Notes on the Revolution VI/Fedwatch Jude Wanniski & David Gitlitz February 28, 1995

NOTES ON THE REVOLUTION VI

MEXICO MELTDOWN: The most important thing happening in the hemisphere is the continuing crisis in Mexico, which is being studiously ignored by the political leadership in Washington. The problem is so enormous it has become radioactive, which means anyone in a position to do anything about it is running as far away from it as he can get. The Bolsa fell 7% yesterday, the biggest one-day drop since the peso was first devalued December 20. Businesses are closing and layoffs are being announced daily by the tens of thousands. A survey of small and medium-sized businesses finds 56% believe they will be bankrupt this year. The Finance Ministry is about to unveil new tax increases and spending cuts to meet the austerity requirements of the Clinton administration’s bail-out. In the chaos, the Bank of Mexico continues to print pesos at a staggering pace to meet nominal liquidity demands, dumping 2.7 billion pesos into the banking system yesterday at the current exchange rate of 6 to the dollar. The architects of the fiasco at Treasury are laying the groundwork to blame the Mexicans. The White House does not want to talk about Mexico, saying “We have done all we can.” The Republican side has been not much better. Senate Majority Leader Bob Dole late Friday afternoon did at last criticize the administration’s plan in a floor statement, for all the right reasons, but his press release did not make it into any of the major media. The press corps is buying the Treasury line that the Mexicans are just, well, Mexicans. Senate Banking Chairman Al D’Amato has yet to utter a word of criticism of the plan, which flies in the face of his demands that the $20 billion Treasury has put up be used only to extinguish pesos. Federal Reserve Chairman Alan Greenspan, who endorsed Treasury’s Mexico plan while knowing it deserved the Nobel Booby Prize in economics, is not about to bring up the subject. Wall Street Journal editor Robert L. Bartley, who earlier this month denounced the conventional economics at Treasury that set Mexico afire, has not said a word of criticism about the gasoline being dumped onto the fire by the Treasury gang. Ah well. We suppose Treasury Secretary Bob Rubin will soon close down Mexico’s relief fund, on the grounds that it isn’t working. He will then congratulate himself on securing Mexico’s oil revenues as collateral. Republicans will demand a share of the credit. 

BALANCED BUDGET AMENDMENT: I’ve never met an ordinary American who says the Constitution should be amended to require a balanced budget. Pollsters tell us voters favor it by 80-to-20, but democracy does not work by asking people who are running thither and yon what their opinion is on matters of public policy. When asked about a BBA, they will shout over their shoulder by 80-to-20, “Sure, why not?” If the BBA is approved by the Senate today, we will have to spend our time fighting it at the state level, or have it become a permanent burden to our democratic institutions. The Constitution is the wonderful document it is because there is nothing in it that is rigid. The Founding Fathers knew it would have to be flexible to meet the tests of unforeseen problems. The BBA would cement rigid fiscal instructions into the system, which would mean that at some future point, a dollar that should be appropriated will not be, or a tax dollar that should be cut will not be. For want of a nail, the shoe will be lost, and so will go the nation. Three cheers for Sen. Mark Hatfield of Oregon, the only Republican who will vote against it. If the vote were by secret ballot, of course, it would not even get a majority, let alone 67. I predict that if it passes, more Senators who vote for it will be defeated when they are up for re-election than those who voted “nay.”

AFFIRMATIVE ACTION: The broad argument on affirmative action seems to have been resolved in favor of reviewing the 160 or so legislative mandates that were turned up in the Library of Congress survey requested by Senator Dole. The White House, the congressional Black Caucus, and the GOP leadership are now agreed that the list should be pruned. The debate will flare again around the cutoff point, when the CBC draws a line and challenges the President to support it. He will draw another line, closer to the GOP list of items to be pruned, and negotiate from there. This is the correct process in a democracy. In principle, there should be no race-based affirmative action by government, but in practice there must be. Affirmative action began with the Nixon administration’s “Philadelphia Plan,” aimed at breaking the de facto segregation of the northern construction trades. The civil rights legislation was all “race based,” to force necessary changes in private racial practices within the majority white American family. The Emancipation Proclamation in that sense was the first “affirmative action,” the 14th amendment the second. In an even more basic way, the Civil War itself was a race-based affirmative action. The silliest idea of the political season is that 62% of white adult males voted Republican because they oppose race-based affirmative action. I doubt that more than a dozen white males cast ballots for Republican candidates last November out of conscious awareness of affirmative action programs. If the GOP can ever get the economy into a real capital-based expansion, the list of programs can be pruned rapidly, and hopefully be gone altogether on January 1, 2000.

Jude Wanniski

FEDWATCH

 After expanding its balance sheet by more than $30 billion last year while in a rate-raising mode, the Fed has drained more than $13 billion from the banking system since early January, a period during which the market has reached a consensus that the “tightening” has about run its course. Some balance sheet contraction is customary in the early weeks of the year as the Fed draws down the pre- and post-New Year seasonal liquidity buildup. But the Fed’s drain mode is now running about a month longer than had been anticipated. Why? Because now that the market has determined that the tightening cycle is all but over, the federal funds rate has been trading below its new 6% target, forcing the Fed to drain liquidity to maintain the rate. This is the exact opposite of the situation found during much of last year, when expectations of additional rate hikes pressured the funds rate and forced the Fed into consistent liquidity injections to keep the rate at target. The Fed is draining liquidity now that it has reached the end of its tightening process, after injecting liquidity all last year as it was raising rates. This is the perverse outcome of a monetary policy wedded to targeting a nominal interest rate, with no anchor to anything real.

David Gitlitz