July Downbeat
Jude Wanniski and David Goldman
July 3, 1991


TAX POLICY is said to be frozen, definitely, through the 1992 elections. Evans & Novak report with authority that any presidential discussions about tax changes, especially capital gains, are merely warm-ups to campaign rhetoric. An expected June push for capgains by the White House seemed a possibility following several aggressive speeches by the President. But this dissolved with the persistent reports that the recession is over, taking political pressure off the White House to do something. The GOP in Congress has now been overtaken by the idea that last year's Budget Agreement is working beautifully, in that it has prevented Democrats from coming up with new spending programs to combat the recession -- which was locked into place by the new Budget Agreement! House Minority Whip Newt Gingrich, who fought the Budget Agreement last year, told The Wall Street Journal this morning that he now thinks Richard Darman & Co. "deserve more credit than I thought last year." Budget Director Darman says: "I wouldn't say I feel vindicated, but I'd say I believe it was well worth taking the flak, because it's an agreement people increasingly recognize to be valuable." Of course, in order to get the agreement, Darman had to agree to higher taxes as well as abandoning the capital gains tax cut. The same WSJ article notes that the recession will probably push the budget deficit over $300 billion next year. A few lonely voices at the White House and Republican National Committee still believe there will be sufficient motivation in 1992 to push a "revenue neutral" growth package through Congress.

WAITING FOR ALAN GREENSPAN'S REAPPOINTMENT remains the single most important cause of market volatility as rumors persist that he will not get a second term. We're told repeatedly by sources that he is 95% secure, which The Washington Post reported yesterday. But we hear the President's best friend, Treasury Secretary Nick Brady, is urging the President to dump Greenspan in favor of New York Fed President Gerald Corrigan, a Paul Volcker protege who is in the hip pocket of the Big Banks and the Corporate Elite. Corrigan, by the way, is a pal of Harvard's Jeffrey Sachs. With this ominous possibility, the market will not bid gold below $365, the trigger-point for uncertainty about inflation expectations. Correspondingly, bond yields remain toward the top of their recent trading range. White House silence only five weeks before the August 11 expiration of Greenspan's term has become an embarrassment, to the point that former Fed Governor Martha Seger complained last week, "Private corporations don't operate this way, and I think this...should be viewed as a real challenge because of what it does to the image of the White House personnel policies and because of what it does to the Fed."

PURCHASING MANAGER EUPHORIA should be taken with a grain of salt. The 50.9% June index level states that in the opinion of the managers surveyed, the manufacturing sector was expanding rather than contracting in June. Scattered government and private survey reports are poor guideposts to the future. Today's DJIA slide suggests that Monday's 52-point rally was a bounce off the bottom of the recent trading range. At 2930, the DJIA remains below its pre-recession peak, hardly a harbinger of a strong recovery.

THE CONFIRMATION HEARINGS OF CLARENCE THOMAS to the Supreme Court will afford the nation the most important opportunity in many years to debate the status of race relations and the role of government in addressing them. Far more so than the televised hearings of Judge Robert Bork in 1987, the September hearings on the Thomas nomination will challenge the Democratic Party's claim to represent Black America through the emoluments associated with the Liberal Plantation. A black Roman Catholic with a white spouse, Judge Thomas is a much more interesting and complex man than the cardboard conservative thus far portrayed in the press. The hearings promise to be pretty rough, with so much political power at stake. Liberal Democrats can't arrange a full-court press against Thomas as they did against Bork, though, without risking a major split in the black community. Their best hope is to "whitewash" him. Black liberals are already spreading the word that he "thinks like a white man." Virginia Governor Doug Wilder's query about Judge Thomas' "allegiance to the Pope," re the abortion issue, adds another dimension to the slam-bang battle ahead.

TOKYO STOCKS not only failed to follow through on Monday's 3.5% rally, but gave back most of it last night on rumors that their stock market scandal is spreading. Kyodo News Service Tuesday cited the view of Japanese economists that the 0.5% rate cut announced by the Bank of Japan Monday morning will avert an economic downturn, but not restore Japan's previous growth levels, Japanese government officials indicated that the rate cut was timed to neutralize the interest rate issue at the July 15 economic summit in London. The discount-rate cut is more than symbolic, since the Bank of Japan is shifting over from a credit quota system to monetary management based on interest rates. Central bank governor Yasushi Mieno has been forced to back off from his commitment to crush "asset price inflation," i.e., discounting of future growth into the price of stocks or real estate. We have been critical of his approach for the past year, and are relieved to see him back off in the face of political pressure. The rate cut marginally reduces risk in the Japanese banking system, a positive step for global markets.

GERMANY'S CONSTITUTIONAL COURT blindsided us on the foreign exchange markets, with a July 27 ruling that will force the German government to increase taxes on interest income. A rush of funds into the U.S. out of the German bond market forced down Treasury yields, breaking the close relationship between the dollar and bonds we noted last month. Before this fiscal shock, bonds had been falling as the dollar rose, indicating that global investors were no longer willing to purchase U.S. securities at the higher dollar price, and that the dollar's rally was ending. The Constitutional Court's unexpected ruling, though, did more damage to domestic markets than to the mark; the DAX index of the Frankfurt stock exchange has fallen 5.1% since June 25. We still believe that the foreign exchange market has already discounted a feeble economic^ recovery into the dollar's value; the new variable is DM weakness, not dollar strength. The new Bundesbank president, Helmut Schlesinger, may work even harder than his predecessor Karl-Otto Poehl to push Bonn towards fiscal austerity.

MEXICAN BANK PRIVATIZATION may yield more than $10 billion, and add 20% to the total capitalization of the Bolsa de Valores, if the results of last month's auctions of three secondary banks are any indication. We understand the government had projected an $8 billion figure on the basis of 2.5 times book value; the three banks brought in 2.7, 3.0, and 3.4 times book value, respectively. The slight softening of the Mexican stock market in recent weeks largely reflected the weakening of the telephone company stock after its blistering advance during the privitization process. The economy remains strong, despite the fact that the government has disappointed us in not following through on further planned economic reforms, though, we're assured they have merely been postponed.

YUGOSLAVIA'S CRISIS again underscores the political prowess of Mikhail Gorbachev, who has for the last three years successfully avoided the kind of direct conflict over ethnic nationalism that now threatens to bring civil war to Yugoslavia. The USSR now seems further away from conflict than it did six months ago, with Gorbachev maneuvering through democratic compromise to placate the separatist impulses in the Baltics. There was no similar skill or maturity displayed in Yugoslovia to deal with the independence movements in Slovenia and Croatia. Gorbachev has also moved the country an enormous distance toward a consensus on economic reform as an objective. He has not made any progress, though, on discovering a path to that objective. We continue to agree with the so-called "hardliners" in Moscow that the government cannot abandon the command mechanism at the center until a parallel mechanism is in place.