The Fed Surprise
Jude Wanniski
May 1, 1991

The only good accomplished by the Fed's surprise move Monday morning to cut the discount rate a half point and fed funds a quarter point was to provide the markets a rough guide to deflation's floor, which we observed was getting close. Otherwise, it threw off the wrong signals, indicating the Fed could be bludgeoned into action by Treasury Secretary Nick Brady. Until this weekend, Brady has simply been a nuisance with his incessant calls for "lower interest rates," as if Fed Chairman Alan Greenspan simply has to turn a faucet located near his desk. Again and again over the last three years, ever since Brady took over from Jim Baker toward the end of the Reagan era, Greenspan has managed to finesse Brady's pleas for confetti money. Nevertheless, as we have been suggesting for the past two years, the entire interest rate schedule for dollar assets is surely higher because of the Brady factor. Global markets have to take hedge insurance on the chance that this close friend of the President, from his powerful post at Treasury, will someday outmaneuver the Fed chairman. He did so over the weekend.

He did so by making himself and the President seem weak and ineffectual as the G-7 finance ministers and central bankers met in Washington. In the days prior to the meeting, Brady had been sounding off about worldwide interest rates, practically insisting the Bundesbank ease up. At the G-7, Bundesbank President Karl Otto Poehl, a mean old man who has a low opinion of Brady and almost everyone else, told Brady to go fly a kite. Whereupon Brady dragged his pal, George Bush, onto the scene, with the President making a plea for a global interest rate reduction. The G-7 politely told the President to go fly a kite. With Brady having been successful in making the Commander-in-Chief of Operation Desert Storm look like a chastened crybaby, the White House turned to the Federal Reserve. Putting myself in Greenspan's shoes, I would have done exactly the same as he. With his renomination hanging in the balance and the certainty that if he is not renominated, Brady will try -- and probably succeed --in getting a Confetti Chairman appointed, Greenspan relented. He was able to persuade his other Fed governors -- Wayne Aiigell excepted --to help him wipe Brady's egg off the President's face.

Angell, who has helped Greenspan find ways to maneuver around Brady these past three years, cast his lone dissenting vote to keep faith with Price Level Targeting and $350 gold. Normally, a Fed chairman tries to avoid dissenting votes in such matters. Knowing Greenspan and the situation he found himself in, though, my guess is that he is pleased to have Angell stand fast to fight another day. Meanwhile, the President seemed so thrilled to be rescued by Greenspan that he came close to endorsing him for another term. Brady, on the other hand, immediately announced his view that the Fed had not eased enough, an indication he might still make a run at Greenspan to get his own boy in the chair.

The dollar's dramatic slide against the Deutschemark, to 169 from 178 in a few hours of trading, was probably overdone. The market's first reaction would be to see the Fed's move as an abdication of leadership to the Bundesbank instead of a necessary political tactic by Greenspan. The price of gold, which had traded almost at $350 at midday Monday, climbed toward $360 on the news, but settled back a bit on second thoughts. Greenspan only had authority from the regional presidents to cut fed funds by a quarter, to 5 3/4%, which I think was fortunate for him and AngelFs PLT. It should seem clear that Angell will continue to dissent on any moves to ease until gold trades below $350, and that his resolve and principle will provide a useful anchor for the rest of the board.

Brady's desperate maneuvers at least revealed his growing concern about the economic recovery he and CEA Chairman Michael Boskin have been promising the President for a triumphant 1992 re-election. As I indicated last week in "Temporary Gridlock," 4-24, the President and his economic team are beginning to realize the end to the "recession" may not feel like happy days are here again. If your income rises by a dollar a week for six years, then falls by a dollar a week for 40 weeks, it will not feel like much if it resumes a climb by a dollar a month. And as we have been warning the President's economic team since October 1989, when it dropped its fight for capital gains tax reduction, emerging economic weakness would be compounded by state and local government tax increases -- not to mention the Darman-Brady-Boskin tax hike of last fall.

Economic weakness in Europe is contributing to the problems here, but Nick Brady's answer of having all the central bankers turn on their faucets is no answer at all. The problem in Europe is Karl Otto PoehPs vindictiveness. Poehl last year fought Germany's Chancellor Helmut Kohl on Kohl's brilliant plan to swap Deutschemark for Ostmark at a one-to-one rate. Poehl's ferocious opposition, on the spurious grounds that it would be inflationary, forced Kohl to cut the plan back to a limited exchange -- cheating the people of East Germany out of some of their life savings, (instead of all of it as Poehl would have preferred). Poehl, having predicted the move would be inflationary, then hiked interest rates to fight the non-existent inflation, sending the DM into the stratosphere and the DM price of gold plunging. When this deflation brought Kohl to his knees, begging Poehl for ease, the Bundesbank President hinted he might do so if the Chancellor did his part in fighting inflation --by repealing the income-tax cuts of the previous three years. The allegedly brilliant Dr. Poehl has thus provided the worst possible climate for the economic integration of Germany. Monetary ease, which would have been appropriate to keep the DM from soaring, now is much less appropriate, with the tax increase doing the damage it has.

Monetary ease in the United Kingdom is no bargain either. As in the U.S., the problem is Nigel Lawsen's 40% capital gains tax. Prime Minister John Major, though, has been persuaded by his Darmans and Bradys that it was the Thatcher poll tax that did Maggie in and threw the U.K. into recession. Neither Britain nor Canada will deal with capital gains until George Bush gets the job done, and the President hasn't begun the fight. He will concentrate on Mexico this month, getting "fast track" approval from Congress. But that gets harder as the economy weakens and unemployment climbs -- playing into the hands of organized labor and the industrialists who want protection from competition, not more free trade. If the U.S. economy were now expanding, the AFL-CIO wouldn't have a prayer of stopping the FTA. As it is, the President has to make more concessions to the opposition almost daily in order to hold his ground.

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The most encouraging developments of the week came from Moscow, as President Gorbachev demonstrated anew his appreciation of the democratic process --by striking a deal with the opposition reformers led by Boris Yeltsin, president of the Russian Republic. At the summit meeting outside Moscow over the weekend, representatives of the 15 republics met for the first genuine discussions about the philosophy of federation. How much economic power should the republics have? How much the central government? Should there be one currency or many? How shall taxes be levied and budgets addressed? We see the glimmerings of a Constitutional Convention.

I was asked this week by the Soviet Embassy what I thought would be in the national interest of the United States a dissolution of the union, a division, or preservation of the union. The optimum, I suggested, would be preservation of the union within a framework of democracy that accommodated the political interests of all minorities in the union. Many of my hard-line friends, including Defense Secretary Dick Cheney and Wall Street Journal editor Bob Bartley, seem to think it might be better if the union dissolved. The upside they see is the reduced threat of a military superpower well into the future. The downside I see is 15 countries each grappling with the same problems the union is facing now, and within each, ethnic and religious factions pressing more and more devolution. In the chaos, the likelihood of nuclear weapons getting out of hand is not a small consideration. Another friend who has been rooting for Gorbachev's failure recently berated me for advising the Soviet government on how to make perestroika work. I asked the man, a devout Christian, if, after years of trying to persuade an atheist to accept religion, he would refuse to give him guidance when asked.

There are so few devout supply-siders in the world, I can hardly afford to turn away any inquiries, from the Kremlin or the White House. Lately, I've been having more luck with the Kremlin.