Notes on the Revolution VII
Jude Wanniski
March 21, 1995


DOLE: Since January 30, the day Jack Kemp said he would not seek the GOP presidential nomination in 1996, Senate Majority Leader Bob Dole has been moving back toward the austerity wing of the GOP, where he has always been most comfortable. I’d hoped Dole would stay with the growth wing of the party and leave austerity to Sen. Phil Gramm. The New York Times Magazine cover story on him March 5 -- with Dole equating Reagan ideology with budget deficits -- finally forced me to conclude he could not fill any of the enormous political vacuum left by Kemp’s withdrawal. There are ferocious debates inside the Dole camp on how he should be positioning himself. Without an internal compass to guide him, Dole’s gifts as a legislative leader are of little help in resolving such conflicts at a presidential level. I’m not counting him out, of course, but can’t justify active support. In a farewell note to him March 6, I informed him that for these reasons I would have to withdraw from his corner, after almost two years as an informal advisor. There was no response. The vacuum in the growth wing of the GOP is obvious to all the political pros, which is why California Gov. Pete Wilson is seriously thinking about jumping in -- somehow identifying himself with Ronald Reagan. (It won’t work.) There will be a genuine growth candidate, I think, but he has not announced as yet. I’ll do a ‘96 presidential round-up next week.

PACKWOOD: The chairman of the Senate Finance Committee spent the weekend at the Maryland Eastern Shore with committee members and Treasury Secretary Bob Rubin. He emerged absolutely, totally persuaded that we can’t have 10 cents worth of tax cuts until we balance the budget in the year 2002. This goes for a capital gains tax cut too! Such is the budget hysteria in the GOP engendered by Newt’s Contract With America. A large part of the problem was Newt’s decision to give up on dynamic scoring, which makes it impossible to cut tax rates without dollar-for-dollar spending cuts. Newt has the votes to make this happen in the House, but Senate “moderates” like Packwood are horrified at the prospect of defending cuts in school lunch programs and Medicaid to finance cuts in capital gains. Only if “experts” agree there will be no negative budget effects will Packwood endorse a tax cut of any kind. The easy answer, as I’ve suggested to Packwood’s people, is to schedule a committee hearing on the interaction of tax and monetary policy, with one witness: Fed Chairman Alan Greenspan. On Sunday’s Meet the Press, House Budget Chairman John Kasich [R-OH], the most exuberant budget cutter on Capitol Hill, joyously cited Greenspan’s recent testimony before his committee in favor of cutting and indexing the capital gains tax. Another easy move would be to leave the 28% capgains rate in place and index retroactively. Using a “static” scoring model, Gary & Aldona Robbins of Fiscal Associates, Arlington, Va., estimate this would bring in $10.3 billion over five years. On their dynamic model, it would add $111.6 billion. John O’Hara, the “expert” who scored capgains for the Democratic 103rd Congress and found it losing money all the way around, has gone to work for Citizens For Tax Justice. This is the tax-the-rich lobbying group that cooked the numbers for the Clinton campaign in ‘92. At the very least, Packwood has to order up a recasting of O’Hara’s bogus estimates. In the end, the issue will be determined by what Bob Dole decides to do. Again, if Kemp were still in the race, this hesitation would not be happening.

GINGRICH & THE CONTRACT: The public opinion polls now indicate a sharp decline in the public’s approval rating of Congress, to about 37%, with President Clinton’s moving up to about 46%. This reflects the PR victory the Democrats are having by casting Gingrich & Co. as mean and heartless spending cutters. The cutting will scarcely be noticed out in the field if the economy expands, but if it weakens, the GOP will be scalded for every sad story around. The prospect will cause the Senate to scale down the spending cuts, leaving less room for tax cuts, which will cause the economy to be weaker than otherwise. The scenario Gingrich holds up as his model is the one enjoyed by Michigan’s Gov. John Engler, whose fiscal reforms have made him one of the most popular Republican governors in the state’s history. In the first year of his reforms, which began in 1991, Engler’s approval rating dropped to 17% as the Michigan media broadcast dire predictions of the homeless and widows and orphans that would clog the streets of the cities. When all was said and done, the reforms worked as advertised, the horror stories turned to be success stories, and Engler was re-elected last year with 62% of the vote. A guest at our Polyconomics conference in Florida, March 2-5, Engler made an enormously effective presentation and was urged by many to get into the ‘96 race. I’m continuing to root for Newt on the spending and tax provisions of the Contract, although still cool to the “process” measures -- the line-item veto and term limits. 

FED WATCH: Even if we get some kind of surprising growth news between now and the FOMC meeting next week, we are hoping Greenspan has become wary of pursuing the line of attack he began early last year. We have reports he is still resisting our “treadmill” arguments, which hold that the Fed’s interest rate increases have merely slowed the economy and have had no effect on reducing the inflationary impulses that aroused him in the first place. The horrible failure of the parallel experiment in Mexico, which Greenspan endorsed, is said to be causing him to go through an agonizing reappraisal of the methodology. One important breakthrough is his acceptance of the idea that if the government of Mexico announced that it were going to buy pesos with the intent of hitting a specified dollar rate, the market would react more positively than if there were no announcement. This is at least halfway to the treadmill argument, which holds that by announcing a higher interest rate as the target of policy, liquidity must be added to reach the target. One confusion I think I cleared up on this end with Greenspan was his belief that I thought an interest-rate increase could be avoided. I actually do believe the fed funds rate would be higher than 3% if he had targeted gold instead of interest rates, in order to reflect accommodation to the Clinton tax increases that took effect January 1. It does make a big difference to market behavior if you employ a commodity target instead of an interest rate target. The latter puts the cart before the horse. This leads us to consideration of...

JAPAN, which is on a reverse, deflationary treadmill, of the kind on which Paul Volcker had the United States in 1981-82. That is, when the Bank of Japan decides to ease monetary policy by lowering interest rates, it finds itself in the position of having to drain reserves in order to support the lower rate. Now it finds itself being asked to cut short-term rates, already at 1.75%, but if it were to do so, it would have to sell assets to mop up yen! The Finance Ministry objects, saying it will do no good, because the Japanese people are not interested in borrowing at the moment! Of course they aren’t. Deflation requires debtors to pay back more in real terms than they have borrowed. Greenspan should be suggesting to Treasury Secretary Rubin that together they urge the Bank of Japan to print yen and let short rates go where they want to go. We would see the yen weaken against the dollar, short rates rise, and the people of Japan come back into the credit markets! Wow! You mean they would borrow more at higher interest rates? Yes, I say! Because the cost borrowers fear is not a half-point annualized, but an increase in the debt principal annualized. 

MEXICO remains on the forward treadmill, the peso still at 7 to 1. Bob Novak reports that Treasury and Fed bureaucrats privately agree their program has been an abject failure. This at least means Rubin and Greenspan, should they wish to start buying pesos to try the method spurned by the bureaucrats, will not get the smug bureaucratic sneers they encountered a month ago. Congressional Republicans who predicted failure of the Treasury method are still not ready for I-told-you-so protests, happy at least that Mexico is off the front pages for the moment