Back with the Bulls
Jude Wanniski
May 23, 1990


In just the last several days our sense of the political landscape suggests we are definitely out of our trading range posture and back with the bulls. The most important development has been the marvelously hostile reaction of congressional Republicans to the Bush Administration's budget strategy. This indicates to us that Richard Darman has fouled out, and we are going to get a new man in the batter's box on capital gains. The key man is Rep. Newt Gingrich, the House Minority Whip, who has been stretching thin the patience of his GOP constituents in the House by going along with Darman, essentially to give him his time at bat. Gingrich, we think, will be much more political, more openly aggressive in making the case for capgains.

The abandonment of the Gramm-Rudman targets for this season is now in the back of everyone's mind, now that a bipartisan consensus has agreed to compromise them anyway. Darman's strategy, last year and this, was to use Gramm-Rudman to wring capgains out of the Democrats, because it can be counted a revenue-raiser. If the G-R targets are kept, after adjustment downward to prevent any real squeeze to the economy, this Darman ploy will still pay off. For this reason alone, Senator Bob Packwood, the ranking Republican on Senate Finance, thinks capgains is in the bag. But the arguments we've been making here for capgains are also spreading, and here Gingrich is the man on the margin: He is unquestionably the one Republican that congressional candidates who are challenging Democratic incumbents are looking to for guidance. And he's fully prepared to fire them up on this issue.

HUD Secretary Jack Kemp, a member of the Resolution Trust Committee, got the ball rolling this morning in testimony before the Senate Banking Committee. Asked by Senator Connie Mack of Florida if the S&L problem would be smaller if capgains had passed the Congress last October, Kemp replied that he had asked William Seidman that very question on Monday, at an RTC meeting, and Seidman replied with certainty that it would. Not only would the S&L portfolios be more valuable, but the assets already acquired by the government in the bailout would have enhanced value and bring better prices at auction. A Treasury study of the budget implications of capgains on the S&L problem is said to be in the works. There's nothing the Congress could do to more quickly slow the budget hemorrhaging over the thrifts than to have the Senate dust off the House-passed capgains bill and put it to a vote. The liberal Democrats will not be able to withstand the withering fire on this issue if they again try to block capgains. As this becomes clearer, the Dow should be past 3000 on its way to the next millennium.

At the same time, our confidence in bonds will be paying off. For weeks, the White House and Treasury have been spreading the notion that the budget summit is necessary to win over Alan Greenspan, to get him to ease up on monetary policy. Any way this is sliced, it's baloney. Darman may have it in his mind that in 1982, when TEFRA, the big tax hike was approved, the Fed eased and interest rates plunged. But this generalizes from an anecdote. In the summer of 1982, we had been screaming for nine months that the Fed was deflating and the economy was starved for liquidity. The Fed easing came not from TEFRA, but Mexico's revelation to Paul Volcker that it could not pay its debt to our banks. The conditions now are entirely different, and we have completely supported the Fed's firm posture pointing out that Fed Governor Wayne Angell proved correct in December, when he warned an easing would produce a rise in bond yields.

Today's $12 plunge in gold to $363 is another bullish sign, in that it gets us closer to a Fed easing that would, in Angell's mind as well as ours, produce a fall in bond yields. Fed policy is disconnected from the budget process, and will stay that way. It should be clear that the old Hooverian arguments about budget "crowding out" in the capital markets can hardly be at work, with interest rates coming down even as Darman jacks up deficit estimates by the hour.

The steadiness of Fed policy is critical around the world, as it continues to give Europe and Japan a dollar anchor as guide. As an example, the uncertainties about how monetary union would be arranged in Germany, which caused bonds to sag in Frankfurt, have now passed, and the credit markets have strengthened there. It was important for the Bundesbank to have the Fed remain steady throughout that exercise, instead of bowing to White House pressures to ease. And but for the Fed's steadiness, Japan's financial markets likewise might still be in a tailspin, instead of now correcting for the Bank of Japan's own monetary errors. Angell will testify June 14 before a House Banking subcommittee on his price-level targeting model, which we surmise will generate positive information for all dollar assets.

As positive as the picture seems on the Western front, it gets worse in the East. President Gorbachev's new economic plan for the USSR resists the "big bang" to which Poland subjected itself. But his scheme is just as awful, doubling controlled prices in an attempt to catch up a little bit with the black market. It's a Solomon-like decision, slicing the baby in two, and the cries of anguish were so quick to appear, he may put the plan to a national vote. If so, it will surely be rejected. He needs to try a little monetary deflation instead, and the huzzahs would be immediate. I am on a list to see him next week in Washington, the Soviet Embassy tells me. If I somehow make the cut, I will personally tell him how to get the bulls running in Moscow.