A REPUBLICAN GRAND SLAM?
In the less than three weeks remaining to the mid-term elections, there is really nothing the Democrats can do to avoid major congressional losses. The Republicans, on the other hand, could stretch their gains with a more creative end game than they are now showing. You may have noticed that as soon as the 103rd Congress recessed, the GOP seemed to lose its voice. The President and his team are making all the noise now at the national level. This will not be sufficient to save them from a savaging on November 8, but unless the GOP leadership finds its own voice, countering the Democratic attacks, its gains will be less than they could be. Bob Novak's political report yesterday advised that "there is no sign of a serious Democratic recovery, with these prospects if the election were held today: 1) Eight Republican Senate pick-ups, giving the GOP Senate control by a 52 to 48 margin. The margin could slip a little below that, denying the GOP control, but could swell to 12-13 seats. 2) The possibility of a Republican takeover of the House (requiring a 40-seat gain) is growing, with important insiders in both parties calling it more, not less, likely that the House rather than the Senate will change sides. 3) Most startling, the Republican candidates in the eight most populous states are leading in the race for governor."
The national electorate, I think, would like to give the GOP control of both Senate and House, but it will not do so without a clearer definition by the GOP of where it stands. The President and his team have been visible and aggressive in bashing the one evident Republican attempt at definition -- the "Contract With America" designed by the House GOP leaders -- casting it as a return to "trickle-down Reaganomics." There is, though, no effective defense coming from the Republican leadership, which inevitably causes confusion and division in the party's national push for control. The electorate doesn't really know the details of the controversy surrounding the GOP agenda. All it sees is that the GOP is not defending its ground, which implies a lack of confidence in itself.
Part of the problem is that the GOP has been accustomed to having its voice broadcast from the Oval Office -- the 12 years of Reagan and Bush. When Congress shut down, the legislative leaders scrambled out of town and are now doing invisible appearances at the grass roots on behalf of GOP candidates. The de facto leader of the GOP, Senate Minority Leader Bob Dole, is running around the country doing five and six appearances a day on behalf of hopeful candidates. He surely doesn't have time to think at that pace, let alone design grand political strategy. He has, though, wisely left his calendar more or less open for the last ten days, which could permit him to engage in national counterpoint with the President. Jack Kemp, Newt Gingrich and Dick Armey are booked so thoroughly on the campaign circuit until November 8 that they can't offer much generalship.
What would make a difference? Polling indicates that Ronald Reagan is wildly popular although "Reaganomics" is not -- a paradox unless you understand that the term has been poisoned by its Democratic opponents for the same reason they are ripping into Gingrich's "Contract." In war, you try to persuade your opponents to drop their most effective weapons in favor of their least. Put aside the howitzers in favor of the pop-guns. In his fascinating report on the Gingrich "Contract" in the October 24 New Yorker, Michael Kelly found that the White House pollsters actually worked at eliciting a negative response from voters on the GOP ideas, but that when the ideas were expressed "in simple, unadorned, neutral language...respondents approved in large numbers." Kelly writes that "When I suggested to [Democratic consultant Tony] Coelho that asking such questions in such a loaded manner hopelessly distorts the picture of what Republicans want, he replied: `That's what polling is all about, isn't it? You poll to get a response. The Republicans polled to get a response, and we polled to get a different response, and we did.' When I pressed the issue, he said huffily, `Ideas are not the issue.'"
What Coelho really means is that if the Republicans are dumb enough to believe his polls instead of theirs, and be frightened away from their best ideas, that's their problem. That's political war. The unadorned polls also show that on specific issues, a clear majority of black Americans think like conservative Republicans, but most GOP pols remain afraid of even asking them to vote GOP -- on the assumption that if they are "stirred up" and come out to vote, they will change their mind inside the voting booth and vote Democratic. Coelho knows that when you are dealt a losing hand at bridge, you can always hope your opponents misplay theirs. If Dole and GOP chairman Haley Barbour can show some creative play in these closing days, they could catch all the tricks.
Today's market action offers distressing evidence that financial asset values will not -- cannot -- regain their rally footing until the Fed acts convincingly to stem the erosion of dollar purchasing power. With gold again above $390, the long bond fluttering around 7.90%, and the greenback threatening to break below 97 yen, the risk to capital is growing rather than receding. Three weeks after the Fed's New York trading desk provided a ray of hope by draining liquidity from the banking system for the first time during this eight-month "tightening" exercise, we see little to suggest that the move was anything more than a fleeting gesture. In the weeks since, the Fed's treadmill has been running nearly full tilt. With lingering expectations of another near-term rate hike continuing to pressure the funds rate at its 4.75% target, the Fed is again injecting cash into the system at a brisk pace. In the first two weeks following the draining operation, the Fed's balance sheet expanded by nearly $5 billion, to $396 billion!
The behavior of the price-sensitive liquidity markets -- particularly the forex value of the dollar and gold -- can also be illuminated by looking at Fed data on the supply and demand for money. Although growth of the seasonally adjusted monetary base (supply) has recently slowed to about a 5% rate on an annualized basis, money demand (represented by M1) has been flat-to-declining for the past three months. In fact, the 70% portion of M1 accounted for by checking deposits has shown no growth all year, actually declining by about $10 billion since a brief July spurt.
There are those who suggest that the behavior of M1 indicates the effectiveness of the Fed's approach this year, in the conventional sense that bank reserves have also been flat throughout the year. If the Fed is controlling deposit growth by restricting bank reserves, this thinking goes, then it is indeed "tightening." This is a one-dimensional view; it fails to account for the Fed's continued provision of liquidity through the open market desk, which still has the monetary base growing at an annualized rate of more than $30 billion. If money demand isn't rising, base growth simply reflects the Fed's replacement of interest-bearing with non-interest bearing debt, an exchange that the markets have obviously not found to their liking. During 1993, when an epochal bond rally brought the long-term yield to a low of 5.78% a year ago last week, the supply and demand for money were maintained in tight tandem, with each growing by roughly 10%. Although this was a period when the Fed was maintaining a widely-advertised steady-to-easy policy course, the markets were obviously much more confident than they are today with the conduct of policy. The nearest-issue 30-year bond outstanding at the time the Fed began raising short-term rates in February has declined in value by more than 17%, its price falling from 98 to 81.
At this point, there are few signs to suggest that the treadmill cycle will self-correct any time soon. The dollar's continued weakness is helping to spur price gains in the gold market, and the rising gold price is undermining confidence in the bond market, thus putting further pressure on the dollar, and on and on. The fact that we remain alone in our analysis is a further discouragement. Old allies in gold commodity targeting, such as former Fed Governor Wayne Angell, continue to call for higher and higher interest rates instead of a slowing of cash flow from the Fed's automatic teller machine.