The Detroit Speech:
Reaganomics Is Back in Town/In the Wind, a New Dollar
Jude Wanniski and David Goldman
September 10, 1992
THE DETROIT SPEECH: REAGANOMICS IS BACK IN TOWN
It is difficult for us to contain our enthusiasm for President Bush's central message at the Detroit Economic Club today: Reaganomics is back in town! Main Street is in essential control of the Bush Administration. Several of the themes are exactly those we had urged upon the White House last week. I've been reminding journalists today that while we tend to think of James Baker III as George Bush's closest buddy, we might remember he was Ronald Reagan's chief-of-staff and Treasury Secretary. Where I have argued for the last year that President Bush could not win re-election as long as Nicholas Brady remains as Treasury Secretary, dominating economic policymaking, it is clear from the Detroit speech that JBIII is now the most powerful policymaker in the Administration -- with essential control of Treasury and OMB. We can still see traces of Treasury's mercantilist influence in the speech, along with Richard Darman's spending-cuts-must-make-room-for-tax-cuts totem, but the central, grand themes are all we could ask for. Conservative leaders who had given up on Bush can still hardly believe what they've heard, dismissing the speech as mere words. My point with them is that if the President continues to speak words written for him by Reaganauts, credibility will follow and crystallize, and he will be able to overtake Governor Clinton. Clinton's people believe it is now too late for the President to do anything that could affect the economy in time to close Clinton's lead. I disagree. The key is President Bush's new commitment to doubling the size of the economy, to $10 trillion, a goal that can only be accomplished with a massive commitment to entrepreneurial capitalism -- a commitment the Democrats will not permit their candidate to make.
IN THE WIND, A NEW DOLLAR STANDARD
As the global market becomes convinced that the Federal Reserve has returned the dollar to a commodity standard, the U.S. currency will regain its role as the focal point of the world monetary system. The continued rally in long-term bonds reflects the market's approbation of the dollar. Washington is moving back toward a monetary leadership role, with the powerful combination of the Greenspan Federal Reserve and the Baker-Zoellick White House. Speaking last night on PBS's "Nightly Business Report," Federal Reserve Governor Wayne Angell made the most emphatic statement by any U.S. official to date on behalf of the Fed's use of gold in price-level targeting! Twice in his remarks, he stressed that the Fed now sets monetary policy with serious consideration to price signals on the gold and commodity markets. Earlier in the day he said that Germany, by contrast, is "thinking a bit small these days." Financial press accounts misconstrued this remark to indicate that the Fed's senior governor thought the Bundesbank was too worried about inflation. Angell meant, rather, that the Bundesbank is shrinking from a world leadership role in monetary affairs, preferring that the United States assume that responsibility. Significantly, Angell brushed off the present 3% growth rate of consumer prices, noting that an important component of the rise stemmed from higher import prices. As the dollar inevitably recovers, he said, inflation will moderate. The dollar recovery "is money in the bank."
It is Jude Wanniski's surmise that Germany is so determined to blow up the Maastricht Treaty, rather than assume responsibility for the Portuguese, Italians and Irish, that it will continue behaving irresponsibly until next weekend's referendum in France. In this view, as soon as the French kill Maastricht, Germany will breathe a sigh of relief and behave. Indeed, Germany is now debating by how much to raise income taxes in the midst of a deep recession, with Labor Minister Norbert Bluem proposing to restore the 7.5% income tax surcharge eliminated last June 30. The Bundesbank's relentless deflation of the mark has already pushed Finland into a devaluation, and forced Sweden to raise its overnight lending rate to 75%. Other devaluations within the European Monetary System appear to be a matter of time. As we have emphasized, the dollar remains steady in terms of gold and commodity prices; the German mark is deflating, with devastating consequences for Europe's economies and political stability.
Rising confidence in the dollar's long-term stability, meanwhile, is sustaining a long-term bond market rally. At 6.34%, the 10-year Treasury bond yield has fallen even faster than our bullish forecast predicted earlier this year. Our model of investor response to long-run gold price stability that we projected shows a gradual decline in 10-year bond yields to 6.5% in September 1992 from above 7% in January, and then to 5.6% by the end of 1993 ["Gold and Bond Yields: A Long-Term View," 2-12-92]. We continue to expect a 30-year bond yield of between 6.5% and 7% by the end of this year. In recent weeks, the market has become far less skittish about short-term fluctuations in the gold price. Between March and June, gold's fall to below $340 raised fears of deflation, as the market feared that the Fed might continue to depress the gold price even further. As we noted repeatedly, statistical analysis showed a close relationship between the falling gold price and the long-term bond yield. Now that the market has seen the Fed nudge the monetary lever toward ease twice as the gold price dipped below $350, it has little concern that the Fed will fail to correct a deflationary bias. Last Friday's quarter-point reduction in the fed funds rate again confirmed the market's perception that the Fed is targetting the gold price. Recent public remarks by Federal Reserve governors, from Chairman Greenspan's Humphrey Hawkins testimony in late July to Governor Angell's remarks yesterday, have given the market increasingly clear signals.
At the same time, the Bundesbank's destructive course has changed the way the bond market responds to shifts in the dollar parity. From the beginning of 1991 through July 1992, our analysis has shown, the bond market moved inversely with the dollar; as the dollar fell, investors bought dollar bonds in anticipation of future dollar strength, and as the dollar rose, investors sold bonds in anticipation of future dollar weakness. The market's underlying assumption was that the dollar was simply fluctuating around an equilibrium price. By undermining the European Monetary System, as well as Europe's chances for economic recovery, the Bundesbank has erased this assumption. The market appears to believe that the dollar has hit bottom. Given Germany's capacity to sustain self-inflicted economic pain, it is hard to predict how much time will transpire before Gov. Angell's "money in the bank" will become cash. During the past several weeks, therefore, bond prices have stopped responding to developments on the foreign exchange market. The prospect of a future dollar recovery, even one that is long delayed, represents a plus for dollar-denominated bonds.
Finally, the influence of White House chief-of-staff James Baker III must now be accorded great weight in this realm, given his experience as Treasury Secretary in the Reagan years. Where Nick Brady has been a remorseless weak-dollar Treasury Secretary, Jim Baker is a hard, gold-standard dollar man. It was Baker's 1987 IMF speech that introduced into global discussion the idea of "a commodity basket including gold" as an independent arbiter among central banks, the Price-Level Targeting policy that Angell acknowledged last night on television. Brady still has enough influence to push mercantilist "export-led recovery" words into the President's speeches, but Baker's influence could be seen in the increased White House coziness with the Greenspan hard-dollar Fed. Baker and his key aide, Bob Zoellick, know precisely what's going on between the dollar and DM, the Fed and the Bundesbank.
Perhaps as soon as the September 21 Annual Meeting of the International Monetary Fund, we expect to hear talk of new institutional arrangements to reaffirm the dollar's role, perhaps including the first soundings for a North American Monetary System. German banking sources emphasize that no one would greet such news with more enthusiasm than the Bundesbank, which does not want to bear the burden of international monetary leadership. A dollar stabilized against the price of gold would resolve much of Europe's problem, permitting the European currencies to peg to the dollar. As discussion of a new institutional format for the dollar proceeds, the confidence level of securities markets will continue to rise, sustaining the present bond rally.