After speaking with key figures in the Bush Administration in recent days, I'm reassured that there's still a high level of confidence that the Democrats will cave in on capital gains. Richard Darman's basic strategy is still intact, not withstanding Dan Rostenkowski's labored pirouette. Rosty played Scarlett O'Hara to Darman's Rhett Butler, first sending the Dow Jones Industrial Average climbing by coyly flirting with the idea, showing a little ankle in the form of a one-year trial balloon. When Darman turned up his nose, Rosty played the maiden scorned, slammed the door in a huff and dashed the DJIA by a hundred points in the process. But Rhett can still see Scarlett peeking through the curtains.
Do not take seriously the press accounts of this skirmishing. Darman is not wimping out, as The Wall Street Journal's Washington Bureau suggests. His plan has always been to have the Democrats accede to the administration on capgains because all the other options are so unpleasant, not because they are suddenly struck by the wisdom of the idea. Rostenkowski's dancing around in public is for the benefit of the Democrats on his committee, his right flank and his left. This is why Darman is maintaining a studied silence. It isn't time for Darman to do anything but look bored with Scarlett's nickel-and-dime flirtations. ("Frankly, Rosty, I don't give a damn.") As long as Darman has the President's OK to go to a sequestration on Gramm-Rudman, he can wait for Rosty to do more than simply flash a little ankle. (You've heard that politics makes for strange bedfellows, haven't you?)
Our ballpark guess is that a 15% capgains rate is worth 500 points on the DJIA. The market had discounted 100 points of that when Rosty did his pirouette. So there's not much downside to losing on capgains, and a big upside if Darman turns out to be right. As we get closer to budget reconciliation, amidst worries of a recession, the administration undoubtedly will be much more aggressive in blaming the Democrats for footdragging.
The signs of economic weakness have been pressing on the Fed, which is pondering "To ease or not to ease." At this juncture, I'd prefer that the Fed stay firm at 9 ½ fed funds, and wait for another slide in the price of gold before throwing more liquidity into the system. For one thing, I don't think the monetary lever should be used to directly stimulate the economy, only to maintain long-term price stability. With gold at the midpoint of the $350-to-$400 range, the dollar losing its recent clout against the DM and yen, and yields on the rise, this seems a good spot to steady. Alan Reynolds would ease ¼ point, but no more, and see what happens all around, and this may be the outcome of this week's FOMC meeting. The sudden softening of the dollar and the climb in the price of gold on Wednesday suggests the markets are betting on ease. But I think it's a positive sign that Alan and I can be splitting hairs at this stage, a week in advance of the Paris economic summit. I'm hoping the G-7 heads of state will have something constructive to say about international monetary policy. The U.S. has been an interested bystander in European Monetary System negotiations, with Maggie playing Scarlett O'Thatcher over there. It wouldn't surprise me to see the discussions broaden, with the U.S. becoming active, rather than bystandish.
These maneuverings and adjustments on taxes and money are par for the course, with recent ups and downs in China, Japan and on Capitol Hill. But the general drift remains positive, moderately bullish. As the commander-in-chief says, stay tuned.