Today's Wall Street Journal
Jude Wanniski
November 25, 1996


What a dismal Monday morning, to read on both Page One and the Editorial Page of today’s WSJ that the stock market’s continued climb is probably a speculative bubble. The “Outlook” column on the front page, by David Wessel, tells us that “the Fed” is worried that stock prices “may be overvalued by as much as 20%.” Wessel’s lead sentence would be enough to spoil our breakfast, if we did not know better: “If you were Alan Greenspan, wouldn’t you be worried about the soaring stock market?” The answer is no, we wouldn’t, and we don’t think Greenspan is either. Wessel goes on to quote Yale economist Robert Shiller, who says his measures indicate the ratio of stock prices to past earnings are at a historic high, and “At best, he expects the market to be stagnant for the next decade.” When are the Journal’s reporters going to learn that Yale’s economic professors have the highest ratio of wrong forecasts to past earnings in academic history? Unhappily, among the Fed’s 300 Ph.D. economists, are many from Yale. “From the Fed’s perspective,” writes Wessel, “if the market is going to take a dive, the sooner the better -- better at 6400 than 7400, better while the economy is still in good shape.” 

On the editorial page, the editors were out to spoil our breakfast again, with a lead op-ed, “Today’s Financial Euphoria Can’t Last,” by Henry (Dr. Doom) Kaufman, who is still using the same tattered economic model that enabled him to predict the imminent collapse of the bond market in the summer of 1982, just as it was entering its biggest boom in modern U.S. history. (Alexander Hamilton presided over a bigger boom, when government bonds went from 15% of par to 105% of par in the two years following the Funding Act of 1790.) Kaufman meanders through previous periods of euphoria -- and I genuinely appreciated his connecting the Smoot-Hawley Tariff Act of 1930 to the market crash of October ‘29. Still, his bottom line is the same as Wessel’s: “At some point, the Federal Reserve will have to face the larger question of whether to take actions that may not be necessary to pre-empt a rise in inflation, but may be decisive in heading off an unsustainable financial bubble. There is a wide variety of preventive measures available, ranging from simple reminders from Chairman Greenspan that risk exists even in a powerful bull market; to greater restrictions on the use of leverage in equity purchases; to considering the state of the equity markets when determining monetary conditions.”

There is, of course, always the possibility of a market correction, but there is also the possibility of the DJIA going to 8,000 by the end of 1997. The analytical model that tells us the DJIA is overpriced at 6400 also told investors that it was underpriced in the summer of 1930. The DJIA had opened 1921 at 72. For a bit of perspective, the price of gold back then was $20.67 per ounce, which translates 72 into 1306 today @ $375 per ounce. It climbed as high as 381 on September 3, 1929, which translates into 6912 at today’s gold price. On Black Tuesday, October 29, 1929, it hit 230 (the equivalent of 4172 today -- an eight week decline of more than 2700 points). It fell to 198 at the end of December -- another 572 points by today’s measure -- but climbed back to 230 in June of 1930 on speculation that Herbert Hoover might veto the bill. On Sunday, June 15, he said he would sign the bill, and stocks fell sharply again in Monday’s trading: “Selling Swamps Exchange, Leading Issues Tumble as Wall Street Assails the New Tariff.” At that point, there set in a sense that the market had been corrected -- stock prices were low relative to past earnings -- but the slide did not stop until the DJIA hit 41 on July 8, 1932, a few days after Franklin Roosevelt accepted the Democratic presidential nomination in Chicago on a free-trade platform. 

The parallel today is the reverse. Where the corporate ruling class of 1928-29 pushed Hoover toward Smoot-Hawley, the Crash, and the Great Depression, it is now the entrepreneurial elements of the Republican Party that have the upper hand. The euphoria on Wall Street reflects the nation’s exceedingly bright political outlook. This is the outcome of this year’s agonizingly long presidential campaign, a conclusion that favors harmonious and productive divided government -- with the supply-side growth wing of the GOP at a level of depth and breadth beyond anything we had in the Reagan years. This was apparent on Evans&Novak’s weekend CNN show, when Chairman Bill Archer of the House Ways&Means Committee said the economy needs a lower capital gains tax in order to foster greater domestic capital investment, as opposed to international capital investment. At the top of the economy, Bill Gates can sell his stuff to 250 million Americans or to 6 billion foreigners. He can promote the latter with trade deals that swap computer software and hardware to Indonesians for textile software and campaign contributions. The end result is a higher concentration of wealth at the top of the U.S. economy and falling living standards among textile workers. 

A lower capital gains tax, especially a fully indexed system, puts economic forces into play that make the bottom of the economy bigger relative to the top. Why? Everyone at the bottom benefits when people at the top make investments in the bottom. At the top, only the successful investors earn a capital gain. The losers swallow their capital losses. Rep. Charlie Rangel, the ranking Democrat on Ways&Means, understands this better than some upscale Republicans in the Congress, especially those who hobnob with the Business Roundtable. Add the weight of the governors of both parties who are eager to see a more rapid growth rate -- and who must have flinched upon reading Dr. Doom in this morning’s Journal -- and you can see the potential for policy progress in the 105th Congress. 

What do we worry about? Mostly about either Newt Gingrich or Bill Clinton getting a sudden advantage in the current balance-of-terror both parties have arranged to keep partisan Inquisitions on hold. If Newt can gain an edge in the composition of the House Ethics Committee, those Republicans who would rather have the President’s scalp than a healthy economy will be calling for all-out partisan war. However, if gridlock can be maintained at this political level, the President and the 105th Congress can get ten years work done in one. In this regard, it was encouraging Friday to see House Majority Leader Dick Armey and Minority Leader Dick Gephardt holstering their six-guns on this issue. It was also good news to see the President put former Senator George Mitchell on hold as Secretary of State and ask Senate Majority Leader Trent Lott’s advice on the matter. Senate Republicans distrust Mitchell as a slippery liberal intellectual. Sam Nunn is the SecState of choice, at least the equal of General Colin Powell, who turned down the job the two times President Clinton offered it to him.

What else worries us? The forces of darkness, who never give up. The rise of the stock market itself creates an attitude that no policy changes are needed, because “Look at the stock market!” This is the position being taken by Clinton’s new Budget Director, Franklin Raines, who surely picks up this kind of talk all over the West Wing and among the Budgeteers of both parties on Capitol Hill -- Senate more than House, as always. As this argument takes hold among the Beltway crowd, they will argue the Balanced Budget Amendment should get highest priority, or something else that will have the boys at each other’s throats again. Thank goodness for Senate Majority Leader Trent Lott, who is on the lookout for such foul play. Happy Thanksgiving, one and all. Enjoy your turkey. There is no Wall Street Journal on Thursday.