Eye of the Storm Jude Wanniski May 20, 1993

In retrospect, it's easy to see that the stock market crash of 1929 was the result of the breakdown of opposition in the U.S. Senate to the Smoot Hawley Tariff Act. The House of Representatives was not in session. The Senate was in special session only to consider the tariff bill. Nothing of moment was in the news anywhere else on earth. The hour-by-hour correlations of vote shifts and convulsions on Wall Street were straightforward, yet it was not until May 1977 that the relationship was discovered, when I stumbled upon it in The New York Times microfilm in the Morristown library.

The wild swings in the markets yesterday, by contrast, took place against a fiendishly complex array of events. The President was meeting with House Democratic leaders in an attempt to save his economic package in the House, as mavericks threatened to bolt out of fear for their political lives. A storm was brewing in the Senate as well, with far greater chances that the Clinton plan would be stripped of some of its basic ingredients, and that Senate Minority Leader Bob Dole would be able to extract serious concessions in exchange for GOP support. The mood in Washington, as I traveled about looking for clues, was one of anxiety, with an almost palpable sense of disintegration of the administration's ability to govern. The markets also awaited a sign from the Fed on whether or not it had decided to raise short-term interest rates in its closed Tuesday meeting of the Federal Open Market Committee. For several days, the administration had jawboned the Fed to ignore inflationary signals in price indices and gold, which at one point yesterday traded above $380 per ounce. The signal on the FOMC decision would come at 11:30 a.m. when the Fed would either show its hand to the banking system by draining reserves from the banking system, or do nothing. In Tokyo, meanwhile, the bond market was continuing its sickening slide, raising new questions of the solvency of the Japanese banking system.

The markets took in stride the Fed's decision to pass at 11:30, without action, a clear indication there would be no immediate snugging up of interest rates. Then again, news of the President's difficulties on Capitol Hill with fiscal policy was also on the wires; in our analytical framework, such difficulty is positive for stocks and bonds. This, because big tax increases would sink demand for dollars and the Fed would have to sharply increase short rates to maintain the confidence of long-term bondholders. Possibly, the market anticipated this morning's announcement by Sens. Danforth (R-MO) and Boren (D-OK) of a bipartisan tax program which would index capital gains prospectively while eliminating the President's onerous energy tax. The DJIA had been down 22, but as the market weighed both the Fed's inaction and the encouraging fiscal news it returned to dead even; the long bond, which had been down 24/32, recovered its losses. A 3% federal funds rate, which has been the Fed target for the last few months, would be okay as long as the Clinton plan failed! Otherwise, it would produce further increases in the price of gold and further sliding in the bond market, as it added liquidity beyond market demands.

I'd worried that Fed Chairman Alan Greenspan carried a greater burden than necessary because of the White House jawboning, which escalated after the President last Friday misinterpreted a press conference question about short-term interest rates — indicating that Mr. Clinton does not yet understand the mechanisms of monetary policy any better than his predecessor did. At midday, I faxed a note to Bob Rubin at the White House and Roger Altman at Treasury, the two most experienced financiers in the administration: "The financial crisis brewing in the world markets can be arrested by a statement from the President that he misinterpreted the question asked of him about interest rates last Friday. The President should state, 'If Chairman Greenspan and the Board of Governors believe that raising short-term interest rates is necessary to retain confidence in the bond market, they would have my support.'"

In the back of my mind also was the alert from David Goldman, who has been watching the slide in Tokyo, where the long bond there has collapsed from a 3.7% yield in early April to 4.63% — the biggest decline of any important financial market in the world over this period. The rank amateurs in the Clinton Administration who have grabbed control of U.S.-Japanese economic issues --  Trade Representative Mickey Kantor and Commerce Secretary Ron Brown — have hammered Japan into producing a gigantic Keynesian spending plan, which we pointed out a month ago produces structural inflation as aggregate demand is pumped up, as in wartime. At the same time, Kantor and Brown have been badgering the Bank of Japan to deflate the yen even further, to make U.S. imports cheaper. Adding this pressure to Japan would have the opposite effect, also threatening the capital base of the banking system there. The banks own more bonds than stocks, and the 25% decline in the value of their bonds in the last month probably does not make up for the stock market advance in that period.

The cacophony of "expert" voices emanating from the Clinton administration on matters monetary has become a real problem — contributing to the sense that the White House is being run like a Montessori primary school, with every kid for himself. Treasury Secretary Lloyd Bentsen, 71, had been keeping the kids in check, but in recent weeks they have simply ganged up on him to neutralize his sobriety. With Bentsen pushed out of the loop, as they say, Greenspan has been having a more difficult time in playing his own dangerous inside game. We don't know for sure, but believe that Greenspan overruled the counsel of fellow Fed Governor Wayne Angell that he play the game above board, using the tools available to the Fed to stamp out inflationary speculating as evidenced by gold. Instead, Greenspan seems to be taking greater risks in quest of greater rewards, banking on his inside political skills to get control of events. I'd warned Richard Darman for the four years he served as budget director that it is more difficult to win an inside game than an outside game, and it turned out I was right in his case. It may be that in Greenspan's ease, he can pull it off. The big risk is that an unforeseen bolt from the blue upsets all the inside calculations. An outside game enables the world to alert the players to gathering clouds, before the bolt from the blue.

In any case, Greenspan was in luck yesterday. At 2:09 p.m., a happy bolt appeared from the blue, with a report crossing the wires that announced, "Sen. Levin Says Rubin Not Uncomfortable With Yen Level":

WASHINGTON, DC: Sen. Carl Levin, D-Mich., said that U.S. National Economic Council Chairman Robert Rubin didn't indicate to him "any particular lack of comfort" regarding the dollar's exchange rate against the yen. Levin made the remarks to reporters following a meeting with Rubin and other top White House officials. Levin said he raised the issue of exchange rates during the meeting with Rubin, U.S. Trade Representative Mickey Kantor and Commerce Secretary Ron Brown. But although Clinton aides expressed a general desire to be tough on trade, Levin said Rubin "didn't indicate any particular lack of comfort" regarding the yen's level against the dollar. The senator's reading of Rubin's attitude toward the dollar is significant since it comes after Commerce Secretary Ron Brown said that "market-driven exchange rate corrections" could be used as a means to even out persistent U.S. trade shortfalls with Japan.

We have to assume that Rubin is the key to Greenspan's inside game, as Rubin is the one man close to the President with a keen appreciation of the efficiency of markets. Rubin is also the only person in the government who might not only have been alerted to the brewing problems in Tokyo's financial markets, but who would have understood them. He would also understand how the report of his calming remarks would send Wall Street flying, as it removed the threat of a devaluation strategy by the administration. It was up three points at 2 p.m., rocketing to close up 55.

The political developments yesterday were all positive on the fiscal and the monetary front. In an important column by David Broder of The Washington Post, we learned that the President is beginning to understand that he needs to cast out for advice beyond his closed circle of advisors, even to Republicans and independents. A change of attitude and policy is in the wind, across the board. It would be none too soon. The President has thrown out so many ideas in his first 120 days that his team is exhausted, "on the verge of intellectual and physical burnout," according to one journalist who is very close to the Clinton insiders. I reminded him that Ronald Reagan slept through his eight years, waking up instantly whenever he heard the words "taxes" or "Star Wars," the backbones of his domestic and foreign policies.

We are, after all, merely in the eye of the storm. The world is an extremely dangerous place. There is not a single leader we hear from anywhere on earth who is advancing the idea of entrepreneurial capitalism — although Senator Dole inches that way. Alan Greenspan, the boy with his finger in the dike, needs help from that direction as soon as he can get it.