Greenspan and the Internet Whiplash Jude Wanniski August 6, 1999

You may have noticed today's WSJournal report on Thursday's action on NASDAQ, where reporter E.S. Browning said the "trading was enough to give investors whiplash." After falling 65.59 points, it bounced up 91.4, a gain of 3.69% from the bottom. The real whiplash was in the Internet stocks, with the Dow Internet Index up 17.88% from its bottom of the day! You may recall the report we sent on April 20, "The Internet Whiplash," which explained why we have to expect huge swings in these stocks. They are the most volatile because they discount deep into the future -- the end of the whip, as opposed to the Dow stocks or the S&P500, which are as secure as the handle of the whip. The secure stocks are as mature as grown-ups. The volatile stocks are like children who seem to have the potential to some day become Albert Einsteins or Amadeus Mozarts or Michael Jordans. They may not be earning money today, but they may be worth their weight in gold when they mature, or they may starve to death in a capital famine before they have a chance to mature.

Our assessment has related the swings to the near future of monetary and fiscal policy, because macroeconomics has more to do with capital formation in the near term than the dazzling future of the Internet for the longer term. For good measure, we have to throw in the unknowns of Y2K, which could upset Internet timetables if there is poor macroeconomic management of whatever stress the computer bug causes here and abroad. I'm relatively sure Amazon and Yahoo! will hit new highs sooner or later. The whiplash is the market's best guess on how soon or how late.

The nosediving of the Internet and NASDAQ stocks in great part is related to the future of the tax bill and its intersection with the Fed's determination to prevent faster growth in the economy. I'm really not that concerned that the $792 billion tax bill will be vetoed by the President. If I were President I would sign it, because it is a net positive for capital formation, which means the bond market would react positively to its provisions. The bill, though, could be improved if there were a serious attempt at bipartisan compromise after the veto. The House version had a cut in the capital gains tax to 15% from 20%. The package that will be sent to the President will have an 18% rate with the money "saved" from the other three points dedicated to prospective indexation of capgains. This was a mistake, I think, because the GOP gave away a bird in the hand for a imaginary bird in the bush. Indexation is something you need enact at the outset of an inflation, not in an era of monetary deflation. It could be fixed in a new bill, or the prospective indexation "money" could be used to cover the exemption for middle-income taxpayers that has a foothold in the Senate version, via the bipartisan work of Senators Paul Coverdell [R-GA] and Bob Torricelli [D-NJ].

Of course, there is plenty of danger that the Republican leadership will stumble into a worse tax package. House Majority Leader Tom DeLay's comments as reported in the NYTimes today make chilling reading, as DeLay, who never forgave Newt Gingrich for caving in during the government shutdown debacle of 1995, seems bent on another shutdown strategy. The only strategy that makes sense to me is that of Senate Finance Chairman Bill Roth -- the legislative strategy I mentioned in "GOP Tax Strategy," 8-2-99. That would enable Congress to have maximum leverage in dealing with the President on appropriations bills, Medicare and the tax bill. A DeLay confrontation would be as bad this trip as it was in 1995, with GOP moderates flocking to a united Democratic Party to make mincemeat of the Republicans. In the end, there would be a cheesy tax bill or no tax bill at all, with Clinton calling the shots on appropriations and Medicare too.

Fed Chairman Alan Greenspan thus far has been no help to the near future of capital formation on any front -- monetary, fiscal or Y2K. His warning against tax cuts as being inflationary, urging all the "surplus" be used for debt reduction, would be fine as long as he always mentioned the exception to the rule -- cutting or eliminating the capital gains tax. If he did that, the Democrats would no longer be able to use him as an ally in their political maneuvers, and the negotiations in September would have a more positive, supply-side cast.

There is good news: Greenspan is finally coming under attack by two presidential candidates, former Vice President Dan Quayle and Steve Forbes. Jack Kemp doesn't have the clout he would have if he were in the running, but when there are two presidential candidates who publicly have announced they would invite him into powerful positions in their administrations, he can make some waves. For the first time in their 25-year friendship, Kemp now is openly criticizing Greenspan on monetary and fiscal policies, as he did Wednesday in a Fox News interview with Brit Hume. The Fed Chairman, who has become used to undiluted adulation, is not happy at all. In his WSJournal column today, Paul Gigot points out that the Kemp-Quayle-Forbes combination is stirring the pot in Iowa, where the Republican straw poll will make political news next week. How are the farmers going to vote when they agree Greenspan's monetary deflation is killing them and yet George W. Bush, the frontrunner, is part of the Greenspan-is-God crowd?

Y2K also contributes to the hammering of the Internet stocks, I think, because there is so little movement by Greenspan in warning the President to take it seriously. If you saw the PBS Jim Lehrer NewsHour last night, you saw warnings that many of the nation's hospitals, especially in small towns, will have many pieces of equipment that will not be Y2K compliant. We had this warning to our Y2K clients almost 18 months ago. We note that ATM machines are now beginning to appear with stickers advising bank clients they are now Y2K compliant, yet wonder if there will be cash in the machines when Y2K rolls around. Greenspan has his head in the sand, with little likelihood thus far that he will advise Bill Clinton there is no alternative but to fix the dollar/gold price somewhere above $300, as Kemp has been arguing since early June. Greenspan now has to see he is being put on the spot, a hot spot that will burn him to a cinder if Y2K comes without his having taken every precaution to limit its damage. What will his friend, the Governor of Texas, tell the voters of Iowa, New Hampshire and every other state when the primary season begins amidst global financial turbulence? In his interview with Brit Hume, Kemp said he called George W this week to warn him about Greenspan's role in the commodity deflation, and the positive reactions Quayle and Forbes are getting in Iowa. Bush, reflecting the views of his chief economic advisor Larry Lindsey, Greenspan's pal, apparently disagreed. When asked who he would support in 2000, Kemp only would say nice things about Quayle and Forbes.

For my part, Quayle would make the better President, although I'm telling the many reporters who call to ask about Forbes that I think he would be fine if he could manage to get elected. Quayle's performance at the National Press Club this week was excellent. I'm halfway through his new book, Worth Fighting For, and am surprised to say it is the best book I've read by a presidential contender since Kemp's 1978 An American Renaissance. I thought it would be political boilerplate, but it is pure Quayle, readable, refreshing and intelligent. So don't lose heart about the future. The whip may soon be moving in the other direction. [I recommend my website posting today, "Money and Cultural Values," which ties into these political, economic and financial issues.]