The showdown we've been waiting for arrives next week, as Congress returns from its recess Tuesday and the Budget Summit resumes Friday. The bad news is that during the recess, President Bush clung to his budget director's strategy of elevating the deficit instead of economic growth, which implies tax increases rather than tax cuts. The good news is that the pivotal Republican in Congress, House Minority Whip Newt Gingrich, finally peeled away from support of this strategy and has committed himself to marshaling GOP congressional forces against it. The Wall Street Journal's "Washington Wire" this morning reports "the White House is steaming over...Gingrich's call for tax cuts rather than tax increases. Budget officials say they may rely on Democrats alone to get any package through the House, ignoring the dissident Republicans."
The idea of getting a budget agreement through the Congress without the majority of House Republicans is absolute nonsense, and the item itself probably will be used by Gingrich to whip up further support among Republicans for his crusade against the bureaucrats at OMB and Treasury. With House and Senate elections two months away, Gingrich's sales job with GOP incumbents and challengers will be as tough as selling lemonade in the Sahara. With the economy edging toward recession and Middle East uncertainties propping up oil prices, Gingrich is also on firm ground. The White House, particularly the President, should soon be happy, rather than "steaming," that Gingrich has paved the way for a change in strategy.
The word I get today is that the bipartisan political leadership in Congress, along with the White House, is preparing a drastically scaled-down budget "deal" that will require no new taxes beyond the nickel-and-dime revenue enhancements included in the original administration budget. Capital gains, which has been burdened with the excruciating demands of budget politics, will be free of these as soon as it is clear all hands will be satisfied with a scaled-down budget agreement.
Gingrich himself will raise the capital gains proposal in the House, in parallel with the Kasten-Mack bill in the Senate. Once capgains is freed of Darman's strategy and standing on its own, the President will be free to speak out for it -- tying it to the health of the economy. The issue will be joined as the Democratic leadership once again insists it will not be good for the economy, benefiting only "the rich." Depending on the level of turbulence in the Middle East, the tax issue will be more or less the central focus of the congressional elections, with Gingrich having dragged the administration back on the right side of the issue in the nick of time. To have GOP candidates running around their districts promising fiscal austerity would be the height of political folly. The Congressional Budget Office, you may have noticed, yesterday fired a volley on behalf of the liberals, issuing a report that dismisses the benefits of a lower capgains tax. The Democrats are careful to avoid discussing any spending cuts; their argument is firmly in place that the Federal Reserve alone is responsible for avoiding a recession via easier money.
The Fed's Alan Greenspan, of course, is in a most unhappy position. The Fed's July move to ease moderately,, cutting Fed funds to 8% from 8 3/8%, might have been okay with everything else being equal. But when Saddam Hussein grabbed Kuwait, that extra liquidity and expectations of more to come from the Fed sent gold soaring, the dollar plummeting, and the long bond over 9%. Greenspan could have offset these inflationary expectations by kicking Fed funds back to 8 3/8%. Such a move would have reversed the runup in oil futures as well, as a good part of the oil price increase of recent weeks in dollars has been related to the Fed stance and continued pressures on it from the bipartisan budget summiteers. Unfortunately, it is still too much to expect the Fed to cut so thoroughly against conventional wisdom. Isn't it funny, though, how experts all over Wall Street were saying the Fed couldn't ease because it would send long-term interest rates up, but nobody was saying if the Fed tightened, long-term interest rates would fall?
Greenspan is almost as ardent as we are in his desire to see a lower capgains rate, but has not spoken publicly on the subject. If I were he, I'd do so for self-protection, to implant the idea that maybe I wasn't responsible for the coming recession because of my refusal to inflate. If he were formally asked his views, I understand, he would do so. The same is true of Fed Gov. Wayne Angell, who privately argues that a lower capital gains tax is the only fiscal measure the government can take at this point that will enable interest rates to come down without further sinking the dollar. Angell believes the grass-roots pressure for cutting capgains is steadily building up, as every hour and every day somebody else in the country realizes how destructive the 28% rate is to his or her finances. The boats, he says, are coming down the river, crowding in behind the dam. Eventually, he thinks, the pressure will not be contained. This is what happened in 1978, when the Democrats controlled the White House and both houses of Congress, yet little Rep. Bill Steiger of Wisconsin sent the wall of opposition down with one blast from his trumpet. In the same way, House Democratic leaders last autumn could not contain the pressures from the grass roots. With the added pressure of elections this fall, which we didn't have last October, it should not take much for the Senate to cave. All that's been missing so far is a push from the President.
Newt Gingrich, the man to watch, is today on his way to Saudi Arabia for the weekend, on a plane carrying most of the budget summiteers. They will spend most of the trip to and fro trying to persuade him to get back in line. More likely, he will make the conversions. He hung in with the Darman strategy far longer than I expected, but once he broke, it was clean. On Wednesday in Washington, he'll make an important speech to the Citizens for a Sound Economy conference, one that will get unusual attention, as the Washington press corps begins to see a fascinating scenario shaping up. It will set the stage for the political campaigns ahead, the outcome of which will bear heavily on the course of U.S. economy and financial markets for the next few years.