Notes on the Revolution XXI
/Bonds Poised for a Rebound
Jude Wanniski and David Gitlitz
March 21, 1996


DEBT LIMIT: The slim chance that Bob Dole might rescue capital gains for 1996 by putting it on the debt limit legislation came and went yesterday when GOP leaders met with President Clinton. House Speaker Newt Gingrich has no stomach for even a symbolic thrust on capgains. The “fairness issue” has defeated him as it has so many other Republican leaders -- excepting Ronald Reagan. Dole has replaced Gingrich as the party leader by virtue of winning the presidential nomination, but if he is going to contest the President on “tax cuts for the rich,” it will not happen as part of the debt limit debate. Dole, of course, has never shown the slightest interest in fighting on the fairness issue and has led the legislative retreats on capgains in the past. He said thanks-but-no-thanks to the suggestion by Jack Kemp and others that he take up the challenge now that he is in command, by asking congressional Republicans to get behind him on the issue. The debt limit will come up next week for the last time this year, stripped of all tax items. Some GOP freshmen may make a fuss about it, enough to embarrass their leaders a bit, but this effectively ends another sad chapter in the capgains saga. Kemp’s disappointment in the party leadership is profound.

DOLE VS. CLINTON: The state-by-state Electoral College survey in the Evans-Novak Political Report this week shows a Democratic landslide if the election were held today -- 377 for Clinton, 161 for Dole. The report does note that exactly four years ago the survey showed George Bush clobbering Clinton by 356 to 164. The problem for Dole is that he has no strategy for winning the votes of blue-collar Democrats. If he is not going to tackle the fairness issue on capgains, he is not likely to tackle it on even a truncated version of the flat tax. This suggests he will harden his positions on immigration and trade -- thinking this will attract Ross Perot and Pat Buchanan voters as well as Reagan Democrats. This, though, will move him further away from a growth agenda. The common ground among the “anxiety constituency” of the national electorate -- the people attracted to Perot or Buchanan or Steve Forbes or Ralph Nader -- is their disconnect with Big Business. These are the folks at the bottom of the socio-economic pyramid. They disagree on a host of economic and social issues, but at their common core is economic distress that can only be relieved by a fundamental rewriting of the federal tax code.

PEROT: There is a conventional assumption that Perot will absolutely, positively run on his Reform Party line, to satisfy his ego, it is said. It is also assumed that he will draw more votes away from Dole than from Clinton. It is further assumed that he will not get nearly as many votes this year as he did in 1992. It may be that Perot will run, but he also has said there might be another candidate, “George Washington II,” who would be better as the standard bearer. Don’t rule this out. Also do not rule out the possibility that the Reform candidate will take more votes from Clinton. In 1992, at his peak of popularity in the opinion polls, Perot was at 40%, Bush at 34%, and Clinton at 26%. And do not assume that Perot or his ticket would do worse than 19% this year, on the grounds that he somehow has lost his appeal. Perot is no dummy. He learned an enormous amount in 1992 about the way the presidential game is played. This year he has no Ed Rollins on hand to alienate Jesse Jackson and the black vote. There would be a serious vice presidential candidate on the ticket. And by Labor Day, when the ticket is filled out, he will know exactly how Clinton and Dole are positioned. If at that point there is general disgust with the two major party candidates, the Reform ticket could win.

Jude Wanniski

BONDS POISED FOR REBOUND: As the long bond yield climbed above 6.7% from just below 6% in mid-January, the move was attributed to indications of stronger economic growth than had been anticipated. The rationale offered by this conventional analysis suggests that bond prices rose to their early-year peaks based solely on expectations of further Fed rate cuts to combat a weakening economy. When indications of stronger-than-anticipated growth emerged, all bets were off and bond prices had to plummet, raising yields commensurately. Among the many problems with this analysis is that it asks us to believe the bond market likes easy money -- as if there were no conditions under which a Fed move to lower rates would be seen as potentially inflationary and therefore negative to bond prices. As we witnessed after the Fed’s last funds rate cut in late January, the nation’s creditors are extremely sensitive to any indication of monetary laxity, which risks the erosion of the purchasing power of their long-dated assets (“Fedwatch: A Bridge Too Far?” February 1, 1996). 

  In fact, the bond market’s recent rout has had almost nothing to do with retrospective indications of relative economic strength or weakness. As the chart below indicates, since late last year bonds have been following with considerable precision the course set by the dollar price of gold, with a 25-day lag. Should these conditions hold, the slow but steady decline of the gold price from its recent highs around $415 per ounce last month would set the stage for a significant bond market rebound. (Due to the lag, the chart does not capture the decline of gold to the $395 range, which would correlate with a bond yield of about 6.2%). The enhanced linkage between gold price and bond yield movements can be traced to the resurgence of gold price volatility late last year. As long as gold remained stable in its two-year trading range around $385, bonds were able to discount a declining level of risk to their purchasing power. Day-to-day price changes conveyed little additional information, as long as the range was not breached. Once the price began deviating significantly from this mean, uncertainty increased enormously. This increased risk required investors, on the margin, to pay much closer heed to the movements of the gold signal and adjust their positions accordingly, with enough of a lag to ensure that the signal was not garbled. This risk now is declining, with the gold price trending lower and volatility becoming more subdued.  

David Gitlitz