The lovely bouyancy of the financial markets reflects progress on both fiscal and monetary fronts, relative to early December. The Federal Reserve gets most of the credit, Chairman Alan Greenspan in particular, for its pre-emptive, full point cut in the discount rate on December 20. This political masterstroke has enabled the Fed to appear easy even while keeping a taut grip on liquidity, as we have since seen the fed funds rate come down by only three-eights of a point, to an apparent target of 4%. The price of gold is, at long last, below $350, albeit only by small change, which offers a golden opportunity in the next few weeks to fine tune the fed funds rate around that commodity target. We assume there are no instructions to the open market desk in New York to do so, as that would be too great a policy leap at this moment. Instead, the instructions on the fed funds target have to be developed with the gold target in mind. We are betting on bonds largely for this reason, even to the point of forecasting a 6% 30-year bond by the end of the year. The only other forecaster (of the 42 surveyed by The Wall Street Journal January 2) who matched our year-end call of 7.5% on the long bond was Edward Yardeni of C.J. Lawrence, who spies a 7% long bond at year's end 1992. The only forecaster who sees a lower yield than 6% is Gary Shilling at 5%, arguably the world's worst forecaster. Shilling had forecast an 8.7% yield for December 31, 1991; his forecast of 5% is based on a Depression Scenario that has GNP sinking by 3.5% in this half of '92, even as we adjusted our GNP forecast for the year up to 3%, because of the progress being made on monetary and fiscal policy. Lehrman Bell Mueller Cannon, easily the harshest critic of Polyconomics in 1991, did not fare so well in seeing a 4.6% growth of GNP in the second half of 1991; we had forecast a 1.5-2% range, and the latest number suggests a 2.1% conclusion.
The progress on the monetary front was made possible in part by progress on fiscal policy. That is, as the demand for dollars rises with increases in real and expected economic activity, it becomes easier for the Fed to manage money against a contour of real growth. What has happened to affect these expectations in the last month? For one thing, the departure of White House Chief of Staff John Sununu helped break the Budget Agreement gridlock that has been holding up serious negotiations on a legislative growth package. For another, the President's sinking popularity rating against the backdrop of continued recession and another dismal Christmas sales season were enough to force a break in White House complacency. The candidacy of Pat Buchanan, with estimates that he might seriously embarrass the President in New Hampshire, was icing on the cake. There is now, within the White House compound, some of the euphoria we used to identify with the Reagan years, the expectation that something serious is going to happen in the State of the Union speech, and in the legislative session immediately following.
The President, for one, has now indicated a willingness to break the Budget Agreement insofar as it means flowing savings from Pentagon cutbacks to the domestic sector. The most important straw in the wind, though, was the decision of the Senate Budget Committee's ranking Republican, Pete Domenici of New Mexico, to announce support of a cut in the payroll tax. If Domenici supports a break in the Budget Agreement for this reason, it means so does Senate Minority Leader Bob Dole; which means so does House Minority Leader Bob Michel; which means so does Budget Director Richard Darman, as Darman is not going to be odd man out. We no longer think, as we once did, that Darman is the smartest guy in Washington, but he is clearly the most agile, having once again landed on his feet, now in the Sam Skinner White House. A payroll tax cut is the prerequisite for a capital gains tax cut, as the Democratic Leadership cannot permit a tax cut on capital without getting something for labor. An "aggressive" capital gains tax cut seems to be in the works -- a retroactive, indexed, 15% rate with a one-year holding period. There is also talk the White House would finally bend to demands for a fourth income tax bracket, a 33% rate, perhaps 35%, at a threshold of $1 million. And not a dollar less. I've recommended here and there around the White House that they could also throw in the top priority of the AFL-CIO, the striker replacement legislation, which makes it very hard for companies to lock out strikers and replace them with strike breakers. In discussing the issue with the AFL-CIO's Lane Kirkland, I pointed out that if the capgains tax were cut to 15%, there would be an abundance of capital and a shortage of labor, and companies would have no incentive to lock out any workers. The issue would be moot.
This all sounds very well and good, but it must be pointed out that no decisions have been made on anything. So far, it is all talk, as the White House awaits the return of the President from Tokyo. After ten days in an airplane with 15 captains of industry, none of whom appear to give a hoot about entrepreneurial capitalism, the President may need to go into a decompression chamber. In the interests of equal time, he should spend at least an afternoon with a dozen smaller fry selected by the Chamber of Commerce before he decides on what his political and legislative posture should be for '92. With all that, the January Outlook is mild and sunny, with scattered clouds guaranteeing at least scattered showers. I'm hitting the Beltway next Monday and Tuesday, to cheer the swearing in of our new Fed Governor, Larry Lindsay, and to check out weather conditions upon the President's return.