State of the Union
Jude Wanniski
February 18, 1993


Happily, our relative calm as the stock market sank Tuesday was not disturbed by the President's State of the Union speech. The only surprise from him last night was a delightful one, his seating of Hillary next to Fed Chairman Alan Greenspan. It was an absolutely brilliant economic as well as political ploy that signals a deepening of the truce between the White House and the Fed to practically an alliance. The bond market, which has been strengthening steadily as it has observed the warming toward Greenspan by Clinton and his Treasury Secretary Lloyd Bentsen, now has confirmation that Greenspan is being wooed. The inflationists in Congress, led by Maryland Democrat Paul Sarbanes, were told by this seating arrangement of Alan and Hillary to forget about any assaults on the Fed. If the President is going to attempt an impossible combination of fiscal initiatives and health reform, he at least is not going to have trouble with the central bank. Ronald Reagan's most important legacy in personnel, Greenspan & Co., has become the anchor we predicted January 18. What the markets still do not yet realize is that Greenspan is now in position to influence mightily the shape of the behind-the-scenes compromise that will emerge on Capitol Hill as the Clinton package wends its way along. The first signs of that influence should appear tomorrow morning, when Greenspan testifies before the Senate Banking Committee. There have been plenty of occasions in Greenspan's checkered political career that have been of moment, but they have all been cushioned by Republicans in the White House -- Nixon, Ford, Reagan or Bush. This is a new experience for him and there is nobody more important in the world at this time, except for Clinton himself, than he.

The details of the tax and spending proposals were about what the stock market saw in Monday's televised presidential pitch. Both Clinton and Bentsen disputed the interpretation that Wall Street reacted adversely to Monday's surprises, which lowered the tax thresholds that had been discussed in the campaign and thus had already been discounted. The steadiness of the bond market reflects the confidence of investors, who are much less interested in economic growth than in protecting their wealth. Greenspan knows this, and Bentsen probably does too, even though his comments supported the White House in its moment of distress. It is the stock market that Clinton must impress if he is to get the economy humming, as equity is where the action is, where investors make their bets on future economic growth in search of capital gains -- the only true measure of economic growth. This market today is telling the President that the economy will grow more slowly than it had expected before it was surprised Monday night with lower tax thresholds. Greenspan is going to be able to gently explain this to his new friends in the White House and his old friend at Treasury. Perhaps the Clinton plan will be gradually massaged on Capitol Hill into a shape that will win applause, not raspberries, on Wall Street. Greenspan defines a capital gain as a rise in the standard of living. Maybe that's what he whispered in Hillary's ear last night, when she smiled so delightedly in response. Think of the possibilities.

The worst new wrinkle that surfaced in the plan this week was the lowering of the threshold to $250,000 on a couple faced with the proposed "millionaire's surtax." The White House is playing games here, arguing that a couple with an annual income of $250,000 is almost certainly a millionaire couple in total wealth. In fact,  a great many incomes of $250,000 or more reported in a given year are once-in-a-lifetime incomes, as a family farm or business is sold. At least it seems clear that capital gains will be exempt from the surtax, an indication someone on the team understands the economic distress that would otherwise occur. Evans & Novak report today that there is keen interest in going further in shifting the definition of taxable income to wealth. Alicia Munnell, designated assistant Treasury Secretary for Economic Policy, "was a big fan of pension taxation while at the Boston Fed and is not known to have repudiated these views." 

There was at least an opening wedge in the President's speech for entrepreneurial initiatives. He at least mentioned the idea that there must be incentives for risk-taking if the job-creating engine of entrepreneurial capitalism is to get the job done. His plan is puny in that regard and would involve another few divisions of lawyers and accountants to exploit. But we still believe there will actually be some improvement in Congress, where there will be attempts made to lever the opening wedge to across-the-board relief on capital gains. Senate Minority Leader Bob Dole and House Minority Leader Bob Michel did rather well last night in positioning themselves for negotiations with the Democrats, and Senator Pete Domenici has also signaled he'd not be interested in a replay of the 1990 budget deal. They are still much too focused on getting more spending cuts as a bargain for higher taxes, when they should be bargaining for tax cuts on capital. Rep. Dick Armey of Texas, currently the most ardent and effective supply-sider in the House, is worth his weight in gold now that he has a leadership position, for he will be able to sound off in White House meetings with the President, as he did this week. Senator Connie Mack of Florida and Senator Phil Gramm of Texas are the most important Republicans in the Senate in this regard, with Mack on the Banking Committee and Gramm on Finance. 

Another minefield worth watching is Puerto Rico, which is in a panic today after learning the President had the Commonwealth in mind last night when he talked about legislation to prevent the export of jobs. The American pharmaceutical industry remains world class partly because Section 936 of the tax code favors its investments in Puerto Rico, along with several other industries. The pharmaceutical industry is especially vulnerable at the moment, of course, because it is the target of Billary's wrath over its pricing of drugs and vaccines. The industry has lost roughly $100 billion in market capitalization in the last several months as the markets have reacted to the Clinton sledgehammer. The evil genius behind all this destruction is Senator David Pryor of Arkansas, one of the true bubbleheads of the Senate, who unfortunately happens to be a friend of the President. Pryor has made a career out of McCarthy-like ravings about the pharmaceutical industry and Section 936, composing his facts out of thin air, as did Old Joe. Somehow, Pryor has to be put back in his cage, or the industry will be crippled and there will be another exodus from San Juan to escape the blight.

All in all, though, we must say things could be worse. The White House hopes to be able to bulldoze through the House and wrap things up by August, then take up health care and more taxes. The Republicans and conservative Democrats will slow down that schedule enough to force some repairs. As long as Greenspan gets to whisper into Hillary's ear from time to time, we will hang in there.

[Note: The Hong Kong stock market is now approaching its record high of last November, before it tumbled over the British political clash with Beijing. You may recall that we discounted the disturbance and said the bull market would resume. Criton Zoakos, editor of our Global 2000 Perspective, issued a bulletin November 18, "Major Buying Opportunity in Hong Kong." Criton has just returned from 10 days of high-level meetings in Beijing and Hong Kong and will produce a special report for our Global 2000 clients.]

[Also Note: Jack Kemp will be on "Larry King Live" tonight at 9:00 p.m., to discuss these goings-on. I'm scheduled Monday morning from 8:00-9:30 a.m. on C-SPAN, with Hobart Rowen, economics editor of The Washington Post.]