The Clinton Plan in Limbo Jude Wanniski and David Goldman May 24, 1993

By Wednesday of this week, the House Democratic leadership will decide whether or not to go ahead with Thursday's scheduled vote on the tax/deficit package that was voted out of House Ways & Means. At the moment, the President appears so pathetically weak after weeks of policy setbacks topped by his experience on "Hair Force One" that it's hard to imagine he will risk a vote. The Democratic moderates are in control, led by Rep. David McCurdy of Oklahoma and Rep. Charles Stenholm of Texas, which means we can expect that the bill that eventually does emerge from the House to be a modest "improvement" on the Ways & Means version, i.e., more spending cuts and fewer new taxes. The reason McCurdy got control is because Sen. David Boren, also an Oklahoma Democrat, has dug in his heels as the swing member of the Senate Finance Committee, indicating he plans to "save President Clinton from himself" by blocking the massive BTU tax. About 70 House Democrats will not vote with the President unless they are sure the President will not cave in to Boren's demands in the Senate, or if they get a sign Boren will cave in to Mr. Clinton.

Boren has always been my favorite Senate Democrat, as close as you could find in the Senate to a "Reagan Democrat." A former Oklahoma governor, Boren doesn't simply represent "oil interests," but "Little Oil" interests — the wildcatting entrepreneurs who are the nation's premiere risk-takers. Boren is not going to cave in on this issue, as he understands how pivotal his role is to the nation's future. Yes, I'd be more comfortable if I knew for sure that Sen. John Breaux (D.-La.), another Democratic rebel on Senate Finance, would not buckle to White House pounding. The two together could change the shape of the final outcome in a dramatically positive direction. But Boren will be solid as long as the people of Oklahoma remain as vocal in his support as they are.

Boren's alternative plan, drafted with Sen. John Danforth (R.-Mo.), includes the first opening wedge on capital gains, a prospective indexation of capgains that would theoretically lose $12 billion in revenue over the next five years. The Boren/Danforth plan can't pass either, because it cuts into social spending in ways the Democratic leadership could not permit. Still, it leads in the one direction that could break the gridlock — some version of a capital gains cut that could be scored as a revenue gainer. The Democratic leaders in the past have jiggered the scoring to prevent President Bush from using capgains to break the gridlock. They can now rejigger to dig the President out of his hole. Fed Governor Wayne Angell's idea of indexing capgains retroactively and taxing capgains at death would produce cascades of revenue, for example.

By our reckoning, inclusion of capgains indexation in the Boren-Danforth bipartisan challenge to the Clinton tax program was worth over 300 points on the Wilshire 5000 Index last week. We use a rough-and-ready index of fiscal policy expectations, consisting of the portion of stock prices which monetary policy doesn't predict. As we have noted frequently, stock prices have changed inversely with risk-adjusted inflation expectations (measured by the gold price and its volatility) since 1987, when a high and unindexed capital gains tax took effect. The correlation between stock prices and inflation expectations has remained so close — about 90% during the past three years — that notable deviations from this relationship generally indicate that something important is underway.

It is noteworthy that three weeks ago our index was dead on the zero line, i.e., the Wilshire 5000 did not deviate from what we might call its monetary-policy valuation. Since then, this broadest measure of U.S. stock prices has gained 300 points in excess of where risk-adjusted inflation expectations would place it. Evidently, the collapse of the Clinton tax program during this period increased the odds that a better program might emerge from the wreckage. Since President Clinton's election, we have insisted that capgains indexation would be a decisive issue for stock prices, and these recent developments reinforce our conviction.

The analysis also suggests that further good news on fiscal policy could be even better for stocks. In November, we estimated that prospective indexation of capital gains alone was worth about 25% to U.S. equity prices from then-prevailing levels, i.e., a NASDAQ of 765 and a DJIA of 3750. If the momentum for a substitute to the Clinton plan including indexed capgains continues to build, the markets still have quite a way to go.

Another boost for equity prices could come from the Federal Reserve, which has kept its powder dry during the past week while the gold price rose to levels not seen since late 1990. Although Federal Reserve Chairman Greenspan did not instruct the Fed's open market trading desk to increase the fed funds rate — as many suspected he had after Monday's rate rose to 3.34% — he has the authority to do so at any moment. Our analysis of the gold market shows that expectations of dollar devaluation as well as the federal fund rate explains gold's price movement during the past several months. As we have emphasized, the Fed's actions of the past 100 trading days would place the gold price just below $350; the rest represents a bet on future Fed action. If our analysis is correct, a sharp tug on the federal funds rate by the Fed might puncture these expectations and send the gold price tumbling. In effect, Alan Greenspan is asking the gold bulls, "Do you feel lucky?"

Our daily bond-yield model suggests that recent gold volatility will depress bond prices for some weeks to come. Decisive action by the Fed to burst the gold bubble, though, could eliminate much of the market's uncertainty, and restart the bond rally more quickly than any model based on the volatility of past prices could predict.