Ronald Reagan went on television to praise the greatest tax...well, er...reform in history and the next day Wall Street vibrated like a struck kettle drum. Or maybe it vibrated because of Henry Kaufman and Albert Wojnilower.
Kaufman, famous for his pronouncements and notorious for his pessimism, has been saying for months that interest rates would rise again. They would rise because the recovery would stimulate private demand for capital, and that demand would collide with the government's borrowing to fund the deficit. Last Tuesday, however, Kaufman said interest rates will fall because there is no sign of recovery. That bearish assessment helped start the stampede of bulls.
Wojnilower, chief economist of the First Boston Corporation, also issued a prognosis of declining interest rates: "The business outlook has deteriorated. The risks of a flare-up of interest rates have therefore diminished...." What ignited the market on Rosy Tuesday was not presidential eloquence but "optimism" about interest rates, based on pessimism about the economy.
Business schools teach that the stock market is a rational pricing mechanism, and so it is, over time. But Keynes (if the current administration will pardon my language) said that you could not explain capitalism without reference to "animal spirits." Various more or less rational calculations summoned those spirits from the vasty deep last week.
The White House suggests, demurely, that it did the summoning with Reagan's speech. Ah, well, politicians live by the post hoc, ergo propter hoc fallacy. (The rooster crows and the sun rises, therefore the crowing caused the sunrise). When a judge who issued a ruling against Father Divine's church soon died of a heart attack, Father Divine said: "I hated to do it."
But the market rally began two days before Reagan's speech: The Friday-Monday-Tuesday gain was 54 points. Yields from short-term (for example, 90-day) instruments have fallen sharply since June, approximately from 13 percent to 8.5 percent. For investors, life is a constantly changing kaleidoscope of choices, and the stock market has suddenly become a relatively more attractive option for a lot of short-term liquidity.
Part of the investor's art is to "find the bottom" of a market cycle and buy as the upturn begins. On Black Tuesday in October, 1929, a panic drove the market down. Last Tuesday a kind of panic -- a fear of missing the elevator -- drove the market up. In spite of the second highest volume in history, during most of the session the New York Stock Exchange tape ran only four minutes behind, because the number of transactions was small relative to volume. Institutional investors, trading blocks of 10,000, were leading the charge.
Reagan increased taxes substantially as governor of California. Nevertheless, the phrase "Reagan tax increase" seems to be an anomalous conjunction of words. But what that phrase refers to today is perceived by many investors as evidence of Congress' capacity to do at least the second hardest and second most important thing to reduce the deficit. The hardest and most important task is to restrain substantially the growth of the large entitlement programs. Congress has not done this, and the budget-cutting zeal is waning.
It is unlikely that any congressman or senator will become a hissing and a byword in his constituency in November because in August, while the country was comatose, he voted for a tax increase that, in effect, diminishes the tax cuts enacted last summer by only about 20 percent. In the American hierarchy of values, measures to reduce deficits rank just below godliness and way ahead of cleanliness.
The market rally reflects underlying pessimism, and that the fight over the tax increase was disproportionate to the principles at issue and to the measure's likely impact. Neither the rally nor the fight about the tax increase is as important as this fact: The Reagan administration is caught in an irony that could be compounded with another.
The immediate irony is this: A government-pruning, bureaucracy-bashing, anti-Washington administration can not blink the fact that the principal domestic chore in this decade is to restore the federal government's revenue base. The next irony may be this: If entire regions, such as the Northwest, or the "automobile belt" from New Jersey to Missouri, continue to suffer economic implosion, and large economic entities begin to fail, the federal government will be drawn, willy-nilly, deeper into economic activism than at any time since 1936.