A Bullish Paradigm Shift Jude Wanniski April 19, 1996

In our report earlier this week, “Republicans on the Rocks,” we mentioned a paradigm shift in connection with Felix Rohatyn’s Wall Street Journal essay of April 11, “Recipe for Growth.” As it has been used in the political universe in recent years, the word “paradigm” has come to mean a system or pattern that operates from a reference point. At a financial conference last week in Florida, I used the examples of the Copernican system as a paradigm shift from the Ptolemaic, in the scientific realm; and in the economic realm, Adam Smith and John Maynard Keynes each made paradigm shifts, Smith from mercantilist to free market, Keynes from free market to a managed market. I discussed my Polyconomics essay of last summer, “An American Empire,” as a monumental paradigm shift from a multipolar world to a unipolar world, the dawn of the Pax Americana. 

The essay of Felix Rohatyn, the Lazard Freres investment banker, qualifies as a significant paradigm shift because the Democratic Party’s pattern of thinking about the intersection of economics and practical finance with the world of politics for more than 20 years has centered on his views. James Tobin of Yale, Paul Samuelson and Robert Solow of MIT, and John Kenneth Galbraith have been the wise men who have dominated the party’s academic theorizing. Rohatyn, as a Democratic wise man of practical affairs -- the man who saved New York City -- has been at the epicenter of the Democratic paradigm. Where previously he had believed the federal tax codes should be used to accommodate the party’s aims of income redistribution -- a flame that was originally lit by Franklin D. Roosevelt -- he now believes it should be focused on economic growth. The party’s goals of income redistribution, better stated as welfare, should be accomplished by government programs that are financed out of a pool of revenues fed by economic growth. Specifically, he says the Democratic Party should be willing to give up on the “fairness” issue -- the use of class warfare arguments to design the tax codes -- and the Republicans should be willing to accept an active role for the federal government in some areas, including education, public infrastructure, and a corporate safety net. 

The Journal reports in its lead editorial this morning, “Minority Leader Gingrich?” that Rohatyn is meeting today with the House Democratic Caucus, a stronghold of Robin Hood economics, to make his case. The fact that President Clinton and Treasury Secretary Bob Rubin recently tried to promote Rohatyn to the Federal Reserve is a clear guide to the administration’s leanings. “If the Republicans aren’t careful, Democrats might even wise up and steal the post-Reagan claim to be the party of economic growth,” the Journal warns, blasting Newt Gingrich and Bob Dole for seeking the “Holy Grail” of a balanced budget instead of economic growth. The Journal did not say so, but it was prodded into this outburst by a letter written March 22 by Empower America’s Jack Kemp to the GOP leaders, criticizing them for once again dropping the ball on the growth issue in favor of the Holy Grail. “At a time when ordinary Americans are expressing increased anxiety about the decline in their wages and living standards, it seems to me the Republican Party should boldly be pressing for a pro-growth, pro-family tax cut. Instead, the decision to rule out an attachment of the party’s tax cut on the legislation to extend the debt ceiling throws away our party’s best argument for reversing the slow growth we are currently experiencing and avoiding a recession in the future.” Kemp, who has been shunned by the GOP leaders since he endorsed the presidential candidacy of Steve Forbes, received only a curt reply from the Dole campaign at the staff level. We suspect both Gingrich and Dole, reading this morning’s Journal editorial, are wondering what is going on. They had better.

We also have been wondering what is going on, scratching our heads to understand the crosscurrents on Wall Street. Our “Bear Market Interlude” of March 28 offered a troubled assessment of the near term on Wall Street, because of the setbacks created by the Republican leadership on the capital gains tax. It has shown up only in the occasional sharp down drafts in the blue chips of the DJIA and the struggles of the bond market. The NASDAQ stocks hit record highs, led by the euphoria in everything connected to the Telecommunications bill and the Internet revolution, which sees beyond the near term. Gene Johnson of Rothschild Securities in Chicago suggests the markets are looking beyond the GOP’s near-term troubles and recovery by November. Scott Grannis of Western Asset Mgt. in Pasadena believes the market disappointment in not getting capgains is being overshadowed by its reckoning that it will get it at least next year, if not this. These client views are consistent with the flow of forces suggested by this Democratic paradigm shift. The bullishness is on behalf of supply-side policy, though, not partisan advantage one way or another.

A paradigm shift at the level of Felix Rohatyn’s epiphany can have cascading effects. We all allow other people to do most of our thinking, especially that which is outside our disciplines. This is why the telecosm revolution is so important to civilization, as it speeds up the flow of information that feeds policy debate. In political forecasting, it is critical to know who gets the last word on policy shifts. President Clinton, Newt Gingrich and Bob Dole each rely on other people to think through the economics. Little by little, President Clinton has been getting better advice, perhaps as his Treasury team spends more time talking to Fed Chairman Alan Greenspan. Dole has good advisors available to him, but they cannot penetrate his bias toward the Holy Grail. Gingrich, at one time a Kemp protégé (as was David Stockman in the early 1980s) has steadily drifted away from growth and opportunity toward the Holy Grail.

In September 1969, Robert Mundell, who at one time had the last word on all my thinking, demonstrated his prowess as a forecaster by predicting the dollar would soon break its gold link and float. In 1975, when I came across the forecast in the transcript of a conference proceeding at Queens College, Ont., I asked Mundell how he could make such a spectacular forecast. He said simply that he had read that day an item in The New York Times reporting Robert Roosa’s comment that the United States might soon not be able to defend its gold monetary reserves. Roosa, who had been President Kennedy’s Treasury Undersecretary of State for Monetary Affairs and Paul Volcker’s mentor, was the equivalent then of Felix Rohatyn today. A practical man of Wall Street, not academia, where he presided over Brown Brothers, Harriman, Roosa had been the Democratic Party’s principal champion of the Bretton Woods gold standard. Mundell reasoned that if Roosa did not understand gold stocks could be defended by contracting the Fed’s balance sheet (selling bonds), then “the forces of history were determined to have one of their periodic experiments in a managed currency,” and nothing could be done about it. With the Rohatyn paradigm shift, we are reminded that those forces are still flowing in a positive direction.