Jitters about October
Jude Wanniski
September 30, 1991


The last two Octobers that fell in odd-numbered years were not happy times on Wall Street. October 19, 1987, was the blackest Monday the financial community experienced since 1929. The DJIA fell 508 points, as the Treasury Department abandoned its commitment to stabilize the exchange-value of the dollar; the selling began in Asia, as U.S. dollar assets held in Tokyo suddenly had to carry an additional burden of capital losses through devaluation. At home, the impact of renewed inflation via dollar devaluation was instantly translated into higher real capital gains taxes on investments. Friday, October 13, 1989, turned black at noon, dropping 190 points that afternoon, when the White House abruptly announced it had abandoned its year-long strategy to wring a capital gains tax cut out of Congress.

How about it? Three odd-numbered Octobers in a row? If the fate of the stock market were entirely in the hands of President Bush and his economic team, we would not be surprised by a major correction.

First, the White House continues to believe the stinko economy is related to the following chain: 1) a tight-fisted Federal Reserve, which will not print money fast enough; 2) a tight-fisted banking system, which will not lend money fast enough; and 3) tight-fisted consumers, who will not spend money fast enough. The President on Friday met with Alan Greenspan and presumably kicked this around. His spokesman, Marlin Fitzwater, would not say whether or not they discussed "the money supply." Instead, the President focused on the second link of the money chain, urging tight-fisted bankers to ease up. He did not exhort consumers to stop saving and start spending, although we would not be surprised to see this soon.

The markets seem worried Greenspan is going to try to talk his fellow governors into shooting some more liquidity into the system to satisfy the President: The dollar has fallen and gold is up $7. We hear Greenspan did rather well in his meeting with the President, rebutting arguments from presidential advisors that he's been too stingy with M-2. If the markets see the Greenspan Fed is going to resist the White House, the dollar should come back, gold will recede, and bonds will be solid as well. Speculation that gold jumped on reports the USSR has only $3 billion in bullion in free reserve, not $25 billion, might be a small factor in the gold price, although the gold market has been discounting the higher figure for a long time. As this news is absorbed, the dollar gold price should recede again. There seems nothing on the horizon, though, to suggest the Fed will signal the kind of relaxation implied by the Treasury's 1987 abandonment of the Louvre Accord.

In our report of March 15, 1988, "A Bush Presidency," I noted insofar as the Fed is concerned, in "the early years, the Reagan legacy would be felt..Just as Reagan was burdened with Carter appointees for his yearly years, Bush will enjoy the benefits of Reagan appointees in his. There is a collective repository of wisdom at the Fed that counts for a great deal." In the same report, in contemplating a Bush White House, I said "we might assume that its outlines would be Reaganesque at the outset, attentive to his campaign pledges on taxes, free trade, enterprise zones, economic growth, and strategic defense. How far and how fast would he drift as his tenure unfolds? We're reminded that Bush is of the establishment, which will try to co-opt him quickly, but he's more complex than his preppie manner suggests; a populist strain was grafted onto him in his Texas years."

This drift now is the greater problem the economy confronts. The President's advisors who are of the establishment, chiefly Treasury Secretary Brady, have thoroughly co-opted him. In his economic policy meetings last week, the President was persuaded to drop his now limp promise of a capital gains tax cut, as a way of getting the economy moving, on the grounds that he had lost the "fairness issue." Once again, there will be the promise held out to the OOP's Reaganaut growth wing of a capgains cut in the second Bush administration, but for now, they will try other policy initiatives.

The centerpiece, we understand, is a revival of the "Small Business Incentives" Plan that the White House floated last fall, in its first Budget Agreement, which went up in smoke. The Plan would include the following: 1) A personal income deduction for investment of up to $200,000 in companies with $50 million in equity or less; 2) indexation of capital gains on the sale of stock in such companies; 3) an R&D tax credit as well as accelerated depreciation of capital assets for such companies.

The scheme, designed by Michael Boskin's shop using a demand model, is worse than nothing. It illustrates a total absence of understanding of the way the world works, especially regarding the dynamics of entrepreneurial capitalism. It would cost $12 billion, White House Chief of Staff John Sununu indicated on the Sunday talk shows, adding the wholly incorrect observation that the economy might be in brighter shape now if it had been adopted last September (instead of being scuttled by Rep. Newt Gingrich and the growth Republicans). The plan would probably cost more than $12 billion, with no noticeable payoff in economic growth. The scheme would also be yet another boon to lawyers and accountants and investment bankers, who will have to work overtime to spin off $50 million units from larger hosts.

Instead of increasing the incentive for individuals to themselves locate the highest and best uses of their capital, the Bush administration decides to locate the investment in any company with less than $50 million in equity and to limit the individual incentive to an immediate write-off of 25% of the 200K per annum investment.

Imagine two horse races. In one, the 40-to-one shot wins. His owner is rewarded, and so are those who bet on him. In the other, it does not make any difference who wins. After taxes, any winner is paid at even money. But all horses in the race with a market value less than X automatically get a government subsidy. (Doesn't that seem fair?)

We keep wondering how far the President will have to drift before it dawns on him that he has to change one or all of his economic advisors. I'm forced to conclude he is far enough removed from the exigencies of life outside the Beltway, where the economy is being fought out day by day, that he will drift until the public opinion polls show the voters prefer some Democrat to a second Bush administration. Even then, the Establishment will give him no signals on whom he should replace, as it prefers he maintain the team around him. It should not surprise anyone that there has been almost no public cricitism of Nick Brady, Dick Darman or Michael Boskin all year, from Democrats or the Establishment media. John Sununu gets whacked around now and then, as with his frequest flyer problems. This is just to remind him not to stray on issues of critical concern to the Beltway.

It's been a very long time since we've had any good news from the Bush administration on domestic economic policy. If there is a serious October correction, it will only occur if the Fed, which has been smart, suddenly gets dumb. All of the other bad news we can think of that could be in the market is already there.