Kerry/Strong Dollar
Jude Wanniski
February 25, 2004


From:Jude Wanniski
To: James K. Galbraith <galbraith@* * * * *.edu>
Kerry/Strong Dollar
2/25/04 6:21 pm

Do you think cutting the capital gains tax would weaken the dollar? If you don't, then you believe cutting capgains would have no effect on the demand for dollar liquidity. Tax policy has no effect on monetary policy. Are you sure you have a PhD in economics?  Hey, I went to a lot of trouble writing you about how all this happens and you said you would get back to me.

In December 1996, I began warning Greenspan that because there was a deal cooking to cut the capgains tax, the price of gold was already falling and the dollar already rising in the forex market. The economic actors began demanding more liquidity because they anticipated a larger economy.  I bet my whole company on my forecasts, which is why I have not only succeed but become very wealthy. My net worth 25 years ago was $25,000, the money I used to start my company. I'm well into eight figures in net worth. I tell you all this so you can see that unlike an academic theoretician, I live and die with my analysis. Krugman pulls rank on me when he says he will not even discuss economics with me, because I do not have a PhD. You said you would engage me in discussion. Well, engage.


At 04:21 PM 2/25/2004 -0600, you wrote:

By Jude's argument then, cutting the capital gains tax would strengthen the dollar, and if that's right (which I don't think it is), then Bush or Snow do have a lever they could use. 

Except that strengthening the dollar per se (as opposed to avoiding a collapse, which is a relatively remote danger but nevertheless what I worry about) is not very good policy just now.

As for my own view, strengthening the economy is the first priority;  I don't believe that would weaken the dollar, since rising profits would attract investment.  To the extent that Bush and Snow are responsible for the poor state of the economy (and they are), then Kerry has a legitimate point, even if it's directed to an objective that should not be a policy priority.

Am I advising him?  No.   J

At 04:27 PM 2/25/2004 -0500, you wrote:

Someone should explain to Kerry that the reason for the weak dollar is not Bush or Snow, who he chastizes, but Greenspan, who Kerry says he would appoint for another term. Your story makes clear the Germans are coming to DC to talk to Greenspan about shoring up the dollar, not to see Bush or Snow, who have no levers to pull, only ineffective jawboning.

The dollar is already strengthening, as witness gold falling from $430 to $395 since the FOMC said it would not keep the funds rate at 1% for a "considerable period." By the time November rolls around, if Kerry is elected, he might be wondering how to weaken the dollar. I wonder, is Jamie Galbraith talking to Kerry? He's not so bad on monetary policy, but still would like to raise the capital gains tax -- which of course would weaken the dollar enormously. It would dry up demand for the dollar.

Jude Wanniski
10:18 2/26/04

At 05:39 PM 2/25/2004 -0600, you wrote:

Jude, there is a plain contradiction in your position.  If raising the cap gains tax would weaken the dollar, as you argue, then surely cutting it would -- in your view -- strengthen the dollar.  I'm not saying that in my view Kerry should advocate this -- I don't agree with it --  only that your own argument must imply that Bush and Snow could strengthen the dollar if they wanted to.
* * * * *

*****Ive been advising my clients ever since the monetary deflation began in 12/96 that it was being caused by the clear movement in Congress to cutting the capgains tax in 1997. Because I could not persuade any of the policymakers in the Clinton White House or GOP Congress that a good tax cut would cause a bad deflation, I advised clients that it would be better to accept the deflation along with the capgains cut and then direct our energies at ending the deflation. If Bush/Snow were to now advocate another cut in the capgains tax, it would cause an increase in the demand for liquidity and send gold down to deflationary territory again,  but only if the market saw it had a chance of being enacted, not likely at the moment. The problem is with the floating dollar, not the capgains tax, as a legitimate demand for liquidity accompanying a lower marginal cost of capital would not be matched by supply. The dollar would be scarce relative to gold and the dollar/gold price would fall, dragging all other prices in its train.

More generally, your approach to empirical argument, which is to associate events and then stipulate a causal relationship that coincides with your previously held theory, is a weak point.  It leads to situations where you only find confirmation for what you already believed, never mysteries or anomalies that would permit you to revise your view, at least in this area.  It does not seem to me very likely that the mere discussion or introduction of a tax change that might or might not become law much later on should plausibly have an immediate effect on currency markets.  At the least, to make this case persuasive to me would require much more exhaustive evidence than you are giving.

*****When Wilbur Mills was chairman of Ways and Means he once joked that if his committee met in a locked room and discussed a cut in the capital gains tax, when they emerged they would find that somehow the stock market had leaped up. What I do, Jamie, is assess the theoretical likelihood that a cut in a tax rate will cause a change in equity values and go from there, not as you suggest state a preference and then look for reasons to support the preference. This is how I discovered the cause of the 29 stock market crash. I knew there had to be a supply shock of some sort and I hunted for months until I stumbled upon Smoot Hawley because of a pamphlet given me at AEI by Gottfried Haberler. In the case of capgains, I've gone through examples all over the world and find a universal fit with the conclusion that the correct rate of capgains is ZERO, which is what Greenspan first persuaded me of, in a long conversation we had in his office at the Fed a dozen years ago. Mundell and Laffer were miffed because they had made the correct rate was 15%. In 1978, a breakthrough came when the stock market leaped by 30 points in a few minutes (when 30 points was a huge jump). It was Bob Bartley who discovered on the Dow Jones ticker that the news had come across that Rep Bill Steiger, who was on Ways & Means, reported that a majority of the committee had signed onto his bill to cut the capital gains tax. I knew Steiger, but didn't know he was even working the Democrats to get their support. I was in DC on another matter when Bartley called me about the link, and went to see Steiger, who said he thought he would do it for the exercise, never imagining he would succeed. He had Richard Rahn of the USChamber with him lobbying the committee members.

My own view is that the effects of tax policy -- even enacted into law -- on dollar asset demand are second-order.  If I can get the growth rate up I would be able to fiddle with the tax code in any number of ways without serious consequences.  Fixing the Bush derelictions to the tax code is however (by the same argument) for me a second priority, mainly aimed at the politics of the issue.  If I ran the zoo I would do that, but not before taking decisive measures to raise the growth rate. 

*****These are assertions you are making, Jamie, with no theoretical foundation but your own preference for high tax rates on the rich. Your father opposed the JFK tax cuts and to this day insists they were a mistake. Yet the stock market loved them when they were introduced in late May 1962, as I recounted in TWTWW, and the DJIA boomed after they were enacted in '64, hitting 1000 at its peak in 1964 when Goldwater Republicans pushed LBJ into a fiscally responsible Vietnam War surtax.

I do not pull rank, at the same time the fact that you are wealthy and I am not impresses me not at all.  I could certainly have become wealthy if I'd put my mind to it early on in life, but I've had other things to do.


*****I have no doubt you could have become wealthy if you put your mind to it, Jamie, but not as an investment advisor in the Wall Street jungle. My wealth is a direct result of the analytical framework I developed with some help from Mundell and Laffer, but also from the Frank Knight ideas on "risk,uncertainty and profit" as developed by Reuven Brenner of McGill. When I founded Polyconomics, my chief competitors were Keynesians and monetarists, almost all of whom are out of business now, having lost their clients wealth. The remaining Keynesians like Ed Hyman and Ed Yardeni are eclectic, and both of them totally missed the monetary deflation that I saw coming from its start. My point goes to the argument: "If you are so smart, why aren't you rich?" But I am, I am, without even trying to become rich.


PS  I'd still like a response from you on the supply-side memo you said you were going to think about. And remember again that this exercise is one I hoped would help elect a Democrat.