Clinton/Lott Government V/Indexed Bonds
Jude Wanniski and David Gitlitz
January 29, 1997


WALL STREET: Even though it quickly withered, the early 100-point surge in the DJIA Tuesday morning -- on news that wage compensation last year did not even keep pace with CPI inflation -- reminds us that there is plenty of room for the bull market to run. On January 2, with the DJIA at 6442, we saw the DJIA running to 7400 before year’s end, perhaps as high as 7800, if bipartisan harmony between the White House and Congress could produce a 50% cut in the capgains tax. The euphoria in the following three weeks of sweet talk in Washington ran the DJIA at one point to 6900, which meant we were almost halfway to the 1000-point gain we forecast with more than 11 months left on the calendar. The sell-off in the last few days coincided with the renewed partisan bickering surrounding Newt’s problems and President Clinton blowing off steam about campaign financing at a Democratic National Committee speech. If the kids who are trying to act like grownups can’t handle it, neither Wall Street nor the world financial markets will be able to sustain positive expectations. Still, things aren’t so bad. The Dow at roughly 6700 is still 25% of the way to 7400 with 11 months to go. The market can only kite itself so high on expectations of good things happening down the road. Unless there is a renewed surge of bipartisan good faith sometime soon, the market may have to will crawl sideways in the coming months. The earliest date we could expect a capgains cut to be in hand is July, given the crab-like budget negotiations. It would be nice if House Ways & Means Chairman Bill Archer and Senate Finance Chairman Bill Roth could put out a statement advising that a capgains rate reduction would be retroactive to January 1. 

GREENSPAN: The Fed Chairman will testify tomorrow before the Senate Finance Committee. We thought his comments before Senate Budget last week were better than usual, but the financial press and the bond bears insisted that he said he will stamp out any incipient increases in wages with an interest rate increase. Greenspan could move the markets up and sustain them at a higher level by assuring them that his favorite inflation signals remain the price of gold, down $30 in two months, and the strength of the dollar, up over 120 yen and 160 D-mark in that period. There may be some reason he is happy to see some of the exuberance out of stocks, but we know he does not enjoy seeing the Treasury long bond in the current stratosphere. The only reason it stays this high is because Greenspan and his fellow governors leave so much room for the bears to drive speculation about the Fed’s fear of growth. We have our fingers crossed that he will be asked to clarify his remarks, but the committee Senators rarely ask the right questions. Greenspan does love to get intelligent questions while he is before a congressional committee, which means he can’t be blamed for rocking the markets. There will be plenty of opportunities for him in the next several days, as his regular Humphrey-Hawkins testimony is due next week before the banking committees, which tend to have better questions on monetary policy.

RANGEL: Rep. Charles Rangel [D-NY], the ranking Democrat on the Ways&Means Committee and the country’s most important black political leader, has been getting a raw deal from the press corps -- particularly the WSJournal and Washington Times -- on assertions that he abused his power in a desire to hurt Newt Gingrich. The paper inferred that Rangel coaxed the Internal Revenue Service into giving him information that enabled him to smear Gingrich, by publicizing the IRS audit of the Abraham Lincoln Foundation that financed Newt’s GOPAC college courses. A simple check with Rangel found that the episode began with a news report in early September that the IRS was auditing Newt’s college course, which led to a letter to the IRS by Chairman Bill Archer of House Ways and Means. Archer wanted to know if Newt had been singled out or if there were similar groups being audited. He also issued a press release that inferred, at least to Rangel, that the IRS was being dragged by the GOP into the political campaigns. Rangel then wrote the IRS asking that it comply with Archer’s request as soon as possible, to remove the suggestion that the White House was misusing the IRS to beat up on Newt. When the IRS responded by saying it was in fact auditing many such outfits, Rangel’s press secretary, Emile Milne, put out a press release to that effect. His mistake was in naming the Lincoln Foundation, which had not been identified by the IRS at that point, on the correct assumption that since the whole thing started with a news item that the Lincoln Foundation was an IRS target, that it was. Milne said it was “stupid” of him to have made that mistake, but the conservative press is acting as if Rangel deserves life imprisonment, if not the electric chair. In my book, there is no more straight arrow than Rangel. To see him dragged through the mud is an indication of how poisonous the atmosphere remains in the Capitol.

LOTT & CLINTON: They remain on the best terms, which is the only reason we continue to overlook the poisonous partisanship elsewhere in Congress and forecast smooth sailing ahead. The President’s press conference yesterday was as good as any he’s had, demonstrating a sure-handedness and diplomacy that can only come with a four-year learning curve. We can already tell the difference in the President having Erskine Bowles as his chief-of-staff, in place of the combative, partisan Leon Panetta. Panetta, remember, was a Republican who changed parties because the GOP had become too conservative for him. Lott, remember, is a Southern Republican who spent his early life as a Dixie Democrat. Lott is not only working methodically to prepare for a full-scale agenda that will put a stack of bipartisan legislation on Clinton’s desk for signature, he has also appointed a 10-Senator Task Force, five from each party, to recommend an overhaul of how the Senate conducts business, to increase its efficiency.   

Jude Wanniski

INDEXED BONDS: Today’s initial auction of  $7 billion of  inflation-indexed Treasuries went about as expected. With the 10-year bonds yielding approximately 3.45%, however, dealers are taking some risk that they will find a wide market for the instruments in the investment community. We have our doubts. The notes are structured so that while they may be attractive for tax-exempt pension and foreign central bank accounts, they are unlikely to trade actively in the secondary market. That’s because the inflation adjustments that will accrue regularly to the nominal face value of the bond will be taxed as current income, although the principal will not be paid out until maturity. For taxable holders, this creates a penalty on the inflation-indexed debt relative to conventional bonds -- essentially paying tax on unrealized capital gains -- that does not yet appear to be compensated for in the yield. Moreover, with the principal’s value tied to the politically-charged Consumer Price Index, holders of the notes are also bearing what might be called “redefinition” risk -- the risk their inflation protection will be redefined downward. The upside is that Treasury is at least thinking of how to take risk out of government securities beyond balancing the budget. Fed Chairman Greenspan next may suggest gold-indexed bonds, which is a pet project of his. Finally, comes gold-indexed dollars, which takes all the monetary risks out of government bonds and corporates as well.

 David Gitlitz