The Twilight Zone
Jude Wanniski
August 3, 1993


The cognoscenti continue to predict the President's budget will pass the House and Senate this week, but I remain skeptical. The defection of Sen. David Boren [D-OK] on Sunday was critical. Ross Perot is correct in calling Boren "a national hero." Boren demonstrated that conscience does matter, and his defection is making it extremely hard for the Democratic leadership to come up with the votes in both houses. Their only real chance for success in the Senate is to tug Sen. Dennis DeConcini of Arizona from the "nay" column into the "aye" column, perhaps by promising him a good job if the switch costs him his seat next year, as it almost surely would. Because the House votes first, on Thursday, DeConcini will not make this move if he senses the White House hasn't lined up the votes in the House, and the House won't vote unless it knows in advance the Senate is lined up. The national press corps has been studiously avoiding the possibility of serious defections in the House, but in fact Main Street America has been stomping all over the bill, and I'm told by Democrats that they simply may not have the votes in either House or Senate. Sen. Kerry of Nebraska, who voted "aye" the first round, is another possible defection, as his constituents are not making it easy for him either. Kerry, like DeConcini, has to assure the House Democrats his vote is secure before they vote on Thursday, which he may not wish to do if he thinks the House will reject the bill anyway. If Kerry defects, it really is all over, and the President would be advised to pull the plug before asking any Democrat to go further in blind support of a bad bill.

The President will address the nation tonight at 8 p.m. EDT, to be followed by a GOP response, probably by Senate Minority Leader Bob Dole. The country often watches the President and skips the response, but not tonight. A Dole statement could finish off the bill if it encourages wavering Democrats to defect, on the assumption that the GOP really will work with the chastened White House to produce more palatable legislation. Dole has been conducting himself beautifully these last several weeks, muting his partisanship, as he must, and encouraging the idea that it will not be the end of the world or of the Clinton presidency if a fresh start is necessary. In a lengthy floor presentation yesterday, Dole built his arguments around a core statement of principle: "The glue that holds the Republican Party together is the absolute conviction that the United States cannot spend its way to prosperity and it cannot tax its way to prosperity." And at another point: 

If we are successful and defeat the Clinton plan, the sky won't fall. We can do better. The President still has time to scrap his tax-now, cut-spending-later plan and try again. If he does, President Clinton can count on help from lots of Republicans who stand ready to meet with him and the Democrat leadership in Congress. No preconditions. Now, that's not an endorsement of a so-called summit, and it's not an endorsement of tax increases. It's just a commitment by Republicans to try to help the President develop a real deficit reduction plan that works...We hope to convince the President and his fellow Democrats that we can do it by cutting spending first and providing real incentives for investment and growth -- like retroactive and prospective indexing for capital gains combined with the repeal of stepped-up basis at death. We may not succeed, but we have to try. The future of our country could be at stake.

The theoretical justification underpinning the President's budget is now in tatters -- in the demand models as well as the supply model. His own Council of Economic Advisors, which doesn't even distinguish between one kind of tax and another, acknowledges that the economy will grow more slowly under the burden of higher taxes and lower spending, minus 0.8% next year! Charlie Schultze of Brookings, chairman of the Council in the Carter Administration, told the PBS' "Nightly Business Report" that the timing of the package is bad, and that he wishes the tax increases would come sometime in the future, after the economy blossoms. Alan Sinai, who seems to be everyone's favorite Keynesian, was on CNN's "Moneyline" last night, predicting an economy that will lose 25% of the revenues predicted in the $500 billion budget plan because of slower growth. Asked if the President will have to revisit his strategy next year, when the slow growth becomes evident, Sinai said he thought he would, but that it could all be taken care of with easier money! Herbert Stein, who was Richard Nixon's CEA chairman, last week wrote in The Wall Street Journal that there was absolutely no theoretical justification for the Clinton budget, but that he should do it anyway.

The only argument left in the Clinton arsenal is that Wall Street has been steadily increasing its applause for the Clinton plan as it has moved closer to enactment, and that if it fails, bonds and stocks will fall. Michael Kinsley waved this warning flag on CNN's "Crossfire" last night. Of course, it can also be the case that Wall Street has been steadily applauding because it sees more and more teeth pulled from the tax bill at the same time the White House pulls further away from the votes it says it must have for victory. If the President somehow succeeds at this point, I'd expect a more sluggish stock market, but steadiness in bonds, still built around residual confidence in the Greenspan Fed. If the President fails, stocks should climb, especially the broader market, in anticipation of a bipartisan agreement that deals seriously with capital gains. Bonds should not be distressed either, even temporarily, anticipating that Dole is serious about an alternative that would clearly produce both growth and deficit reduction.

Alan Greenspan has persuaded the bond market that he is serious about maintaining the purchasing power of the dollar in terms of gold and commodities. It only remains for him to persuade the gold market that he is serious. The two markets can be out of synch for a while -- one being a market for liquidity and the other a market for debt. Eventually, they have to come back into synch, and I continue to believe it will be the gold price, not the bond price, that falls. The relative weakness in gold mining shares during the recent move suggests the stock market is making the same bet. Greenspan, of course, has clear authority to put the federal funds rate up to 3.5% from 3%. We may have to wait to read his memoirs to find out exactly why he has held back so far, although he may be waiting to see if gold comes down on its own at 3% fed funds after the vote this week, one way or the other.

The run-up in gold has not been without political consequence. It is no coincidence that Europe's Exchange Rate Mechanism has blown up while Greenspan has allowed gold's rise. The European monetary system keys off the dollar, which is the world's reserve currency. If the gold price rises in dollars, it rises in all currencies that key on the dollar. The ERM blew up, as we all know, when the Bundesbank would not bow to pleas from France to ease. If the dollar price of gold were still around $350, the regional currencies of Europe would have had that anchor around which to make their minor adjustments. With the DM price of gold climbing along with the dollar price, the Bundesbank was not about to ease, and the arrangement unraveled. This is nothing new. We've been arguing for as long as I can remember that European economic integration cannot realistically occur until the dollar/gold price is once again fixed. Theoretically, the Bundesbank could establish a gold fix, but I doubt that it has the political courage to cut that firmly against conventional wisdom. The Germans would still rather hide behind M-3. It was only two weeks ago, after all, that Greenspan mustered the courage to reveal to the Senate Banking Committee his reliance on the information imparted by the gold price. It may be that China will have to take global leadership in establishing a gold link, although Greenspan does finally have us back in the ballpark.

Fed Governor Wayne Angell, who has been wrestling in a variety of ways with the deficit issue that nags at everyone, throws off a marvelous idea related to gold. If the President and Congress ordered the Fed to eliminate inflation, it could also scrap all the cost-of-living-adjustments in the federal budget, saving hundreds of billions of dollars by the end of the century. Because the Fed would get blamed for any inflation not compensated by COLAs, it would have to fix the dollar/gold price! There are so many painless ways to get the deficit under control. Eventually, President Clinton will hear about them. But as necessity is the mother of invention, first his own painful program has either to be tried or rejected. There are plenty of people who wish Mr. Clinton and his party ill who want his plan to pass this week. Fortunately, Senator Dole is not one of them. Tune in tonight for one more episode of this twilight zone.