Executive Summary: The Presidential campaign will be waged over economic theory and the policies that flow from "demand-side" and "supply-side" theories. Reagan is the first Republican candidate since 1952 to carry the "supply-side" banner. Reagan parallels with Goldwater's 1964 campaign are false. An aggressive Reagan campaign that puts tax-rate reductions and central-bank reform at the center will translate into a Reagan victory and effective control of Congress. The financial markets will respond positively as the scenario unfolds, a bull market getting underway in earnest when the markets gain confidence that supply-side policies will be instituted by a President Reagan. The loss of John Sears was a temporary setback. But President Carter's economic mismanagement plus Reagan's growing confidence in his own platform points to the possibility of a Reagan landslide.
A Reagan Landslide?
In its hasteLeonard Silk of The New York Times, the dean of Keynesian economic writers (Lindley Clark, Jr., of The Wall Street Journal being the leading monetarist commentator), began his column on February 29 with the assumption that it would be Carter versus Reagan in 1980. He went on to observe that economic issues would be paramount in the campaign, and the voters would have a distinct choice of economic strategies. Carter continues to rely on policies that flow from Keynesian and monetarist "demand" models of the economy, he said, while "it seems clear" that Reagan has "bought supply-side economics."
The Carter approach thus requires monetary and fiscal restraint (taking money out of people's pockets) to combat inflation, and monetary and fiscal ease (putting money into people's pockets) to combat unemployment. The model provides no simultaneous solution to the problems of inflation and unemployment (you can not put money into people's pockets while simultaneously extracting it, except in a Marx Brothers movie).
The "supply-side" or "neo-classical" model, broadly speaking, uses monetary policy to combat inflation and fiscal policy to combat recession, (permitting individuals to keep in their pockets more of what they produce, in the form of hard dollars, thereby encouraging them to produce more).
"The great debate of 1980 could turn out to be demand-side versus supply-side economics — if the candidates are up to it," said Silk.
This point, "if the candidates are up to it," is the single most important question facing global financial markets this year, especially: "Is Ronald Reagan up to an aggressive offensive on supply-side policy at the center of his campaign for the Presidency?" If he is, and at the same time can diffuse the "warmonger" attack that crippled Goldwater in 1964, Reagan can defeat President Carter. Indeed, he could not only defeat Carter easily, but in proportions that could give the Republican Party effective control of Congress for the first time since Eisenhower's first term. In 1964, remember, the Johnson landslide was built on a platform of economic expansion ushered in by the Kennedy-Johnson tax cuts, which Barry Goldwater and the GOP bitterly opposed, arguing austerity and "fiscal responsibility." Although the terminology was not employed, we can say that the Democrats carried the supply-side banner in that election while the Republicans were demand-siders, a situation that has reversed in 1980. The only other Presidential election since World War II that contained a supply-side banner was in 1952, when Eisenhower vaguely flapped the tax-cut flag urged upon him by Senator Taft of Ohio, a flag Eisenhower shelved as soon as he was elected.
In this ideal scenario, in which Reagan would both attack President Carter's "politics of despair" and ardently press for supply-sider solutions of tax cuts, deregulation and hard money, there are three stages the financial markets must follow in determining whether Reagan is "up to it." The first is the period up to the July convention in Detroit, the second is the period up to the November elections, and the third is the period up to the Inauguration.
That is, the more evidence the markets have that Reagan is preparing an effective supply-side campaign against Carter, and the more the markets see the campaign is leading to the power to implement supply-side policy, the more likely we will see the beginnings of a bull market. The period between a Reagan election and inauguration is critically important. In that period the markets will be able to assess the level of boldness in the Reagan administration's implementation of supply-side ideas. Prime Minister Thatcher of the U.K. and former Prime Minister Clark of Canada came to power in 1979 with supply-side campaigns, but almost immediately reverted to demand-side austerity programs. There is no special reason to believe that Reagan would be different. We can't assume he would automatically reject the enormous pressures that would be brought to bear on him as President-elect to go slow, or maybe not go at all.
If Reagan does follow through all three stages as an ardent supply-sider, his program in early 1981 would contain at least the following elements:
1. A 30 percent reduction in marginal income-tax rates at 10 percent a year.
2. Indexing of the tax system, to offset future inflation.
3. Elimination of the gift and inheritance taxes.
4. Abolition of the "windfall profits tax"on the domestic petroleum industry.
5. Reform of the central bank to restore a convertible dollar-gold exchange rate.
Coincident with this ideal scenario we would expect a dramatic bull market in stocks, a bond market rally of equal vitality, and a decline in the dollar price of gold, oil and other commodities. That is, the markets would see the freeing of the nation's productive energies as a signal to shift, relatively, from real assets to financial assets. And the rallies would be echoed in foreign markets. The U.S. dollar would have been restored as the numeraire for world commerce, giving foreign central banks a footing for their currencies, and ending the global inflation. The positive effects of the U.S. example in adopting supply-side policies would likely topple tax progressions like dominoes throughout the West and the Third World. By mid-1981, a non-inflationary boom would be well underway.
Is Ronald Reagan geared up for this ideal scenario? Not quite; he is still a distance from being the ideal supply-side candidate. But he has at least reached the stage of adequacy, where the ideas are penetrating into the fabric of his beliefs. His political success this year has also raised his confidence in the ideas. But he is a long way from mastering the model, which makes him vulnerable to attack by the liberal Keynesians of the Democratic Party and the conservative Keynesians and monetarists who now dominate the Carter administration. And there are conservative Keynesians and monetarists on the periphery of the Reagan campaign, including a great many former advisers to the other GOP contenders, ready to warn Reagan against "radical" supply-side prescriptions. When Reagan is relaxed and full of energy, he is at his best in aggressively arguing the supply-side. When he is fatigued or under pressure, he seems to slip back into traditional Keynesian rhetoric ("putting money into people's pockets").
If Reagan can "gear up," able to parry attacks and at the same time persuade the electorate he knows what he's doing and will do it, he could win by landslide proportions. President Carter could get as many or more votes than he did in 1976 and still lose in a landslide to an aggressive supply-side Reagan. It has been so long that the American electorate has had a genuine supply-side Presidential candidate that middle-class voter turnout would increase sharply from the pitiful levels of recent elections. There are reports the Carter pollsters are already nervous about the swollen Republican primary turnouts, surpassing all expectations. It does not seem probable that the 1976 stay-at-homes would surge to the polls in 1980 to vote for a Jimmy Carter whose mismanagement of the economy is certified in all public-opinion polls. Even among Democrats who have been voting for Carter in the primaries, the polls are consistently showing that only four of every ten give the President a good or excellent performance rating. Six of ten rate him poor or fair, and it is only because Senator Kennedy is distrusted by the electorate that Carter has been winning against him so handily. (The voters also discovered that Kennedy is not the economic expansionist that his brother John was. Kennedy's economic model is neither demand-side nor supply-side; Galbraithian wage-and-price controls and egalitarian tax policy involve only the redistribution of goods, not their production.)
What is Reagan's main deficiency? It is not his age, not his background as a movie actor, nor the general disdain by both liberal and conservative elites of his Main Street populism. The biggest presidential landslide in history was achieved in 1920 by Warren Harding, a colorless, ex-newspaperman from Main Street, Ohio, who was also held in disdain by corporate royalty. Harding's central belief was that the nation had to "return to normalcy" by lowering tax rates to their pre-World War I level, a belief that attached him to the greatest American supply-sider of the century, Andrew Mellon, who became his Treasury Secretary. Reagan's main deficiency is he does not see that tax and money policies are the only central issues; \as important as strategic military issues are, they remain secondary. If he believed that taxes and money (economic growth) are the central issues, he would insist that there be a commensurate commitment of campaign resources, including his own intellectual resources. As long as he sees several issues of roughly equal weight, the supply-side issues become vulnerable because they are so new, and as a result seem complex and controversial. There will be a natural tendency for Reagan to drift toward issues in which he feels more comfortable, because he has been over the terrain so often: excessive government spending and regulation and inadequate national defense. If the national campaign were fought exclusively on these issues, there is less chance Reagan could defeat Carter. In a nuclear age especially, the known quantity has a definite edge over the unknown. Reagan can only get back this edge plus gain the margin for victory by forcing the debate onto economic policy.
The dismissal of John P. Sears by Reagan, a few hours before the polls closed in New Hampshire on February 26, was the most serious blow to a supply-side strategy so far. Sears alone was responsible for bringing Rep. Jack Kemp of New York into the Reagan campaign. Kemp, the leading supply-side politician in the country, had the effect of sharpening Reagan1 natural supply-side predilections. Instead of being mired in Old Guard budget-balancing austerity rhetoric, Reagan could be upbeat, buoyant and expansive. In January he stunned Robert Novak, the syndicated columnist, by calling austerity "old-fashioned economics," and by saying that if offered a tax cut or spending cut, he'd take the tax cut.
Sears' chief lieutenant Charlie Black, also fired on February 26, was caught up in the enthusiasm of supply-side ideas as well, and as a result made the single most important tactical move of the campaign, deciding to use supply-side TV spots in the first eight primaries, through Illinois. This meant that the spots produced at the initiative of the California wing of the campaign — the team that had been with Reagan since his days as governor — had to be canned.
Black and Sears handed the assignment to Jeff Bell, who ran a supply-side campaign to defeat New Jersey Senator Clifford Case in the 1978 Republican primary, only to lose to Democrat Bill Bradley in the general election. Bell and film producer Elliott Curson of Philadelphia turned out 10 spots @ $2,500 each, displacing the four California spots that had cost $25,000 each. They began running two weeks before the New Hampshire primary, with Reagan falling in the polls against George Bush, at roughly the time the decisions were being made to fire Sears because of his losing strategy! Here are three of the best:
"Leadership" : 30 seconds
ANNOUNCER: Some of our leaders say our country has to stop growing; that our children may have to accept a lower standard of living than we've had. Ronald Reagan doesn't buy that.
REAGAN: This is the greatest country in the world. We have the ability to solve our economic problems...our energy problems — even our social problems. We have the talent. We have the drive. We have the imagination. Now all we need is the leadership.
"Taxes" : 30 seconds
ANNOUNCER: Ronald Reagan believes that when you tax something you get less of it. We're taxing work, savings and investment like never before. As a result we have less work, less savings and less invested.
REAGAN: I didn't always agree with President Kennedy. But when his 30% Federal tax cut became law, the economy did so well that every group in the country came out ahead. Even the government gained $54 billion in unexpected reveunes. If I become President, we're going to try that again.
"Good Shepherd" : 60 seconds
ANNOUNCER: In the past few years, our income has been eroded by the worst peacetime inflation and the largest tax increases in history. Our leaders tell us that in order to help energy consumers, we have to tax energy producers. And to have lower prices, we have to keep Federal tax rates high. Ronald Reagan doesn't believe that.
REAGAN: If there's one thing we've seen enough of, it's this idea that for one American to gain, another American has to suffer. When the economy is weak....as it has been in recent years...everybody suffers...especially those who have the least. If we reduce paperwork and unnecessary regulations... if we cut tax rates deeply and permanently, we'll be removing many of the barriers that hold everybody back. Those who have the least will gain the most. If we put incentives back into society, everyone will gain. We have to move ahead. But we can't leave anyone behind.
The California team could not believe the spots, which were technically inferior, could be effective. But Reagan's pollster, Richard Wirthlin, found they scored 80 percent positive in New Hampshire, only 10 percent negative. A tentative decision to throw the spots out along with Sears and Black was reversed by William Casey, the 67-year-old New York lawyer brought in to succeed Sears as campaign director. They were clearly Reagan 's "secret weapon" in the eight primaries, a big reason why he would surge in the last days of each primary campaign — after early polls would show him nip-and tuck with Bush or Connally or Anderson. The only reason Reagan remains behind Carter in the national public-opinion polls is that he is not perceived nationally as the politician in those spots. His supply side agenda has only been exposed to a fraction of the media market. The CBS/ New York Times poll in New Hampshire showed that in a Reagan-Carter matchup, Reagan loses 18 percent of the GOP vote to Carter, but Carter loses 30 percent of the Democrats to Reagan. If those numbers held up in a national match-up, at the end of the long campaign, Reagan would win in a landslide and carry in a Republican Congress.
The pressures on Reagan to moderate his stance on supply-side issues began in earnest as soon as it was clear that the nomination was his: when former President Ford looked hard at the numbers and decided Reagan couldn't be stopped, and on March 18, when Reagan ended the fiction of the John Anderson candidacy by winning the Illinois primary by 11 points. The conventional view is that Reagan must "reach out" to the Republican "moderates" and "balance" the ticket in order to get to the "center" where President Carter resides. In other words, that he must become more like George Bush or Howard Baker, or better yet, Jerry Ford. The problem, of course, is that the less supply-side Reagan becomes, the less interested the electorate will become in pitching Carter out in his favor. Given the depth of President Carter's economic mismanagement, Reagan might still win even after watering down his supply-side impulses to the vanishing point, and running as a moderate, traditional Republican. But it would be a narrow win, and Republican congressional candidates would, in following these themes, not bring out a big vote. Nor would the financial markets respond with dramatic advances, observing a confused, instead of clear mandate for the new President.
The chance that Reagan may turn away from supply-side issues is now close to zero, however. Three or four months ago there was still a chance he would submerge the issues if he found that they were not selling, or if he could not handle the complexities of the model in political debate. Although he still has to struggle a bit when confronted with sharp questions from an aggressive reporter, and can be made to sound unsure of himself, he does have the ideas in his bones. In January, for example, he came up with a perfect supply-side anecdote out of his Hollywood past. He recalled how, in the Thirties, he was making three or four movies a year and enjoying it. But in the Forties, when he was in the 94 percent tax bracket, his agent would insist that it was useless to make more than one picture a year. He also saw the destructive effects of tax progressivity on the entire motion-picture industry and 20 years ago was calling for a return to proportionality in tax systems.
It is this kind of awareness and understanding on Reagan's part, not the outcome of internal politicking or the shape of TV commercials, that suggests a successful candidacy. The national electorate, I think, knows what he is saying is right, but it has to be persuaded that he knows what he is talking about and will follow through, if elected.
What do we watch for now?
1. Reagan's progress in discussing dollar/gold convertibility as part of his anti-inflation strategy. He now argues on the stump that monetary policy should be used solely to maintain price stability and that the U.S. should mint gold coins. He is only a hair's breadth away from endorsing a "modernized gold standard."
2. Who represents Reagan before the platform committee of the Republican National Committee? How ardently does the Reagan team push for a supply-side GOP platform? Who is picked as Reagan's running mate? What are the principle themes of the acceptance speech? Who writes the TV spots for the national campaign? Do GOP congressional candidates run on supply-side issues? How big does Reagan win and does the GOP get effective control?, of Congress? Who gets picked as Treasury Secretary? As Undersecretary of Monetary Affairs? As Assistant Secretary of State for Economic Policy? And what does President Reagan say in his Inaugural Address?
If Reagan turns out to be a "perfect 10" he will win bigger than anyone could imagine a few months back, and we should see the positive reactions in the financial markets. Unless President Carter has as rapid a conversion to supply-side economics as he did in December, when he suddenly discovered the Russians could not be discovered, it hardly seems possible he could stop a Reagan "10" or even a "9."
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