Darman's Shot at the Fed Jude Wanniski August 15, 1989

I had been mildly critical of OMB's Richard Darman two weeks ago for passing up a chance to warn Democrats they will be blamed for recession if they spurn the Bush capgains proposal. Darman, as is usually the case, turned out to be correct in his strategy, as the Democrats crumbled anyway, offering serious negotiations that will almost certainly produce a deal this fall. Darman's more aggressive shot at the Fed on Sunday's "Meet the Press" came at precisely the right moment, although it will be several weeks before it is apparent to the rest of the players in the administration.

The fact is that there are several members of the Federal Open Market Committee, including Chairman Alan Greenspan, Governor John La Ware, and several of the regional Fed presidents who do not want the economy to grow at a pace that the financial markets are now anticipating. The 50-point swing in the DJIA last Friday, the 11th, was the first whiff of a battle that is shaping up between the Phillips Curvers and the supply-siders at the FOMC. The Dow advanced 20 points in the morning, on the heels of the promising report on retail sales, which reinforces our belief that the real economy has turned upward. At noon, when the Fed intervened with a matched sale of bonds, draining reserves from the system, the market headed south until it closed down almost 30 points. The message seemed to be that with the first sign of renewed growth in the economy, the recession possibility behind us, the Fed was prepared to nip any boom in the bud.

It would have been nice if Darman, in warning against this sort of thing, had observed that the price of gold is, at $365, close to Wayne Angell's personal lower limit of $350, that the dollar is snug up against the top G-7 range for the yen and D-mark, and the other usual inflation signals are dormant. If the economy is to grow in a non-inflationary mode, the Fed must respond to legitimate demands for bank reserves. As long as the price signals hold steady, the Fed must continue to chip away at the Fed funds rate, or the expansion will be choked off by monetary deflation. Will Greenspan and his fellow Phillips Curvers (those who believe growth must be inflationary) sit still if quarterly GNP numbers start rolling in at 4 or 5% annual rates? With a decent capgains package, which we think will push Dow over 3000, we will have to expect those kind of numbers. It is extremely important that the White House fill the open seat at the Fed with a supply-sider, who will allow this kind of growth to unfold as long as the price signals behave. Fed Gov. Jim Kelley's term is up in January, and if he's not reappointed, we'll need someone as good.

Expansion of this sort of course will solve Darman's budget problem in 1990, when the Gramm-Rudman numbers get tougher. But we're not going to get it without another struggle over growth. There are timid souls in the White House who fear that criticism of the Fed at any point will force Greenspan into a mode of macho independence. I disagree. Darman is correct in opening this discussion now, in advance of a period when the policy debate will become heated. In the fall of 1983, we were on a similar path, and there was no criticism from the Reagan White House when the Fed began its second earnest deflation of the Volcker years. There's enough strength on the Board of Governors, with Manuel Johnson, Wayne Angell, Martha Seger and Kelley, that this time we can confidently expect a more constructive outcome. As usual, Richard Darman is well ahead of the curve.