The gulf between Washington and New York always has been more than geographic. The two towns don't think the same way. Washington exists to control something or someone. New York exists to make money. In Washington you can be (relatively) poor but still important. That's tough in New York. Even artists need quick commercial success.
The two towns live in a perpetual tension that sometimes flares into the open. Like now. Long-term interest rates, largely determined in New York have risen just when the Reagan administration wants them to decline. Rates of 15 percent for top-quality corporate bonds compare with less than 9 percent in 1979 and 11 percent last summer.
The increases anger President Reagan, and the implications surely must chill his advisers. Prolonged high rates would threaten economic stagnation, foreign policy conflicts (the rates spread to Europe, causing slump) and distress inkey sectors -- autos, housing and saving associations.
Long-term interest rates typically consist of two ill-defined components: the "real" rate expected by the investor (perhaps 1 to 3 percent) and some "inflation premium" to maintain the value of the principal during the loan's life. The recent rate increases means either that investors expect higher "real" returns or that their inflation outlook has worsed.
It's perplexing. The country elects a conservative president committed to tight money and tight budgets. He has initial success with his policies, as well as some good luck: a leveling of oil prices and lower-than-expected food increases. Yet the financial judgment is that the outlook has deteriorated.
Reagan's response (and the news media's) to the puzzle is to picture Wall Street, that convenient symbol of unrepentant capitalism, as subverting Washington. But this overdramatizes and oversimplifies the real story.
The reaction of the money market is a crude barometer of skepticism that government can do what it says. Economists such as Henry Kaufman of the Investment banking house of Salomon Brothers believe that higher defense spending and big tax cuts are inherently inflationary. Alan Greenspan, President Ford's top economist, thinks that the financial climate has changed fundamentally:
"Up until 1978, the general expectation was that inflation was a short-run phenomenon related to war or its immediate aftermath. The change came in mid-1979, when it no longer appeared that way -- whether it was the Iranian oil crisis or something more fundamental is hard to say -- and you get this explosion in rates. The adjustment is still working its way through the system."
Another basic change involves the relationship between short-term and long-term interest rates. Once upon a time, long-term rates almost exceeded short-term rates. Investors got higher rates to reward them for the increased uncertainty of lending over longer periods. Now that's not necessarily so. Indeed, since mid-1979, short-term rates -- with a few lapses -- have exceeded long-term rates.
If you're going to sell bonds and mortgages, you have to have buyers. The shift in rate relationships, combined with more uncertainty about the future, has alienated many of the largest buyers: pension funds and insurance companies. The managers of these funds have been burned badly. They increasingly shy away from long-term risks and stick with lucrative short-term securities.
"The guy who won't buy a 30-year Treasury bond at 13 7/8 percent is the same guy who was furiously buying 8 3/8 bonds in 1978," said a New York bank economist. "What he got for his efforts is a bond selling for $67."
That's $67 on an original investment of $100. As interest rates rise, the prices of existing bonds fall. Consequently, any rise in short-term rates tends to drag up long-term rates to attract increasingly reluctant bond buyers.
At worst, there's a vicious circle. High bond rates mean that firms temporarily shift more of their financing into short-term loans or securities. Corporate treasurers don't want to get locked into high rates for 20 or 30 years. Combined with the Federal Reserve's tight-money policies, that pushes up short-term rates. Long-term rates then may follow.
The upshot of all this is that Washington is reacting to New York as much as the other way around. Interest rates are driving social policy and politics. Greenspan, for instance, argues that all the budget cuts didn't make much impression because exempting the "safety net" of social programs was taken as a pessimistic "signal."
"Once you get through the controllables [of federal programs], the safety net -- still growing -- takes over the growth of spending," he said. That raises the specter of more deficits, more govenrment borrowing, more pressure on the Fed to increase the money supply -- and more inflation.
So the administration sought to repaint this picture. It rushed to publish its proposals for cutting future Social Security payments. Similar anxieties have made the White House more willing to reduce the size of its proposed tax cut.
The contest between Washington and New York mostly involves conflicting views of the world. The administration hoped that tight money and budgets would lower inflationary expectations and, thereby, long-term interest rates. Economic expansion and lower inflation would coexist. It was as if sheer will power could change economic behavior.
New York -- really everyone outside Washington -- reacts according to experience. This is not cynicism but human nature. People peg wage gains (now running between 9 percent and 10 percent) to past inflation, preparing future inflation. Investment managers remember that other presidents pledged to lower inflation but didn't succeed.
This may be a contest without a winner. The shrewd investment managers consistently have guessed wrong; anyone who bought a 4 1/2 percent bond in 1965 looks like a fool now. Too optimistic before, they may be too pessimistic about Reagan's perseverance against inflation. But the White House may learn equally that the past simply cannot be wished away. The path of lower inflation may be the joyless one of slow growth and stubbornly high interest rates.