The decline in long-term interest rates in 1993, practically the only thing to cheer about during the year, should resume in 1994, which will again probably be the only thing to cheer about. That's not insignificant, as only a firming in bonds will keep the U.S. economy from drifting back into stagnation. A year ago, we anticipated the strength in bonds, predicting a 6% yield during the year. We did so on the assumption that President Clinton would not interfere with Alan Greenspan's management of Fed policy. The long bond yield hit its low of 5.78% on October 15, roughly coinciding with the first rumblings on Wall Street and in Washington that there was no need for Greenspan to raise short-term interest rates in order to lean against incipient inflation. The creditors of the United States, who determine the interest rates we must pay in order to sell public debt, have in these last seven weeks seen Greenspan's position of independence erode. On December 14, the President himself parroted the argument that "it would be a mistake" for the Fed to raise rates, because "there is no inflation trend in this economy." Even as budget deficit projections have come down in the period, the yield has crept back to 6.4% in the antsy credit markets. Meanwhile, the NASDAQ index, which hit its peak of 787 on October 15, the same day the long bondyield hit its low, drifted lower to close the year at 776.
There are several important reasons why we think the bond rally will resume and break new ground in '94, to at least 5.5%. First is the President's political weakening at year's end due to the Arkansas scandals. These have cast a permanent cloud over his administration, sapping his moral authority, which suggests he will not win re-election in 1996. The White House, of course, believes it will be able to overcome these difficulties, but not if, in addition, the economy stagnates or heads south. This suggests there will be less of an appetite for jawboning Greenspan in the Oval Office or Treasury Department than we saw in mid-December.
Second is Senate Minority Leader Bob Dole's appearance in the monetary discussion. As I continue to believe, Dole will be the most important political leader in Washington this year, the shadow president. In '93, he cemented his position at the top of the GOP power pyramid, having the best year of his 32-year political career, in the opinion of Robert Novak, who has watched him throughout. 1994 will be a year-long chess game between President Clinton and Senator Dole, on foreign and domestic policies across the board.
On December 21, Dole cautioned the President against trying to "manipulate monetary policy from the White House," as this is invariably counter-productive. The White House now has to take Dole's position into consideration, as he has laid down a marker in defense of Greenspan's independence. Dole's statement isn't yet appreciated by the bondholders, not only because it was scarcely reported, but also because it again signals Dole's willingness to play the monetary game himself on behalf of America's creditors, who are, of course, chiefly U.S. citizens. Dole's first initiative on this issue was in an October 21 speech to the Jerome Levy Economics Institute, which also went unreported. In it, Dole derided the idea that economic growth is bad for bonds and defended Greenspan's anti-inflationary policy, "a policy that has taken a lot of the risk out of holding government bonds and allowed interest rates to fall." The statement expressed the precise philosophy of Greenspan and of fellow Fed Governor Wayne Angell, the two men most responsible for bringing interest rates down from the stratosphere.
In that regard, Angell's departure from the Fed at the end of this month, after almost nine years of incredibly important service, is being read by the bond market as another reason for being antsy. Will Greenspan be as good without him at his side? Will Angell be replaced by a Phillips Curve inflationist, who will breathe down Greenspan's neck in carrying out White House instructions? Admittedly, these are negatives. On the other hand, do not forget that Angell -- a Kansas farmer, banker, economics professor and legislator -- is a close, close ally of Bob Dole, whose intervention with the Reagan White House got him the Fed seat in 1985. Their friendship goes back at least 30 years. As Dole has to be considered a serious contender for the presidency in '96, it would make perfect sense and perfect timing for Angell to join in that enterprise, formally or informally. This is sheer speculation, as Angell has refused to discuss his life after the Fed, but I think it's bound to happen. This would further strengthen Greenspan's ability to manage Fed policy without blatant administration hindrance, with Angell free to counsel Dole in a way he could not as Fed governor. It's also clear Angell needs a political rabbi of presidential stature if he is going to succeed in institutionalizing price-level targeting -- which is the only way we will see a long-bond below 4 to 5%.
As the new year begins, most of the political press is concentrating on the President's health-and-welfare reform agenda. Dole, though, is showing ever-increasing aggressiveness in pushing economic issues, which will inevitably lead to political conflict as the House and Senate elections approach. On Meet the Press yesterday, when Dole was asked by host Tim Russert to "be president just for a few moments here," Dole instantly responded: "Well good. We'll cut the capital gains tax -- (laughter) -- or index it at least, or maybe eliminate it entirely." On a CNBC news interview this noon, Dole again responded to a question about raising taxes to finance health reform by repeating a call for cutting or eliminating the capital gains tax to expand the economy. By embracing the concept of a zero rate, Dole is now the first GOP leader to do so, as far as I know, all the way back to the beginning of the income tax in 1913. Greenspan and Angell are, of course, zero capgains advocates. Dole's position starts out as mere rhetoric, although he said yesterday "there will be a push" by Republicans this year. With Dole in the lead, all the GOP presidential contenders and congressional leaders will back him in developing this as a GOP battering ram leading up to the elections. Alone among the Republicans, Dole has the standing and credibility to effectively take on the Democratic "fairness" issue, which confounded the silver-spooners of the Bush administration.
Where is the counter from the President? Can he realistically argue that if only his health reforms are passed the economy will enjoy such efficiencies that people will dance in the streets? After a year of hullabaloo, the President has only 31 Democrat and one Republican co-sponsor in the Senate. Dole says flatly that if a bill is passed, it will bear almost no resemblance to the Clinton plan. Rep. Dick Armey [R-TX], leader of the House Republican Conference, told The New York Times today that if Clinton is to have any chance of getting legislation passed in '94, he has to abandon the ideology behind his own plan by April. In the current mood of Washington, it is extremely doubtful that a bill can be passed without the support of Dole, Newt Gingrich and Armey, a rapidly rising star in the GOP. [This week we will publish a lengthy analysis of the current health reform status, to give you a clear picture of where it stands as it comes out of the political starting gate this year.]
For all the anxiety in the world at the moment, there is plenty of reason to be optimistic about the year ahead. A year ago at this time, with Republicans divided and demoralized after defeat, it was difficult to look much beyond Alan Greenspan and the Fed as anchors to the economy. President Clinton appeared to have momentum behind a counter-revolution to the Reagan years, and it was an open question as to how much damage he would do. In 1993, he did not do much damage at all, except for various tax increases that can easily be rolled back later in the decade. We're still stuck in Somalia, but it seems to be under control. There are no U.S. armies pinned down in the forests of Bosnia. The Russian elections have stymied shock therapy, which was always a threat to produce a nuclear Bosnia. Haiti is still a mess, but it remains on everyone's mind, and I suspect the months ahead will yield a solution. North Korea is a problem, but with alternating gestures of carrots and sticks from the rest of mankind, it will remain under control. China is more exciting than ever, elevating the sights of all impoverished Asia with its special brand of klondike capitalism. America's inner cities are still desperate places, with a lost generation of African Americans at the end of a rope, but there will be answers there too as the Republican Party finally abandons its Southern strategy and applies its competitive energies to that problem. There will be more outbursts of senseless crime and violence before we've seen an end to this phenomenon, but by year's end we should see some light at the end of this storm -- as the social pathologies are finally addressed. It may sound trite, but this year could turn out to be a watershed year all the way around. At least, we open with a cautious smile.