Dismal Developments Jude Wanniski August 8, 1990

We're not exactly thrilled with President Bush's decision to send planes and troops to defend Saudi Arabia. Yes, Iraq's Saddam Hussein is the bully on the block, but the block is an Arab one, and the Arabs should be the first to deal with him. There is now not even the excuse of Soviet-Iraqi adventurism. The decision by Egypt to watch the Iraqi-American confrontation from a safe distance up the block is most disturbing. It already alerts us that the President is pushing chess pieces around without thinking through the possible combinations and permutations that lie ahead. Before the President committed the U.S., Egypt's President Mubarak certainly sounded as if he'd be at our side with his Saudi brothers. Now, alas, he says he really meant he'd only join a Pan-Arab force. As no such force will be gathered, he and his Arab brethren will watch from up the block as Saddam contemplates engaging the U.S. in a wild-and-woolly desert shoot-em-up. If the oil blockade is successful, we have to expect that Saddam will start shooting. When we start shooting back, who knows what the Arab world will think of this U.S. intervention? Anti-American demonstrations will surely occur throughout the Arab and even Islamic world. Jordanians, Libyans, Sudanese will be marching to Iraq to join Saddam's fight against the Yankees, who will be seen as killing poor Arabs in order to protect their rich clients. Saddam's message to the world, especially his world, is that he is simply trying to even out the income inequities within the Arab family.

We could not help but notice the enthusiastic encouragement the President got from the liberal Democrats, including a wide assortment of Jimmy Carter's old foreign-policy hands. At the moment, they are behind him 1000%. Senator Paul Simon, for gosh sakes, even urged the bombing of Baghdad. Once the shooting starts and the body bags are counted, we can expect Senator Simon to announce that no American boys would have died if the President had simply followed his advice and bombed Baghdad. The liberal Democrats and Jimmy Carter's old hands will reflect that we should not be shedding American blood simply to protect the interests of the big oil companies, who are gouging, I said GOUGING!, the consuming public with high gas prices. The Washington Post has already had its first letter from a reader advocating nationalization of the petroleum companies!

It is deja vu all over again in economic policymaking. The Keynesians have practically set up a chant inside the Beltway, and the Bush Administration seems mesmerized. The higher gas price, you see, acts like a tax on consumers. Fiscal drag. This means the government must put this money back in the pockets of the consumers, or recession will result. The best way to do this is to have the Federal Reserve print more money!! Drop it from airplanes if necessary!! So help me, I spent Monday and Tuesday in Washington and got this argument again and again from Bush people in high places. The President's Council of Economic Advisors at least has a fancy argument that suggests the Fed could "accommodate" the higher oil prices by adding liquidity. I pointed out that the dollar price of oil has risen faster than the Deutschemark price of oil because the markets are confident the Bundesbank would not be so stupid as to fall for such silly arguments.

Treasury Secretary Nicholas Brady, who had been beating on Alan Greenspan to inflate even before Iraq, is now ready to march on the Fed with arguments not so fancy. Treasury's chief economist, Sid Jones, was assistant to Richard Nixon's chief economic advisor, Herb Stein, during the 1973-74 oil crisis. In a brief corridor conversation, Jones actually told me with a straight face that the Fed had to give back to consumers what the White House had taken away with the oil embargo. Load up that airplane! One of Brady's top assistants snarled at me that "your friend Greenspan" is responsible for the decline in the bond market, by refusing to lower interest rates. Brady, by the way, is now said to be promoting an easy-money businessman for the open seat at the Fed. As far as I can tell, the White House is completely in tune with the liberal Keynesians on this. George Perry of the Brookings Institution occupied the top spot in last Sunday's Washington Post "Outlook" section with a dismal analysis that argued only an easing by the Fed can now prevent a recession.

If you are going to ease to prevent a recession caused by an oil shock, how do you prevent the inflation that might result? If you remember the Nixon-Carter years, you will understand immediately that the answer is to cut spending and raise taxes! This is also the chant in Congress and in key spots in the Administration. The budget summit may be dead, but the Democratic leadership still hangs out the hope to Richard Darman and Nicholas Brady that come September, they will be happy to resume the summit talks. That is, as long as Brady and Darman continue to recommend tax increases and spending cuts, and the Democrats are allowed to play Santa Claus on both taxes and spending by saying nothing.

In advance of the serious political season that begins on Labor Day, the White House is planning to have the President really, really blast the Democrats. He's going to take off the gloves and get partisan, the House and Senate GOP Campaign Committees are being assured. The plan, of course, is to BLAST the Democrats for being big spenders.

Having spent much of my life as a liberal Democrat, I can assure the Administration that there is nothing the Democrats enjoy more than being denounced as big spenders. The Democratic coalition, which loves the spending Santa Claus, rallies 'round the old boy when the GOP plays grinch. In the Reagan years, the GOP played the tax-cutting Santa Claus to the Democratic grinch, but not at the moment. Even as the Bush Recession unfolds, the White House is still talking up a budget deal. The Republican message of the week a la Richard Nixon was that maybe it would take a recession to get the Democrats to listen to reason!

The more promising strategy is to have the President announce that the weakened economy and the Iraqi oil shock require him to shift economic policies. He would ask that when the Congress returns on Labor Day, it should quickly pass two measures to prevent the economy from sinking into recession. First, the Senate should vote on the House-passed capital gains cut that the President had hoped to get in the stalled budget talks. Second, it should pass the Social Security tax cuts that Senator Moynihan, a Democrat, and Senator Kasten, a Republican, have worked out recently. The tax cut on labor balances the tax cut on capital, if that's a subject of concern.

This single move puts George Bush back into GOP Santa Claus garb, wiping away his bent — but not yet broken — promise not to raise taxes. The Democratic leadership will either agree to the proposal, or it will not. If it doesn't, Republican candidates for the House and Senate will have a field day bashing Democratic incumbents. If it does, the economy and the financial markets will indeed turn up, away from the recession that would otherwise send George Bush into the Hoover Hall of Fame. The demand for dollars would increase, making it easy for the Greenspan Fed to ease without accommodating higher oil prices.

The U.S. Chamber of Commerce this morning announced that the economy is either in recession or about to enter one, for the first time in nine years. The Chamber's chief economist, Richard Rahn, still makes the mistake of blaming the Fed for the weakened economy, reflecting the views of his monetarist friends. But at least the Chamber calls for cuts in capital gains and Social Security taxes as the surest way of lifting the economy off the ground again. Inside the Administration, HUD Secretary Jack Kemp has been making the same argument.

So far, the White House resists, chiefly because it would mess up Darman's hopes of getting a budget deal this fall, which he wouldn't get anyway. Darman has argued internally from early last year that he could only get capital gains as part of a bigger budget deal. In fact, it was always easier to have the President beat on Congress to give him the capgains cut, which he won in the 1988 campaign. But Darman wanted to get his austerity measures through Congress by wrapping them around capital gains, a diamond in burlap.

As the administration contemplates the change of scenery, in the economy and the oil markets, and as the Labor Day political campaigns approach, we should hear less talk of austerity, more sounds of Santa Claus. The Greenspan Fed, which so far has performed admirably in resisting the mistakes of 1973-74, is under terrific pressure to cave. But my guess is it will dig in its heels and keep the bond markets from caving. Except for that bright spot, the last week has been one of dismal developments.