September Odds & Ends Jude Wanniski and David Goldman September 24, 1991

THE ECONOMY continues to baffle the Bush Administration and other wellsprings of conventional wisdom. The New York Times this morning reports a "savings crisis" in America (Americans are not saving enough). At the same time, in a separate story, the Times advises that the recession has ended, but the economy remains weak because consumers are not participating (Americans are not spending enough). In 1980, I remember telling The Village Voice that it is not possible to fight inflation and unemployment simultaneously, because you cannot put money into a consumer's pocket and take it out at the same time, except in a Marx Brothers movie ("A Day at the Races"). Michael Boskin, the President's chief economic advisor, continues to tell the President that Americans are not saving enough even as he insists the Federal Reserve should put more money into the consumer's pocket to get the economy going faster! We have not altered our November forecast of an anemic recovery beginning in the third quarter. (JW)

CAPGAINS MONOMANIA. A client asked the other day if we are not becoming monomaniacal about the capital gains tax, as if a cut would cure everything that ails the world. We replied: If a doctor determines the patient has a brain tumor, only its removal will enable the doctor to work on the patient's other afflictions. We have been advising the patient for four years that he has a brain tumor, and it has been growing while the patient gets second and third opinions from other doctors, who advise him he will feel much better if he saves more or spends more. (JW)

A DAY AT THE RACES. A client asked the other day if, instead of cutting capital gains, the Government would allow individuals the first $5,000 of interest income to go tax free. Wouldn't that solve the problem? No. The problem is not a shortage of savings, but a shortage of production. Imagine a horse race, with the frontrunner going off at even money, others at 2-to-l, 5-to-l, 10-to-1, 15-to-l, and 40-to-one. The longshot wins, but when the $2 bettor submits his winning ticket at the window, an IRS agent skims all but $4. Two things happen at this track. Bettors only bet the frontrunner and owners do not enter longshots. In the extreme, there is only one horse, who need only walk around the track. The U.S. economy isn't quite in this extreme position, but it is at the point where only a few favored horses are attracting the bets. Since economic growth is driven by risk-taking and innovation, we will get only feeble growth out of the recession. (JW)

FRONTRUNNERS IN FRANCE score a terrific victory over longshots! The French government has announced it will increase the capital gains tax in 1992 to 34% from 25%. This is to pay for a cut in the corporate tax rate to 34% from 42%. Jean Baptiste Say, who created the economic concept of the "entrepreneur11 early in the 19th century, must be turning over in his grave. The government, of course, will find that the revenue loss from this combination will be considerable. The Bank of France will also find itself having to raise interest rates to ration the diminished availability of capital. (JW)

FRONTRUNNERS IN ITALY score an even greater victory over longshots! The government, we are told, has decided to begin taxing the unrealized capital gains on real estate!! At the very time the big-time economists are worried about a "capital shortage" in Europe as a result of the demands of the East bloc, the poison that began in the United States with the 1986 Tax Reform Act has spread to the continent. It reached the British Isles in 1989. (JW)

BRITISH TORIES are planning to cut the U.K.'s 40% capital gains tax, which they adopted two years ago on the U.S. example. We hear one serious proposal would eliminate it altogether after a four-year holding period. Chancellor of the Exchequer Norman Lamont in an interview Monday hinted at this in the Financial Times, speaking of a "supply-side tax reform" he is contemplating. Unhappily, the Conservative Party seems to think the voters will not be thrilled to see the capgains tax eliminated, so they will not tell them about it until after the coming elections. Meanwhile, the Labor Party has moved into the lead in the opinion polls, which the Tories could overcome if they revealed their growth plan, which they won't. Catch-22. (JW)

DEMOCRATS nibble on capital gains issue. New York Gov. Mario Cuomo, who is not running for President, did break the ice a few months ago in coming out for a rinky-dink capital gains differential. Virginia Gov. Doug Wilder, who is running, says he favors cutting the rate on "productive assets," shying from the "C" word. Massachusetts' Paul Tsongas says it is "idiotic" for the Democratic Party to oppose capgains tax cuts; his proposal is a bit better than the Administration's. Arkansas Gov. Bill Clinton has a version he's toying with. Nebraska's Sen. Bob Kerrey was an entrepreneur, so we are assuming he might pick up on the message. The frontrunner in the polls, former California Gov. Jerry Brown (24% in the ABC News preference poll, Wilder second with 13%) is talking to us with some frequency about the economy in general, as well as our suggestion of a zero rate. Senate Majority Leader George Mitchell is telling businessmen angry about the state of the economy that President Bush could have had a capital gains tax cut last year if he were willing to accept a 33% income-tax rate! By April, it should be clear that the candidates of both parties will favor a capgains cut; I wouldn't be surprised if the Democratic platform is superior to the GOP's. (JW)

AS SNOW BEGINS TO FALL in parts of the USSR, the Bush Administration is deciding maybe there is an emergency after all. Plenty of food is stashed away in hoards, as the population has had several years warning of disaster, but without a ruble of value, the mechanisms in place may not be enough to get much more than bread and potatoes into the cities. Fed Chairman Alan Greenspan, just back from Moscow, thinks the situation is hopeless, rejecting any idea of a gold ruble to invite massive dishoarding, because Moscow doesn't have enough gold, we're told. It has more than enough, as I've tried to explain to the Chairman. One slim ray of hope is that Ambassador Bob Strauss, the newest kid on this block, seems receptive to the idea. Somebody has to get the ball rolling. It will not be the IMF or Harvard's Jeffrey Sachs, who wish to "strengthen the ruble by floating it," as the NYT put it. (JW)

A MODEST RISE IN THE DOLLAR is indicated by the relative price of U.S. and European long-term bonds. The dollar's recent fall from around DM 1.73 to DM 1.67-1.68 tracked the fall of U.S. bond yields, as the global market weighed lower long-term inflation expectations in the U.S. against higher yields available overseas. The yield spread between U.S. and West German 10-year Treasury bonds widened to 70 basis points this morning, from less than 40 basis points in mid-August. The dollar's weakness shows that the market is not sure whether the Fed is targeting gold and other commodity prices, i.e., a stable measure of the dollar's value, or each month's U.S. economic data. We are betting that the Fed will remain committed to a long-term noninflationary approach and that the market will soon decide that U.S. bonds are a good buy at current yields, even at a higher dollar parity. The disintegration of the Soviet Union adds another negative to the German outlook. If the Fed stated its intention to pursue price-level targeting, both bond prices and the dollar would soar. It seems unlikely, though, that Chairman Greenspan would commit the Fed to a specific philosophic orientation before his still-unscheduled confirmation hearings are completed. (DG)

A FIRMER MEXICAN PESO was promised by Mexican Finance Minister Pedro Aspe in recent public comments. In private discussions with business leaders, Bank of Mexico officials are considering reducing the peso's rate of devaluation against the dollar from the present 0.8 pesos per day (about 5% on an annualized basis) to a symbolic 0.1 pesos. Given the dollar's volatility on world markets, Mexican officials want to maintain at least a nominal rate of devaluation as a matter of flexibility. Expectations about the peso's stability have led the Mexican stock market upward during the past year; a lower rate of devaluation would be a plus for Mexican equities. (DG)