George Bush, Demand-Sider
Jude Wanniski
January 23, 1990

 

We've been pointing out for years that George Bush is a composite personality the Connecticut Yankee and the Texas wildcatter, old money and entrepreneur, elitist and populist. Like Ronald Reagan, he has a college degree in economics. But where Reagan studied at a time when only supply-side theory was in the curriculum, Bush at Yale in the late '40s had a mixture of older teachers professing supply theory and young teachers asserting the avant garde Keynesian demand-management. The President can move easily from one to the other, from growth to redistribution, which is what we're afraid we've been seeing happening in recent weeks to the Bush administration in general.

It is also true that the dominant economic players in the administration are composites. At the micro-economic level, CEA Chairman Michael Boskin and OMB Director Richard Darman are firmly entrenched in the supply model. But at the macro-level, there are policy strands in their heads that emerged from old-fashioned, conservative demand theory. These ideas, which center on Keynesian "propensity to save" concepts and their concern about a low national savings rate, find resonance in Nick Brady's Treasury. We've worried about this element in the Darman-Boskin team, which found expression in Darman's "now-nowism" speech last year. And I've argued with both in recent years that their focus is misplaced. Indeed, two weeks ago I reminded Boskin that when I first met him, in the 1970s, he was introduced as a supply-sider, but immediately launched into a discussion about the savings rate. I reminded him that I advised him back then that savings was a demand function, which has little direct relevance in a supply model.

It has not been a problem to any great extent thus far, because it has been confined to generalities and speechmaking. But now it is, in a major way, directly threatening the supply-side agenda, the economy and both the stock and bond markets. We can now see a realistic scenario that has the Dow, the price on the 30-year bond, and the President's popularity rating already having peaked for the entire year.

We were nervous earlier this month when Treasury unveiled its Family Savings Plan, a foolish waste of resources that sprouted from Nick Brady's fascination with the most conservative aspects of Keynesian savings-rate concepts. It's an expensive plaything for the Secretary, but we yelled instead of screaming because it will not do much damage, and it is difficult for anyone in the administration to tell the President's old pal Nick that it's a bummer even if they'd like to do so.

Suddenly, though, the Darman-Boskin fascination with savings has crept into policy. This is a result of Senator Moynihan's proposal to take the Social Security Trust Funds off budget, in order to expose the enormous surpluses in the funds and force populist cuts in the payroll tax. This "hand grenade," as Darman calls it, would simultaneously force tax increases elsewhere to meet the dictates of Gramm-Rudman. We have been in agreement with the administration that the budget should remain unified, but not that the payroll tax should remain intact. It seems to us that it is appropriate to allow a big surplus to build up in the Trust Fund, to cushion the pressures on the system when the baby boomers retire from 2012 onward. But it isn't right for the administration to allow an excess surplus to build, a "surplus surplus," one that was not contemplated by the Greenspan Commission. The commission, of which Moynihan was a member, did not anticipate the success of Reaganomics in pulling the Trust Fund out of its $4 trillion actuarial deficit as quickly as it has, just as no demand-side economist saw unfunded corporate pension liabilities being wiped out by the roaring success of supply-side economics.

Darman, though, has gotten greedy in a policy sense, and he's talked almost the entire Bush team into backing him on his scheme to use both the surplus and the surplus surplus to retire the national debt in the 1990s, all $3 trillion of it, thereby adding enormously to the national savings rate. He thinks. As Alan Reynolds explained the Darman Plan, forcing budget balance in the general fund and the paying down of national debt by Social Security surpluses would simply bankrupt businesses and households at a colossal rate. In this Great Depression, the Social Security Trust Fund would be sent back into deficit by several trillion dollars, along with corporate, state and local pension funds.

For this reason we have not the slightest doubt that it will be laughed out of the ballpark when given a bit more scrutiny. Richard Rahn, chief economist of the U.S. Chamber of Commerce, is already semi-hysterical with laughter. We also have not the slightest doubt that the Moynihan Plan of taking the Trust Fund off budget will get nowhere, as the Democratic leadership in Congress fully realizes it will put pork-barrel and new welfare-state spending beyond their reach for another generation.

Why do we worry, then, if all this nonsense is going nowhere? First, because it threatens the administration's proposed cut in the capital gains tax. As we have previously noted, when a GOP administration is dominated by demand-siders and the Democratic Congress is as well, at best we have a repeat of the Eisenhower years. The Republicans oppose a tax cut on labor and the Democrats oppose a tax cut on capital. Political gridlock results.

This leads to our second worry. In the Eisenhower years, because of gridlock over taxes, the White House spent its energies yelling at the Fed to provide lower interest rates. The Fed tried to accommodate, but of course all that happened was a gold outflow. We're already seeing the beginning of this, with President Bush, egged on by his advisors, telling the Fed he wants lower interest rates. And it isn't Paul Volcker's Austerity Fed that he's complaining about. It's Vice Chairman Manuel Johnson and Gov. Wayne Angell, the two most growth-oriented, supply-side Fed governors appointed by Ronald Reagan. Both Johnson and Angell know that any sign that they will comply by lowering short-term rates will bring a collapse in the bond market. In fact, the White House pleas for lower rates have had the opposite effect on long-term interest rates, which the Fed doesn't control at all. I am certain that the President doesn't understand this subtlety of monetary policy, or he would see that long-term interest rates would fall if he defended the Fed. Global markets for dollars and dollar assets, though, smell devaluation in the air. Japan, which is most sensitive to this possibility because it has accumulated more dollar assets than others, has been getting clobbered as these dollar fears waft across the Pacific.

Johnson and Angell, along with Greenspan, have policy under control at the moment, which is why spot gold and the dollar are holding steady. But the markets have to fear that the scenario unfolding will undermine their position, and the Fed will be pushed into an easier stance, which is why we're seeing weakness in the longer maturities. In the 1950's we had a gold outflow. Now, with no link to gold, the dollar will simply decline in value as the gold price rises, and foreign investors in dollar assets will suffer capital losses. The quickest way to get the Japanese to stop buying Treasury bonds is for the President to yell at the Fed!

There is nobody who admires Darman more than I do, as our clients know full well. His brilliance has also made him the premiere architect of the Bush Administration's economic agenda. A highspeed computer, though, gets to the wrong conclusion faster than others when it is fed a wrong assumption. So too with Darman. The glitch in his analytical framework threatens all of 1990, and he is so certain of his logic that he can't be budged. In a Darman profile in the National Journal this week, an OMB aide is quoted as saying of him: "When he seeks advice, Darman looks in the mirror."

We're trying our best to find a way around him. If somehow Darman can get past this glitch, we could be back on track in a hurry. But if the economic quarterback on our team is throwing against us, how can we be other than discouraged?