The Economy Has to Get Worse
Jude Wanniski
July 17, 2001


Memo To: Mitch Daniels, Budget Director
From: Jude Wanniski
Re: Bob Novak’s column

I see we both made Bob Novak’s syndicated column Monday, which gives me a good excuse to finally contact you. When I was in DC earlier this year, I suppose I should have stopped in to welcome you to the Office of Management and Budget, and warn you that revenues would be declining as the economy continued to weaken. I did think I told enough Bushies about the monetary deflation that has us in its grip that word would get around to you. As days go by, I see you being dragged before Senatorial Inquisitions, pounding you for giving away in tax cuts the surplus Bill Clinton left you. As Novak points out, I predicted this result nine months ago, but because the problem facing the economy is so unusual, I knew the economy would have to get worse and worse before policymakers realized I was on to something. Novak tells me I have growing support in the administration, although as usual he does not separate the sheep from the goats. Of all people, you should be eager to hear my deflation arguments and beat the drums for relief, as the only way federal, state and local tax revenues will stop declining and begin expanding is if the deflation rolling toward us is halted and rolled back. Our mutual friend Jack Kemp wrote about it in the WSJournal recently. You should give him a holler if you find me too “iconoclastic,” as Novak puts it. Then again, you might want to hear all about it from the horse’s mouth. I’d be glad to help you in any way I can. I remember warning David Stockman in 1981 about the monetary deflation headed toward the Reagan Administration, but he said he did not have time to learn monetary policy. A big mistake.

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A specter is haunting Washington – the specter of prolonged economic stagnation and monetary deflation. Inside and outside the Bush administration, pessimism abounds. The hard truth is that nothing is being done today to turn around the economy in the foreseeable future.

It turns out that Jude Wanniski, the iconoclastic supply-side consultant, was right in his diagnosis. He has predicted for nine months that repeated interest rate cuts by the Federal Reserve Board and President Bush's tax cuts would not revive the economy. Nobody in authority wants to admit it, but Wanniski's warnings of dire economic consequences appear validated.

If Federal Reserve Chairman Alan Greenspan has no remedy, what is to be done? Senior policymakers in the administration are at a loss. Prestigious figures in the financial world privately call Wanniski correct in urging the Fed to end deflation by increasing the liquidity of money and setting a higher price of gold. They remain silent because there is no political support for such a course, and the economy must get much worse before the gold option would be seriously explored.

Meanwhile, the administration and its Democratic critics irrelevantly debate the size of the budget surplus. Newly installed Democratic Senate Budget Committee Chairman Kent Conrad harassed Budget Director Mitch Daniels at Thursday's hearing because the surplus for this year has declined to ''only'' $200 billion. Any serious economist laughs at considering the declining surplus as a cause rather than an effect of a languishing economy.

Republican and Democratic politicians seem oblivious to insufficient liquidity. The one political figure to forthrightly address deflation is Jack Kemp. In a June 28 essay in the Wall Street Journal, Kemp noted that the Fed's short-term interest rate reductions totaling 275 basis points have not managed to raise the price of gold above deflationary levels. He suggests that the Fed calibrate liquidity ''to keep the market price of gold stable.''

Senate Republican Leader Trent Lott, a rare voice on Capitol Hill worried about deflation, will insert Kemp's essay in the Congressional Record this week. But the 1996 Republican vice-presidential candidate is not a major public figure today, and his essay was the tree felled in an empty forest.

Even Kemp hesitates to suggest that the venerated Chairman Greenspan wears no clothes, but that opinion is shared by an increasing number of Fed-watchers outside politics. Greenspan disappointed markets the day before Kemp's essay was published when the Federal Open Market Committee cut interest rates only 25 basis points. Ultra-cautious Federal Reserve regional bank presidents still see inflation behind every bush, and Greenspan characteristically split the difference between him and them.

Greenspan gets little help from fellow governors of the central bank. A decade ago, esteemed economists Wayne Angell and Manuel Johnson were on the board urging that the price level of commodities be targeted – a regimen that today might bring needed liquidity. Today's Board of Governors, mostly picked by Greenspan, does not challenge him. The chairman last week pressured Bush into naming to the Fed Mark Olson, an amiable but unimpressive old Washington hand, though the president's aides had a different candidate.

Frederick Feldkamp, a Chicago lawyer and expert on corporate financing, comes from a different direction in doubting the effectiveness of the Fed's interest rate cuts. He sees danger in widened interest rate spreads between high and low grade business borrowings. The cause, he suggests, are Securities and Exchange Commission rules. Feldkamp's question: ''Can rising spreads be reversed before the U.S. economy falls into a liquidity trap and drags the world into a recession?''

When I suggested to a senior Bush official that he might take a look at Feldkamp's paper, he replied that he just didn't have time. At any rate, the SEC is powerless to act because Bush's nominees are caught in the Senate confirmation logjam.

Early this year when the outlook was less bleak, Wanniski warned Vice President Dick Cheney about deflation but added this: ''Because I was alone in making the argument, nothing could be done until enough damage had been done to Wall Street to force policymakers, out of fear, to take it seriously.'' That point may be in sight.