Don't Blame Greenspan
Jude Wanniski
July 20, 1995


Poor Alan Greenspan. By chance, this was his week to sit before the congressional banking subcommittees that oversee the obsolete Humphrey-Hawkins monetary standard (written a generation ago in Milton Friedman's M-l heyday). He thus gets the blame for the mini-Crash that hit Wall Street yesterday and the day before. This is because the financial commentators in the trading trenches and in the business press spied his sourpuss on the screen and decided they need look no further for a culprit The breathtakingly stupid consensus is that his relatively cheerful remarks about the economy's soft landing, which restate exactly the conventional wisdom on that score, absolutely terrified investors. His relative cheer is somehow supposed to mean that he will not cut the federal funds rate another quarter point later this summer or fall. At five-and-three-quarters instead of five-and-one-half overnight money, women and children are supposed to dump their high-tech investments at any price and head for the lifeboats.

It is much more likely that yesterday's opening plunge was helped along by Polyconomics, with our Tuesday missive "NASDAQ Breaks 1000," although we merely helped spread the growing fear that there will be no capital gains tax cut in 1995. "At the moment" we said, "the likelihood of a veto still seems extremely high from the perspective of our best sources on Capitol Hill. If this turns out to be the case, we would expect a major sell-off on Wall Street, with NASDAQ leading the way. The sell-off today is almost certainly a market correction along these lines, having nothing to do with shifting expectations surrounding monetary policy." To tell the truth, I could not have been happier with the market's convulsions yesterday, in that the scare will cause steps to be taken that will bring back the likelihood of capgains relief in this calendar year. Greenspan himself is the fellow most likely to succeed in taking the first steps. This is because he knows the sell-off is related to capgains, not fed funds. It is also because he knows he will be the scapegoat for the '96 recession, which we will have to forecast if capgains goes down the drain this year. As soon as the issue shifts into next year, it is no longer possible to make the exclusion retroactive to January 1, which explains the market's sensitivity.

If we do not get capgains this year, we will not get it next year either. The political die will be cast in the next few months, with the two political parties hashing out the tax issue in next year's elections. Two years of expansion will be lost to the U.S. economy if that happens. This is the chief reason why a company like Microsoft, which has the most to gain from a capital gains cut, climbs sharply in value in anticipation of a retroactive capgains cut, and why it plunged this week as the assessment reversed. It is the blue-chip NYSE stocks, which have most of their capital gains behind them, which have relatively more to gain by positive changes in the Fed's monetary policies. Mature enterprise relies more on debt finance. New enterprise relies more on equity finance. The high-tech companies are competing in such a hothouse climate of rapid change that relatively small changes in the rewards to capital can mean life or death two years out.

The reason Microsoft benefits so enormously from a 50% exclusion on capital gains is not because Bill Gates will feel better with $24 billion in net worth instead of $12 billion. It is primarily because Microsoft is now, today, far ahead of known and unknown competition. Gates is where Henry Ford was in 1920. If the next two years are going to be big years of expansion in the U.S. economy, Microsoft will be better able to extend and deepen its leadership position. Without a capgains cut this year, we might surmise there will be fewer than 600,000 new business startups in 1996 and 1997. With it, we might surmise there will be more than 700,000 in 1996 and more than 800,000 in 1997, perhaps heading toward a million by 1999. Microsoft not only benefits by having these higher increments in business, buying product from Microsoft, but also from the fact that existing business, flush with profit, will be able to upgrade and expand as well.

If Microsoft remains atop the software pyramid here, it will have similar successes in extending its global reach, before competition can arise from Japan or Europe. It will never be able to monopolize the domestic or global market. Just when Henry Ford thought he had it made, General Motors came up with the crazy idea of painting their cars colors other than black. Still, it was the U.S. auto industry that became the global standard in that era. Now, just as Zenith, our last TV manufacturer is going abroad, we are dominating the planet in computer software. Give us another long recession, capital starved instead of capital flush, and we could lose that domination. I single out Microsoft as an example, but it should be clear that all our high-tech industry has an enormous stake in whether our divided government can deliver on capgains this year.

No, it is not Greenspan, but the Republican Senate that is giving Wall Street the willies. In rapid order, Majority Leader Bob Dole is having to acknowledge that he can't clear a simple spending recision bill, can't move the regulatory reforms, the tort reforms, the welfare reforms, the line-item veto, or the telecommunications bill. It is a glidepath toward gridlock that seems ominous for budget reconciliation and capital gains. Part of the problem is that Dole is wearing two hats, one requiring partisanship, the other bipartisanship. It would be easier to get things done if he left his leadership position to run for President. It is also because the GOP needs the co-operation of the Democrats, which is hard to manage when it is also investigating the President's Whitewater investments, spotlighting the fiasco at Waco, threatening to close off Treasury's slush fund to mop up the mess it made in Mexico, and challenging the White House on Bosnia.

The market correction is probably over for the moment. We remain optimistic that the gains to be had from a capgains cut THIS YEAR are so great that business interests will in the end subsume narrower political interests. If we were still on a wartime footing, this would be unlikely, for harrow business interests would take a back seat to the broader political interests. The elections of last November 8 elections, however, signaled that shift, which normally leads to a convergence of business interests. As it becomes clear to Big Business, Medium Business and Small Business that the nation's competitive future may hinge on this dinky little capgains cut, they will make it clear to both parties that there can be gridlock on everything else, but not on capgains. If they don't quite see it yet, they can ask Alan Greenspan, who will be happy to explain it to the Democratic White House and to the Congress.