Market Jitters
Jude Wanniski and David Goldman
March 13, 1991


GROWTH AGENDA: The stock market retreat from a 3000 DJIA, with a steeper slide in the low-cap NASDAQ hi-tech stocks, reflects a growing fear of White House inertia on economic policy in the face of continued weak economic news. Insofar as Wall Street's euphoria since mid-January has fed Administration complacency on the economy, it might take a sharp slide and more rumblings about a puny recovery from recession to jar the White House back to reality. OMB's Richard Darman counsels patience on the economy, arguing it will be okay without the political fuss of pushing a capital gains cut. This flabby posture is what Ways & Means Chairman Dan Rostenkowski sees, which is why he advised the National Association of Business Economists today that they shouldn't expect a capgains cut. He said he doesn't think the White House has the stomach for an all-out capgains fight and he doesn't think a bill could be reported out of his committee this year. My soundings continue to turn up more support in and around the White House for a capgains push than Rosty is seeing, even a sense that Rosty's threat of a nasty war is as hollow as Saddam Hussein's blustering last fall. Treasury Secretary Nick Brady was better than ever yesterday in a tangle with Rosty over capgains during his Ways & Means testimony. I'm also told the President himself is still serious about capgains and his political advisors are cautioning against the idea that his extraordinary popularity following the Gulf War will allow him to coast to re-election. The next two weeks may be very important in determining how the issue will be shaped. (JW)

DOLLAR RALLY: Massive central-bank intervention has had remarkably little effect in stopping the dollar rally we called, on the button. The more noise the Bundesbank makes about keeping the mark "strong" at overvalued levels, the more the market smells blood. British, French, and Italian hostility to Germany's overly tight money policy doesn't add to the credibility of the intervention. Although Treasury joined the intervention earlier this week, Washington agrees with London and Paris that German interest rates should fall and is unlikely to remain in the trenches with the Bundesbank indefinitely. Bundesbank President Karl-Otto Poehl worries that the dollar will overshoot, disrupting German capital markets at a difficult time. Germany's best bet to prevent this would be to keep the mark stable against gold, emulating the Federal Reserve's commodity-oriented monetary policy of the past year. By jacking up the mark artificially, Poehl contributed to the danger of overshooting, which now appears likely to become reality. (DG)

EUROPEAN RECESSION: U.S. economic officials worry that Germany's monetary errors may spread recession throughout Europe. In addition to excessive monetary stringency, the German government succumbed to pressure to "take the burden of fighting inflation from the Bundesbank" and wiped out the growth stimulating tax cuts of the past two years with a 7.5% rise in average tax rates. Finance Minister Theodor Waigel announced yesterday that the value added tax would be raised in 1993 as well. These measures, designed to compensate for a DM 100 billion increase in Germany's deficit due to the absorption cost of the eastern half of the country, will make matters worse. East Germany desperately needs tax relief to get off the ground; instead, the former communist sector will start out with a tax hike. The Bundesbank's defenders point to a significant drop in German bond yields during the past month, but this appears to reflect a decline in real, not nominal, interest rates, anticipating a sharp growth slowdown later this year. Other European economies were buoyed by exceptionally strong German growth during 1990, when industrial production rose by 5.6%, and retail sales grew by 11.6%. German imports from European {rading partners showed double-digit increases last year. Stagnation in Germany will push the already weakening Italian economy into recession, put France on the borderline, and worsen the present recession in the United Kingdom. During her Washington visit last week, by the way, Margaret Thatcher told people we know that one of her worst mistakes was allowing Nigel Lawson to increase the capital gains tax to 40% two years ago. (DG)

MEXICO BOOMS: Mexico's stock market has risen about 18% since the beginning of the Gulf War, driven by the rally on Wall Street as well as falling inflation and an expected boom in 1991 corporate earnings. A set of policy triumphs by the Salinas administration during the past two weeks contributed to the rally. These included a remarkably broad base of support for the first round of bank privatizations and a hedging operation on futures markets which guarantees high oil revenue through 1991. Mexico's northern provinces are experiencing spectacular economic growth, far in excess of the official GNP growth rate of 3.9%. For the first time, the Finance Ministry is publicly talking about growth policies that could shift the GNP rate to 7%, which it had experienced in the '60s. We will have a longer missive on this next week. (DG)

CANADA BUSTS: Unemployment in Canada now tops 10%, exceeding 14% in Quebec. Prime Minister Brian Mulroney's popularity is challenging Mikhail Gorbachev's ratings in Lithuania. The Bank of Canada's John Crowe continues his maniacal austerity on interest rates. Finance Minister Michael Wilson does not seem to have the slightest idea of what to do as his budget deficit soars --the equivalent of $350 billion in the U.S. Shall he propose higher taxes again to restore confidence, and maybe John Crowe will relent on his squeeze? Or should he cut the capital gains tax that he boosted in '87? Should he ask Dick Darman? (JW)

FTA IMPERILED: Only a week ago, Democratic leadership on Capitol Hill was said to be divided on the "fast-track" approach on a Free Trade Agreement with Mexico. House Minority Leader Richard Gephardt leads the opposition forces of economic nationalism, protectionism and the environmentalists; in other words, the Forces of Darkness. Senate Finance Chairman Lloyd Bentsen and House Ways & Means' Rostenskowski, though, were said to be allied with President Bush in supporting the fast track. Now they've written the President asking him to address "specific concerns [that] include the disparity between the two countries in the adequacy and enforcement of environmental standards, health and safety standards and worker rights." Clearly, they have been co-opted by the Forces of Darkness and, as with capital gains, are testing the President's willingness to fight for free trade and entrepreneurial capitalism. If he loses fast-track authority, which would come with a House or Senate disapproval resolution prior to June 1, not only does the Mexico agreement go down the chute, so does the GATT's Uruguay Round. A Bush speech next week to a Hispanic audience gives him a chance to signal his resolve. (JW)

JOINT TAX COMMITTEE: The new chief economist of the Joint Tax Committee of Congress, Alan Auerbach of the University of Pennsylvania, is about as ardent a foe of capital gains tax differentials as the Democrats could find. We're advised Auerbach has even floated schemes in the past that would enable Internal Revenue to tax unrealized capital gains -- forcing individuals to mark to market! Imagine having to mark the family farm to market annually, then finding the cash to pay the capgains tax! This guy is more dangerous than Willie Horton. (JW)