The Gingrich Gambit/Fedwatch Jude Wanniski & David Gitlitz September 27 1995

THE GINGRICH GAMBIT

House Speaker Newt Gingrich's recent threatening remarks toward the debt limit extension should be seen as a tactical maneuver in the budget reconciliation chess game. The process is still moving toward an agreement that avoids a "train wreck" and preserves the crown jewel of the Republican contract — the capital gains tax cut In Gingrich's rhetorical gambit last Thursday, he told the Public Securities Association that "I don't care what the price is" for delaying the debt limit extension until the GOP plan for a seven-year path to budget balance is adopted. His statement, "I don't care if we have no executive offices, no bonds for 60 days," was more strident than we would have preferred. It had the predictable effect on the markets, sending the dollar below 100 yen and the 30-year bond reeling to a one and a half point loss.

As a tactical device, however, threatening to hold the debt ceiling hostage to a budget agreement at this moment clearly has utility. With at least another month remaining before the current $4.9 trillion limit would be reached, Gingrich has given everyone ample notice and helped place the onus on the administration to engage in good faith negotiations. The Democrat plans to use a budget/debt limit crack up as an exhibition of Republican perfidy will not be nearly as effective if the White House is drawn into the process. As we wrote last week in "Train Wreck Update," saber-rattling on the debt ceiling can be a positive element of GOP budget strategy if used early enough: "Because there would be time to avoid default, such a move would be seen as a negotiating ploy, rather than as a terrorist gun at the President's head." Now that the issue is in play at this relatively early date, Gingrich can even profit by seeming to back off slightly, as he did this past weekend. "My position is real simple," he said Sunday. "My position is. we are going to balance the budget and I will not schedule raising the debt ceiling except on a very temporary three- or four-day or one-week-at-a-time basis until we get to a balanced budget." [Our italics]

The strategy already appears to be bearing fruit. Word is circulating in Washington that the White House is prepared to accept capgains if the total tax cut (including the family credit) is kept under $200 billion, compared to $350 billion in the original House budget resolution. Importantly, support for this approach is coming from the rising-tide-lifts-all-boats wing of the Democratic party led by Rep. Robert Torricelli [D-NJ], the odds-on favorite for the 1996 Democratic nomination to succeed retiring Sen. Bill Bradley. Slimming down the overall tax cut should not impact the capital gains reduction, since the big push to satisfy the budget scorers at CBO (who must certify that the budget is on course toward balance before tax cuts can be enacted) comes in the first two years, when the capgains cut is scored as a revenue raiser anyway. According to the static estimates at CBO, it loses $50 billion over five years.

Presidential politics is also helping drive reconciliation in a positive direction. Steve Forbes's entry using the 17% flat tax with zero capital gains as the battering ram of his hope-and-opportunity candidacy, together with Colin Powell's increasingly serious flirtation with the GOP nominating process, puts considerable additional pressure on front-running Senate Majority Leader Bob Dole to push for a reconciliation agreement with capgains. Those who still buy the idea that Colin Powell is an "establishmentarian" creation of the Beltway should read his interview in last week's New Yorker, where the retired JCS chairman told Henry Louis Gates, Jr.: "You know, I'm sort of a liberal guy...but here's where I become a Republican: once these kids come out of school, there has got to be a capitalistic entrepreneurial system that is just burning up the place to create the jobs for these kids. And therefore you've got to get the tax burden off business. You've got to lower the capital gains tax."

Despite Gingrich's rhetoric, no one in Republican circles in Washington seriously conceives of the possibility of default The Gingrich gambit, in fact, increases the likelihood that a budget agreement we can all cheer will be achieved without disruption.

Jude Wanniski

FED WATCH

The Fed's decision yesterday to maintain the status quo set the stage for today's long bond sell-off, with the stronger-than-expected durable goods number providing a convenient excuse for traders to dump long positions. With the Fed on hold with a 5.75% funds rate for at least the next eight weeks, the bond market has no good reason to maintain the 30-year Treasury in the 6.50%-6.60% range. Any sign of economic life must be interpreted by the market as reason enough for the Fed to continue the policy status quo. Although up an impressive 4.9%, it is also worth noting that August durables were heavily skewed by a delay in recording a backlog of Boeing jet orders and a resumption of full-scale auto production after a longer-than-usual early summer lull. The August gain, in addition, was a bounce back from a 1.8% decline in July. Whatever strength the economy currently is exhibiting still must be seen as a response to interest rate declines earlier this year. With the real federal funds rate being maintained 50-75 basis points above its historical norm, it is unlikely these gains can be sustained. But the Keynesian fine-tuning mind set increasingly prevalent at this Fed probably makes the best hope for additional short-term action dependent on Congress and the White House reaching agreement on a budget-balancing package. The central bank also may be holding some interest-rate reductions in reserve against the possibility of a financial market meltdown if push comes to shove on the debt limit extension.

David Gitlitz