Even as Ronald Reagan is winning the battle in Congress over the first phase of his "economic recovery program," he is losing a struggle that his own senior aides consider at least as important: the struggle for hearts and minds on Wall Street.
The Reagan economic plan may be boffo in Washington, but in the financial markets of New York interest rates have soared and other signs of uneasiness abound. The long-term bond market is all but moribund, and the prinicipal architect of the Reagan plan, budget director David A. Stockman, acknowledges that his earlier, rosy predictions for lower interst rates and revived bond markets have proven premature.
The new administration's failure to make the impression on Wall Street it had hoped for is causing strain inside the White House and among some conservative Republican backers of "supply-side" economics on Capitol Hill.
One of those, Rep. Jack Kemp (R-N.Y.) blames much of what has gone wrong in the financial markets on the Federal Reserve Board. "One has to question whether or not they know what they're doing," Kemp said of the Fed's governors. Unexpected growth in the money supply -- which the administration and the Fed both agree publicly should be controlled -- is one factor that has alarmed the financial markets, pushing down the bond market and propelling the prime rate to 19 percent.
Some administration officials also blame the Fed for mismanaging the money supply in a way that brought oin the new interest-rate cruch. But on the record the White House has supported the Fed, and privately senior officials say that if the Fed did make a mistake, it was inadvertent and temporary.
"If we can't turn the financial markets around, then we can't suceed," Stockman said in an interview this week. "There's a much deeper skepticism in the markets than anyone expected," he added, speaking of Wall Street's attitude toward the Reagan economic program. "You can announce a policy, but the markets aren't going to respond until they see sustained action and some credible results."
as Stockman admitted, this is a substantial change in his own tune. Just a few months ago he was confident that when Wall Street realized how determined the administration was to cut the bugdget and taxes too, improvements in the investment markets would be dramatic, and interest rates would fall.
The bond market is crucial for the Reagan theorists because it mirrors what sophisticated investors think the long-term future will bring. For several years, those investors have signaled their belief that high inflation will continue. So far, nothing the Reagan administration has done has changed their minds. Without a change in outlook and a corresponding reduction in long-term interest rates, companies will continue to have trouble raising the capital for expansion -- the economic growth President Reagan promises.
In the interview Stockman said emphatically that the markets still will improve, but that this will take longer than he originally hoped. Now, he said, Wall Street wil be waiting for irrefutable evidence that Congress will go beyond the budget resolutions that outline cuts in many spending programs to the final legislative action that will secure the budget reductions.
But on Wall Street many money men say they are waiting for more than that. An influential school of Wall Street economists typified by Henry Kaufman of Salomon Brothers and Albert M. Wojnilower of the First Boston Corp. has encouraged deep skepticism about the Reagan plan's prospects.
Wojnilower made a speech to a private meeting of First Boston clients last month in which he predicted the latest rise in interest rates. It was "clearly indicated," Wojnilower said, because an expanding economy was on a "collision course" with the Federal Reserve Board's policy of restricting the growth of the supply of money.
Kaufman -- who also predicted the recent rise in interest rates -- and Wojnilower both regard the Reagan-Stockman budget proposals as essentially expansionary and thus inflationary. The economists say the administration's proposed reductions in domestic spending will be more than offset by its program for expanding defense spending and its tax-cutting plans. On balance, they say, the federal budget will continue to stimulate the national economy. If the Federal Reserve Board is simultaneously restricting growth of the money supply, demand for money will outpace supply and interest rates will rise, according to both economists.
These two economits "have a very big following," according to one bond trader on Wall Street who handles hundreds of millions of dollars for regional banks. "If they [government officials] don't get it under control," this source added, "you can forget about balancing the budget. . . . The European philosophy is entering this markketplace," he added. And what is the European philosophy? "That anything over six months has got to float" -- in other words, that fixed-interest, long-term bonds will disappear, to be replaced by short-term instruments whose interest rates are pegged to market conditions.
That prospect is anathema to Stockman and others in the Reagan administration who believe that a relible, long-term capital market is crucial to the development of the American economy, and will be crucial to the kind of sustained growth they are hoping for. "You've had a total collapse of horizons" in the capital markets, one high official said this week. c
Has the administration already lost its fight to win over Wall Street? Stockman and other officials refused to accept that proposition.
"We low-balled our political forecast a little bit and high-balled our economic forecast," one senior official said, referring to better-than-expected political results and worse-than-expected economic ones after 110 days of the new administration.
The administration hopes it can revive confidence by demonstrating its seriousness about cutting the budget, and by emphasizing how significantly its program would reduce the burden of federal taxes and the proportion of gross national product eaten up by government activity. Many on Wall Street, though, seem more concerned about the large tax cuts the White House wants. The tax-cut issue could turn out to be a critical one in the contest for Wall Street's hearts and minds, according to several Wall Street traders.
Kaufman has urged Congress not to endorse the Reagan tax cut. A more conservative tax cut -- which would mean smaller budget deficits, its proponents say -- would "absolutely" alter attitudes on Wall Street, according to a partner in one private investment banking firm.
Stockman expressed faith that a steadily shrinking rate of growth in the money supply would reduce inflation. The current rise in interest rates is just "a sharp bump on a downward-sloping plane," he said.
He noted that the capital markets have absorbed huge federal borrowings in the first half of the current fiscal year, now just over, and that the government won't have to borrow much more during the next six months, which may reduce the pressures forcing up interest rates. Treasury Department officials said the government will actually repay more than it borrows in the capital markets during the next three months.
Stockman's chief economist, Lawrence Kudlow, said the critics were misstating the true impact of Reagan's program. The tax proposals, he said, would reduce the overall level of federal taxation by less than 1 percent of GNP by 1985. "Now that's a very small tax reduction."
"I do concede there won't be any immediate improvement" in Wall Street's attitudes, Kudlow said, predicting that it will take several months for the administration (with the help of Congress) to make its points convincingly.