[On Sunday, 7/20/97, I wrote the following as an op-ed submission to The Wall Street Journal. It was rejected on the grounds that it did not seem plausible that investors would be following the nuances of budget negotiations as closely as I believe they are.]
By Jude Wanniski
When the stock market sold off sharply last Thursday afternoon and Friday, there were plenty of opinions in the news on why it occurred. The most prominent was that stocks had been overbought in the previous ten trading days and that Wall Street was taking a breather. A few analysts looked at the bump in the merchandise trade deficit as an excuse. Some noted a modest weakening in bond prices. The real reason was Newt Gingrich.
For those few of us who believe that most of the movement of the broad financial markets is related to the political environment, it was an easy call. The robust run-up in the market prior to last Thursday was almost entirely due to the news that the Democratic President and the Republican Congress would finally agree on a budget that would include increased rewards to capital formation. How could we be so sure of this reason?
We noted the breathtaking climb in the high-tech stocks in that 10-day stretch, not only Microsoft and Intel, but more importantly, the smaller companies with lower capitalizations, stocks like Ascend, Avanti and Netscape. These are the infant companies of an infant industry, and like infant babies, they need to be fed continuously, with capital, the mother’s milk of entrepreneurial enterprise.
If infant high-tech companies are not cared for in a capital-rich, hothouse, incubated economy, their reason for being will not be able to take root. The ideas that make them particular and potentially competitive with the Big Boys will not have time to produce a timely return on investment -- one that is realized before their ideas are overtaken by new babies coming up behind them or replicated by the Big Boys.
All young and fledgling enterprise benefits most from increased rewards to capital, which is what they need and do not have. Older, mature enterprises, on the other hand, have accumulated assets that can be collateralized in the debt market, if they want to expand or make it through a rough spot in the economy. This sector reacts positively to good news on interest rates, less so on taxes.
The high-tech babies were extremely happy with their environment last January. It then seemed the Republicans, having retained control of Congress in November, were in the dominant position. The President was in a passive position, with no mandate except to prevent the Congress (i.e., Newt) from becoming excessive in whatever it might do. On January 22, the NASDAQ stocks hit a peak of 1388. The low-cap, high-tech stocks began to fall to pieces after that date. What happened?
It was on that date that House Speaker Newt Gingrich was found guilty of breaching various rules of conduct by the House Ethics Committee and fined $250,000. From this point on, President Clinton and the liberal Democrats gained strength relative to the GOP. The President had signaled a willingness to accept a cut in the capital gains tax, but now it appeared he would be able to squeeze it down to a bare minimum and keep the money saved for federal spending.
The fortunes of the infant high-tech companies did not turn around until late April, when it began to seem possible that a deal could be struck. News began to leak out that the Congressional Budget Office had discovered $225 billion in tax revenues over the next five years that it had not counted upon. Even though Speaker Gingrich dealt away the entire amount for spending, at least it appeared the $38 billion over five years promised for capital formation would now be safe. The baby NASDAQ stocks squealed with delight! NASDAQ’s high-tech index hit bottom at 198 on April 25 and then began the steady climb that did not end until it hit 256 last Thursday.
The squeals of delight turned sour last Thursday as soon as it was reported that Rep. Bill Paxon, chairman of the House Leadership Conference and a Gingrich protégé, had resigned. It instantly was clear to House Minority Leader Richard Gephardt that the soft underbelly of the GOP was exposed, with a fresh chance to kill the little tax cut for capital gains -- putting it back where it was in 1986. Gephardt was immediately at President Clinton’s ear, urging a fresh round of class warfare.
With the political marketplace so efficient, why should the financial markets be any less so? Clearly, the budget deal suddenly was again at risk. On Thursday afternoon, the Dow lost 18 points, 0.23%, but NASDAQ’s percentage loss was three times as great, 0.75%. On Friday, the Dow lost 130 points, 1.62%, but the NASDAQ high-tech index was socked 2.2%.
This might sound like techno-babble. To supply-siders, it means the GOP weakness is likely to produce a further watering down of the tax cuts that benefit the little guys -- not only high-tech little guys, but all fledgling enterprise that will be more vulnerable without fresh capital formation.
Why is it so hard to understand that an increased reward to risk-taking will induce more capital to be put at risk? And if risk-taking is the source of all economic growth, as it surely is, any threat to its rewards should cause a decline in the value of the nation’s capital stock. Even more obviously, it will cause the equity value of infant corporations in infant industries to decline fastest of all.
On Sunday’s "Meet the Press," Treasury Secretary Bob Rubin took the hardest negotiating position yet, insisting that any cut in the capital gains tax would be a waste of resources and that the funds should be used instead for the lower-income classes. Senate Minority Leader Tom Daschle says he will urge a veto unless the benefits to the rich are reduced. With the stroke of his pen, it’s true, the President can abort a great many enterprises now in gestation. If he understood what the markets are telling us, maybe he wouldn’t.