Reagan's Homestretch:
Money & Star Wars
Jude Wanniski
October 10, 1986


Executive Summary: What will President Reagan attempt to accomplish in his last two White House years? The November 4 elections will bear on the options. But by all accounts, the two issues that excite him the most are international monetary reform and his Strategic Defense Initiative. The Treasury team sees the impracticality of coordinating national economic policies; Jim Baker is frustrated with Germany and Japan. Only gold addresses sovereignty concerns. Monetary reform can proceed into '88, even with a Democratic Senate. Will Regan, Volcker, Darman stay on? It is especially important that Darman not leave. After the elections, expect firmer policy at the Fed, a snugging up.

Will Reagan do a sweetheart arms deal with Gorbachev? He is more likely to sell Gorbachev on a package deal that cuts back on offensive weapons and accepts early deployment of SDI. Time works in Reagan's favor. Pro-Star Wars scientists resolve their differences on early deployment. Maybe the most interesting Reagan years are coming up.

Reagan's Homestretch: Money & Star Wars

What can we expect of President Reagan's last two years in the White House? An arms-control agreement? Star Wars? Monetary reform? Trade agreements? Trade war? Welfare reform? Budget squeezing? The "social" issues? Lame Ducksville?

The November 4 elections, of course, will determine at least the psychological cast of the Administration. If the Republicans retain control of the Senate — even by a slight margin (which now seems most likely) — there will be those in the Administration who will want to put all energies into budget balancing, "Budget, budget, budget," is how one White House acquaintance listed domestic priorities when asked about '87.

If the Democrats take control of the Senate, the White House will surely forget about a serious budgetary strategy, knowing non-defense spending is beyond its reach. With Democrats having accountability along with congressional control, the Administration would likely think confrontational, developing a veto strategy. The new Speaker of the House, Jim Wright of Texas, not as politically astute as Tip O'Neill, would soon be talking tax increases. Deep down, some combative conservatives might even prefer this scenario.

By all accounts, though, the only issues that really interest the President when the '87 agenda is discussed are monetary reform and his Strategic Defense Initiative — two major objectives that absolutely require presidential enthusiasm if they are going to be realized in his two remaining years. Budget and trade and welfare matters have their own champions in the Administration and Congress. Only the President can lead on a new gold-exchange standard and Star Wars.

A Monetary Obstacle Course

The President has wanted to reform monetary policy — making the dollar as good as gold — throughout his tenure. But either he didn't have the support of his advisers or there was something else that had to be done first. "In due time," his Treasury Secretary told him in his first term, when the President asked Donald Regan when we could get back to gold. The President knows how much time he has left. He asked in his State of the Union address last January for a report by year's end from Treasury Secretary Jim Baker on the feasibility of an international monetary conference in the following years.

The White House staff is burned out at the moment, due to the crushing pressures of the last several months — tax reform, Nick Daniloff, South Africa and Gramm-Rudman. But with Congress out of town and the elections and Iceland mini-summit out of the way, clearer heads will be able to think and plan ahead. No matter how the elections turn out next month, they will see the utility of a Reagan Administration focus on global monetary reform next year, probably extending into 1988. A Democratic Senate wouldn't slow this initiative in the slightest, and frankly could even concentrate more of the West Wing's attention on monetary reform.

A Bretton Woods Parallel

There is no partisanship associated with monetary reform, no narrow, special-interest groups lining up coalitions on Capitol Hill. The Bretton Woods agreement of 1944 that created the World Bank and International Monetary Fund was negotiated during a world war and a presidential election year, and Congress was barely aware of it. Unlike all other possible presidential initiatives, a Reagan exchange-rate plan could realistically extend deep into the 1988 election year and still succeed. By itself, it would give vitality to the President's closing years and smother lame-duck talk. The Democrats are already conceding Ronald Reagan's enormous popularity, success, and place in history (all due to his "personality" and "telegenesis," of course). They would just as soon throw monetary reform on his pile rather than risk seeing a COP successor get the credit.

An ancillary benefit is that the reform process, like tax reform this year, gives the Administration a shield against the forces of austerity and protectionism. Martin Feldstein is already busy writing essays in The Washington Post about the evils of the twin deficits and how they have to be attacked pronto. If the White House can't offer an alternative solution, it will be forced to do "budget, budget, budget."

The economic growth solution is the correct one, and a gold anchored fixed exchange-rate system is the only policy that could provide the kind of growth that will reduce both deficits. The Treasury team of Jim Baker and Richard Darman must surely have come to realize that it isn't possible to manage exchange rates by coordinating global economic policies. They spent most of the year trying to coax foreign central banks toward expansionary (anti-deflationary) monetary policies. It would have been nice if they'd succeeded. But it isn't realistic to expect governments to be conducted as an orchestra, with the United States as maestro. It's hard enough for a Jamaica or a Peru to give up national economic policymaking to the IMF when they come as supplicants. For Germany or Japan or France or England to raise or lower taxes or spending or interest rates on a signal from James Baker III was always improbable. Nation states guard their sovereignty on economic matters almost as much as they do their frontiers.

Dealing With the Sovereignty Issue

It has been a terribly frustrating experience for the Treasury team, more difficult than dealing with Congress over tax reform. But then the executive and legislative branches of the U.S. government at least derive their powers from the same pool, the American electorate. Coordination of national economic policies involves a variety of democratic perspectives. For this reason alone, a "managed float" or a system of target exchange-rate zones can't be sustained. Neither deal with the sovereignty issue. Remember how frustrated the Johnson Administration was with France's President DeGaulle in 1966-67, when it wanted France to accept U.S. Treasury bonds in lieu of gold bullion, and DeGaulle wanted the bullion? DeGaulle, it turns out, was right. West Germany, which knuckled under to LBJ, wound up with huge losses on its bonds when Nixon devalued in 1971. Gold is the only vehicle that can deal with the sovereignty issue, as it has in the past. The reason is simple: National governments are always ready to look upon gold as a neutral monetary reserve. Almost half the gold in the world is held by governments as monetary reserves anyway. If, as in the past, gold were agreed upon as the world's common money, policy would be orchestrated not by a single maestro, but by a gold metronome (with national currencies fixed in value to it, either directly or through a new IMF gold unit of account — paper gold).This was essentially the reasoning behind Robert Mundell's recommendation last April that the Treasury announce gold sales from its reserves of up to 25 million ounces (5% of its stock) to hold the market price — then at $350 — below $400. Had this been done, the monetary events of the summer would have unfolded a bit differently.

The Resistance to Baker's Pleas

We're not absolutely sure the Bundesbank and the Bank of Japan resisted Jim Baker's pleas because of a fear the U.S. was leading the way back to a new inflation. But they were given no reason to believe otherwise. There was no guarantee that if they did cut their interest rates to satisfy him that another round of "coordinated" cutting wouldn't begin immediately. For the U.S. to commit a significant chunk of its gold reserves to the $400 level would have assured all our trading partners that a new dollar inflation wasn't at hand. The Japanese would have been especially comforted, knowing that if they did cut their discount rate the yen would weaken against the dollar and the U.S. wouldn't be able to offset it with a cut of its own ~ or shoot over $400 gold.

As it is, the Baker browbeatings of Germany and Japan —threatening further dollar devaluations unless they eased — have only succeeded in rattling the bond markets and sending up the gold price. The Fed's discount rate cut in August, which seemed to be managed by Treasury, with Volcker's assistance, came with gold already within shouting distance of $400. Instead of being welcomed by the bond markets, as had the previous cuts this year, this one sent the long bond south. And all further talk of another Fed easing only pushed gold higher and bonds lower. One bright spot occurred September 17 when Fed Vice Chairman Manuel Johnson spoke on behalf of a "pause" in pushing rates down, which sent bonds up for the few hours before Jim Baker got back on the wires -- talking down the dollar.

The November elections, admittedly, are causing an unusual amount of trouble this year because of the number of farm state Republicans who are in difficulty. The Administration wants interest rates to go down to help the farmers, but lowering short rates spooks the long market and they are worse off than before. Because a weak dollar is seen as good for exports, Treasury talks down the dollar, and because economic growth abroad is also seen as being good for U.S. exports, Treasury calls for easier money abroad, which would make the dollar go higher. This maze of contradictions could be finessed somewhat if Treasury sold gold from reserves to get it back below $400. But Republican senators from western gold-mining states would fight any such move prior to the close of the polls November 4.

Election-Eve Easing

If not for the Senate elections, with a climate threatening protectionism, the Fed would be marginally tighter, both in word and deed. Instead of brushing off the rise in the gold price to over $440 as a South African supply concern or a Japanese demand episode (related to their new gold coins), the Fed's Reaganauts would be snugging up short rates and watching bonds rally with gold's decline. Ironically, COP candidates would be better off if nobody was trying to help them.

We'll also know after November 4 what the Reagan Administration will look like in terms of personnel. There will surely be many departures announced after election day. After six years in the pressure cooker, thinking the last two years could easily be lame duck, coasting-home years for the Gipper, some of the team will want to leave. There's speculation that Donald Regan, who has begun to look a bit haggard, might be ready to pack it in. Paul Volcker is said to be ready to leave when his second term is up next August — which led to the speculation that he might be interested in the top post at the IMF. Deputy Treasury Secretary Richard Darman, a key strategist (perhaps the key strategist) of the six-year administration, is reported to be mulling departure. If any one of the three would leave we'd have to discount chances of monetary reform in the homestretch, but it still could happen. If Darman leaves, though, it might mean he doesn't think it could be done with or without him. It's hard to imagine Darman sticking around the next two years to administrate.

One very positive sign was Treasury's blocking of Holland's Finance Minister, H. Onno Ruding, as the new IMF director. Ruding, an ardent monetarist, would have made an international monetary conference an obstacle course. Early press reports that he had won the "backing" of the United States were discouraging, but turned out to simply indicate he had won over the U.S. bureaucrats at the IMF, Richard Erb and Charles Delara, and probably Beryl Sprinkel at the CEA. (Ruding was championed by Karl Brunner, a Friedmanite who coined the term "monetarist.") When Baker and Darman got into the act, Ruding's U.S. backing ended.

As it stands, the more interest the President shows in monetary reform, the more likely his team will feel it's worthwhile to stay the course and try to pull it off, which in turn will reinvigorate the Administration. We will await November and further signals from the players, as well as the Treasury report called for last January by the President. In any event, there is a good probability that day-to-day monetary policy will snug up after the elections, when the political heat turns down.


Half the analytical stories that came out of the Daniloff affair seemed to suggest that the way it unfolded proved that Mikhail Gorbachev really, desperately wants a summit meeting with President Reagan. The other half argued the opposite, that it was Reagan who jumped at the deal, took a trade for Daniloff when he said he wouldn't, and swooned at Gorby's Iceland invitation.

The probability is that both Gorby and Ron want to get together by more than half, each seeing a good chance at a highly beneficial horsetrade. The conservatives and, even more so, the neoconservatives, are sick to death that Reagan is going to "waste" the six years he has invested playing hardball with the Russians by embracing Gorby in a sweetheart arms-control deal. The Wall Street Journal editorial of October 6, "Ronald Reagan's Killer Rabbit," was almost frantic on the point. Earlier, The Washington Times had editorialized on the Daniloff affair in the same vein, "Let Reagan Be Carter," suggesting that Ron was becoming wimpier than Jimmy.

The unspoken assumption is that President Reagan, knowing he only has two years left to be immortalized as a Peacemaker and Arms-Controller, will allow George Shultz, Nancy and Gorby to talk him into doing things he wouldn't have dreamed of doing a few years back —like give in on Star Wars in exchange for some Mickey Mouse cutback on offensive weapons!

The problem with all this flapping about is that a few years ago, when the President first advanced the concept of strategic defense, he had almost zero support from conservatives and neo-conservatives — who saw SDI as diverting resources away from the offensive weaponry they were boosting at the time ~ including The Wall Street Journal. The way I look at it, Reagan is playing poker with a pile of chips he has built up with his own wits and instincts (and poker face). The kibitzers have every right to kibitz, this being a free country. But it's hard to believe the President is going to bet the pile on an inside straight, which is the way the kibitzers are carrying on.

Reagan's Loftier View

Of the two, Ron and Gorby, the President has by far the clearer picture of the future, which is what summits and poker games turn on. There was a time when a Khrushchev could imagine the future with confidence that Soviet socialism would eventually bury us. But Gorbachev can't have much confidence that Marxism-Leninism will make it to the '90s, observing it hanging out to dry in Peking and, with few exceptions, seeing the model rejected around the Third World.

The natural tendency is to see time working against Reagan because his term is running out. But in a way, this is working to his advantage. General Secretary Gorbachev knows Reagan and, we must assume, likes him. Who doesn't? If you put yourself in his shoes for a moment, you realize you'd much rather do a deal with Reagan than play Russian Roulette with the mob of Democrats and Republicans -- all unknown quantities — lining up for 1988. These are not only Gorby's shoes you're standing in; everyone in the Politburo has them on.

The time factor has worked in other ways to facilitate the process. Until a month ago, the SDI proponents seemed hopelessly divided on the question of early deployment. Rival theories on an ideal SDI were at the heart of the problem, but when the scientists could not agree, the President was immobilized. The President's July letter to Gorbachev, offering to defer SDI deployment for 7-to-10 years while R&D proceeded, seemed to shock the pro-SDI scientists into realizing that their narrow interests were threatening the overall objective. At a September 29 meeting in Washington called by Rep. Jack Kemp and Rep. Jim Courter, the feuding scientists were urged by Kemp — who expects to be President during the next 7-to-10 years — to commit themselves to an early deployment in order to save SDI. The scientists — most importantly Dr. Edward Teller — agreed, and with tactical differences resolved, they advised the White House they now favor early deployment. Conceptually, early deployment simply means there are SDI elements that can now be constructed — in the way footings can be built for a house — although the completed structure is years away. The commitment is what's important. A future President wouldn't have the luxury of ignoring the idea of strategic defense. Demolition of the footings would have to be debated.

President Reagan, of course, hasn't made such an early deployment decision. But he has the comfort of knowing the SDI advocates are unified on the issue, no longer at loggerheads. He is in a good position, after all, to sell Gorbachev on Star Wars. He could accept a Mickey Mouse deal on offensive nuclear weapons if the Soviets would accept the beginnings of SDI deployment, an end to the ABM Treaty, etc., which they are now saying they absolutely oppose as a precondition to any arms-control agreement! The fact is that President Reagan more than almost everyone else seems to know strategic defense is in the cards, sometime soon, and mutually assured destruction is on the way out. Somewhere between Iceland and Washington, Gorbachev should get the picture.

A gold standard and Star Wars with two years to go? There's no reason why President Reagan can't do it, as long as he keeps his team together. Lame Ducksville? That's what the Beltway was betting in 1985, yet Reagan at the moment is at the peak of his charisma — soon to sign into law an historic tax reform that was said to be undoable. Those who bet on Reagan the lame duck are betting against the record. Quite the contrary, these homestretch years may be the most significant of the Reagan Revolution.

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