to the polls.

My expectation is that the Fed will do as little as possible on this round, even if the unemployment number drops as expected. Just as the Fed voted to ease marginally in January and snug marginally in March, it would be difficult for Greenspan to get a consensus on anything but marginality in the weeks ahead. If these to's and fro's were symmetrical, we could expect a snugging by an eighth or sixteenth on Fed funds this month and an offsetting ease of the same magnitude in June. There would be screams from economists about "fine tuning," but when you are managing the value of the dollar, fine tuning is the only way to go.