Our moderate March gloom has given way to a sprinkling of April sunniness. There are still clouds over Tokyo and Vilnius, but they're not quite as dark as they were just a week ago. At home, the national credit squeeze is still underway, but at least there is heightened awareness that it's been caused by regulatory excess and creditor psychology, not the absence of liquidity. Psychology could turn rather quickly with a little zip out of the Bush Administration on tax policy, and we note that the White House has lit a small fire under itself to go after the capital gains cut. The last two quarters of slow growth, which we thought was inevitable after the capgains debacle of last October, should be behind us. Economic activity should poke through soon, with the tulips. Herewith some embellishments on these observations:
The Credit Squeeze: Excesses in extending credit are always followed by excesses in withdrawing it. We do it with our children. They do it at banks. We are now in the withdrawal period. Regulators, who had been criticized for not regulating when banks and savings institutions were throwing around federally insured deposits as if the party would go on forever, are now strutting their stuff after the party has closed down, berating the clean-up crews. Michael Milken, who began warning of debt excesses in '87, in the midst of the party, is now being blamed by the drunks for having brought the booze. Bank lending officers who did not know bad loans when they saw them now do not know good loans when they are under their noses. Across the whole country, established enterprises and thriving concerns are confronting credit institutions that have "pulled their horns in," as the saying goes. The banks are simply buying gilt-edged commercial and government securities until the psychology changes. They can't be talked into lending. The change occurs when brave souls go out and take business away from the faint-hearted, who are then subject to criticism by their credit committees for letting business get away from them in a perfectly good economic climate. This will happen sooner or later, depending on the profit opportunities.
Capital Gains: The credit squeeze psychology will end sooner if there is progress on capgains. The Washington Post last Sunday, April 1, reported on its front business page that the White House is going to go all out this year to win on capgains. No fooling. My guess is that the President will go all out, and his chief of staff John Sununu will, and OMB's Richard Darman will, and even Treasury's Nick Brady will. They will all be mad if they fail. I still don't think they are going about it in the right way, but it is early in the season and we're not even out of spring training. I'm at least encouraged by the enthusiasm. The more we see, the more enthusiastic the equity markets will be, a condition that also loosens up the banks. Treasury's Nick Brady blames the Fed for being too tight on credit. But he does not quite understand that the problem is not one of liquidity. An easing by the Fed would simply drive buyers out of the bond market without much effect on bank loans. You can't push on a string, as our grandfathers learned in the Great Depression.
Fed Policy: The plunge in the gold price into the $360 range was blamed on sales by the Arabs. But we know, don't we, that Arabs don't make the dollar price of gold. Arabs sell gold when they expect the price to go lower than $380. Why should it go lower? Because the Federal Reserve is not going to supply more liquidity to the banking system to permit it to go higher than $380, at least under the present circumstances. Gold has bounced back to $375 because others are betting maybe the Treasury will agree to sink the dollar at the G-7 meeting in order to accommodate the Japanese, who are complaining about the yen weakening. It doesn't make much difference what the Treasury team decides to do about the dollar, though, because the Fed is still in control. The Treasury can order the Fed to dump a carload of greenbacks on Tokyo, to soak up yen. The Fed will simply withdraw a carload of greenbacks from New York, at the open market desk, and the pool of liquidity will be exactly the same. As the tulips appear, with the robin on the wing, economic activity will poke through, increasing the demand for dollar liquidity. Gold will slump toward the $350 level, which will then suggest we can expect an easing, adding liquidity to meet genuine demand. This will really help break the credit squeeze psychology
Tokyo: The tailspin in the Tokyo stock market remains insulated to a great degree to other world bourses, as if "Japan, Inc." were a single stock on a world market, its fortunes soured by internal difficulties and trade and finance problems with its principle customer, the United States. The idea that the Japanese would pull their "money" out of the U.S. financial markets to cover their losses on the Tokyo exchange is only possible at an anecdotal level. Japan's $50 billion trade surplus with the U.S. requires a capital outflow of that amount from Japan, directly or indirectly flowing to the U.S. A weakening of the Tokyo stock market represents a decline in the estimates of profit opportunities there, which means more capital, not less, leaving Japan for the rest of the world -- hence, a greater trade surplus. The tide is inexorable! Japan can not run a trade deficit with the U.S., because the U.S. is the only nation big enough to absorb Japan's surplus capital and so far willing to do so. The only way out of this dilemma is for Central and South America, and the USSR and China, to become magnets and major users of capital through supply-side fiscal and monetary reforms.
Lithuania: On the margin. For the last year, we held our breath, waiting to see where Mikhail Gorbachev would draw the line, and it turned out to be the land of my maternal grandparents. If Lithuania were to blow up on him, chances are it would be the end of Gorbachev as we have known him, his political reserves depleted. He needs time to devote to the economic deterioration at the center of the empire, which is what he bargained for with Lithuania. Once again, my hat is off to James Baker III and his team at State, mixing exactly the right diplomatic ingredients to pull Lithuania away from the switch without selling them out. In a few years they will get their referendum on independence, after Gorbachev has had time to make the USSR a more attractive place for federation.
The Soviet Economy: On Friday, of this week, I travel to Moscow at the invitation of the government to outline a supply-side plan to lift perestroika off the ground. I'm proposing an 18-month strategic study involving an international team of economists, which would operate with the assistance and resources of the Soviet government. I'm advised that my outline is the only one known to Moscow that does not require an initial period of austerity, pain and suffering by the Soviet people. (The lead editorial in today's New York Times concedes that it does not know how to avoid such pain and suffering.) I've advised the Soviets that I believe 75 years of pain and suffering is enough, and Gorbachev should not have to inflict more. Nor can he; no mix of diplomatic skills could prevent widespread rebellion in the republics. In Moscow I'll meet with the Deputy Prime Minister, Dr. Leonid Abalkin, Gorbachev's chief economics minister, and several other ranking economic officials at the finance ministry, foreign ministry, and state bank. I've invited the WEFA Group of Bala Cynwyd, Pa., the combined Wharton and Chase econometric companies, to participate as associates in the project, if the Soviets choose to go ahead. With me on this trip will be the WEFA Group's CEO, Gerald Vilas, and its COO, William Mundell. I'll let you know how this turns out when I return next Wednesday. It could be big stuff.