Alert! Political Typhoon Ahead/Fedwatch: Are We Dreaming?
Jude Wanniski & David Gitlitz
September 22, 1994



With every passing day, the Beltway citizens of our nation's capital are becoming aware of the great anger and frustration boiling outside, threatening to sweep the Democrats from power in the Congress in a tidal wave demanding change! This week's Democratic primaries in Washington and Oklahoma and the GOP Senate primary in Massachusetts have the political pundits throwing all their old forecasting tools aside. If Rep. Mike Synar, the 8-term Democratic powerhouse from Oklahoma, can be knocked off by a 71-year-old codger who spent only $16,000, whose only campaign promise was that he was not an incumbent, anything can happen in November. By winning his primary race with only 35% of the vote, Speaker of the House Tom Foley looks like a dead duck. By usual measures, a powerful incumbent wins easily. In this typhoon, however, Foley's power is evidence that he is a major part of the problem. Prior to Labor Day, it seemed possible the GOP could pick up two dozen seats in November, well short of the 40 it would need for control. There are now dizzying estimates of a 48-50 seat pick-up. The anti-incumbency mood is not touching the GOP nearly as much as it is the Democrats, because of the growing hostility toward President Clinton. About the only thing I can think of that would make the nation feel a bit better about him at this point would be an announcement that he will not seek re-election in 1996.

The Senate is practically in the bag for the GOP. Prior to Labor Day, the optimists were talking of a six-seat pickup, which would tie the Senate at 50-50, enabling Vice President Gore to allow the Democrats to organize the Congress. But because every committee would have equal numbers of Democrats and Republicans, and a tie vote defeats legislation in committee, the Republicans would be able to preserve gridlock for Clinton's last two years as President. The scenario, though, has become even rosier, with pessimists now guessing a pick-up of seven seats and optimists guessing ten. 

Tuesday's GOP Senate primary in Massachusetts provides evidence that this may be Teddy Kennedy's last year in the Senate. Alas, my friend John Lakian, a longshot contender for the GOP nomination, was buried in an avalanche of votes for Mitt Romney, son of former Michigan Gov. George Romney. Lakian, who barely qualified for a ballot spot against Romney, tried to pull an upset with a last-minute campaign built around Rep. Dick Armey's 17% "flat tax." On Wednesday morning, Lakian, surprisingly cheerful, told me "Everyone loves the flat tax, but nothing else mattered to Massachusetts Republicans than the idea that Romney could beat Kennedy." Romney's total campaign was built around his name, his handsome family, his pleasing appearance, and his relentless message, "After 32 years, it's time for a change." Post-election, the Massachusetts GOP and Gov. Bill Weld appear to have adopted the flat tax. Romney, who questioned its cost, will be happy to hear that the Citizens for Tax Justice, which said it would cost $300 billion, has now acknowledged making analytical errors. Its new number is $22 billion. Armey figures a truer test of his idea will be in New Jersey, where the GOP nominee, Assembly Speaker Chuck Haytaian, is running with it against Sen. Frank Lautenberg, a two-term Democrat.

Why is all this happening? It is because the Democratic Party is essentially the party of security, which requires action by the state, and the Republican Party is the party of enterprise, which requires action by the individual. The American people simply want less security and less state, and more enterprise, individual action and accountability. If Bill Clinton had been governing these last 18 months as a "New Democrat," trying to move in the direction of individual and enterprise instead of security and state, the electorate would now be less angry and the Democrats would be in better shape. In the same way, if the Republicans in Congress had been less alert to the wishes of the electorate and had compromised with the Democrats every step of the way, the Democrats would be in better shape. The voters would simply be angrier, throwing GOP incumbents out along with the Democrats. The typhoon has generated a tidal wave because Clinton has done just about everything wrong and the Republicans have done just about everything right. 

Senate Minority Leader Bob Dole, the leader of the GOP, now looks like a political genius. He has halted the Clinton march toward statism in its tracks, driving a stake through the heart of Ira Magaziner's health care scheme, and, with Jimmy Carter's help, he saved the United States from a grotesque invasion of Haiti that would have taken a century for the world to forget. Dole will be on John McLaughlin's "One-on-One" CNBC interview show this weekend, which may prove more interesting and reflective than most of the Dole interviews we see on the network shows. We also look forward to next Tuesday's event on the steps of the Capitol, in which House Minority Whip Newt Gingrich has an opportunity to audition as Speaker of the House in the new Congress. Control of the House could actually be determined by whether or not he pulls off this "contract" with the American people. If it strikes a strident note of partisanship, it will increase the cynicism of the voters and subtract from potential GOP gains. If it can be made to rise to a higher level, charting a course of governance that includes the security concerns of traditional Democrats, Gingrich will energize the typhoon that is coming.

Jude Wanniski


To put it mildly, surface indications do not suggest that this is the week to restore financial market confidence in Federal Reserve policy. With gold fast-approaching $400, the dollar threatening new post-war lows, and the long bond yield breaking through 7.80% in a seemingly inexorable climb to the 8% plateau, (it was on the 5% plateau just a year ago), the failure of the Fed to safeguard dollar purchasing power on its current policy course is becoming painfully obvious. In fact, in the midst of this gloom there are signs that the Fed is adjusting its "treadmill" funds-rate operating procedure, which has forced it to continue feeding excessive levels of liquidity into the system even as it raises interest rate targets. 

The Fed's New York desk has confounded expectations all week by staying out of the market. On all four days, analysts surveyed by the wires agreed that the desk would be injecting reserves. We believe this is the first time since the Fed started hiking the funds rate in early February that it has refrained from intervening throughout a four-day period. On Monday through Wednesday, we remained skeptical that the inaction represented any shift in the desk's open market posture. This is because funds were trading below the 4 3/4% target during the usual 11:30 a.m. intervention period on all three days, indicating that reserves were not under pressure. A step off the treadmill would require the Fed to allow funds to trade above target without an injection of liquidity to accommodate the pressure. Today, the desk passed up the opportunity to add reserves with funds trading tight at 4 13/16! We may be dreaming, but we sense Fed Chairman Alan Greenspan's hand in this. The only other possibility being suggested, that this could be a subtle way of telegraphing the markets that another rate increase is on the way at next week's FOMC meeting, seems implausible. And we know for sure that Greenspan and the other Fed governors are well aware of our treadmill argument.

Indeed, we recently faxed former Fed chairman Paul Volcker our treadmill analysis of September 1, "Bonds: A Liquidity Overload," and he tells us that he essentially agrees with it, at least to the extent that funds rate-targeting is unpredictable. Volcker was on a similar treadmill during 1979-80 that led to more, not less inflation, as well as record high bond yields. He was not rescued until the Reagan tax cuts were in hand, increasing the demand for dollar-based liquidity as he genuinely tightened, turning inflation into deflation. At present, the only fiscal shift that could make a difference on this scale would be the indexing of capital gains, which would quickly soak up the liquidity overload. There is no such tax-cutting white knight on the near horizon to rescue Greenspan, which means he must find a way to reverse the treadmill by any hook or crook. If we see this week's pattern of stinginess at the open market desk continue tomorrow and into the FOMC meeting week, we would feel much more comfortable about calling a turn.

David Gitlitz