Presidential Homestretch Jude Wanniski October 4, 1984

Executive Summary: With President Reagan's wide lead over Walter Mondale holding up in the polls, the GOP has a chance of winning control of the House through a combination of major gains and Democratic defections. Several things have to happen to pull this off, including Reagan targeting key House races and assault on Mondale's basic strength, the black vote. The Fed's deflation chickens are finally coming home to roost, though, and a continuing stock market slide into November 6 could crimp Reagan's growth themes. Volcker has to ease to prevent a 1985 recession, an international banking crisis, but until the Fed accepts a GNP growth path higher than 3 percent, there's a Catch-22.

Presidential Homestretch

Can the Republicans win control of the House of Representatives on November 6? We first suggested this possibility six months ago, in the course of contemplating a Reagan landslide and political realignment this year.1 At the time, almost all political handicappers were forecasting a possible Democratic takeover in the Senate and trivial COP House gains, even as they foresaw a Reagan victory over any possible Democratic ticket. The President's lead over Walter Mondale seems so secure that these experts, such as Kevin Phillips, now see a "negligible" chance of a Mondale victory and are boosting their estimates of COP congressional gains. Where they saw a possible COP pickup of 6-to-8 House seats as recently as August, they now can imagine a gain of 20 or so, with 50 needed for an absolute majority.

The reason the experts see no chance of this kind of gain is that in going over each of the 435 races they can find only 50 or so seats, now held by Democrats, where they can at least conceive of a Republican victory. They also see a half-dozen GOP seats that can fall to the Democrats. Given this view, it would take a miracle.

The view, though, may be shortsighted. For one thing, it would not necessarily take a 50-seat gain on November 6 for the GOP to organize the House. If the GOP can gain 35 or so seats, there are 19 identified conservative Southern Democrats, "boll weevils," who would be open to negotiations with the GOP to organize the House. The enormous Reagan landslide now taking shape in the South could even provide the political atmosphere for direct party conversions, a la Phil Gramm's switch of his Texas seat to the GOP in 1981.

More importantly, there may be more than 50 seats where the Democrats are potentially vulnerable. Bill Anderson of the Independent Petroleum Association of America thinks there are. Anderson, IPAA's political director, was the only expert who in 1980 predicted the GOP pickup of 34 House seats and control of the Senate with a month to go in the campaign. Now, in going over the 435 races, he finds 69 seats held by Democrats that could go to the GOP "if lightning strikes." By that he means a Reagan landslide of 20 points, 60-to-40, with coattail effects. He's not forecasting a gain of 69 seats; he also sees a half dozen that could go the other way. But a 69-seat potential increases the probabilities of a gain of 40 or so seats. At that level, the boll weevils would have sufficient cushion to make a party conversion and not worry about Tip O'Neill's wrath.

For lightning to strike, a number of things have to happen in these last weeks of the campaign.

1. The President has to devote the last weeks of the campaign to helping congressional candidates. It has been thought that if Reagan still had a 10-point lead on October 15 the campaign would shift away from shoring up the weakest states, thereby risking a few electoral votes, and target congressional districts where his visit could help pick up a marginal Democratic seat. For example, Rep. Jim Jones of Tulsa, chairman of the House Budget Committee, might narrowly win in a Reagan landslide in Oklahoma. But a Reagan visit to Tulsa on behalf of his GOP opponent could finish off Jones. A dozen such rifle shots could help win control of the House. As it happens, there's now little chance this could be done until October 22, because the second Reagan-Mondale debate has been scheduled for Sunday the 21st and the previous week will be chewed up in preparation. On the other hand, the President's luxurious lead has already enabled him to put more focus on helping the congressional candidates in states he is visiting. Iowa's Senator Jepsen jumped 10 points in the polls and into the lead after a recent Reagan visit that directly boosted him, in a race that was supposedly unwin-nable six months ago. The President has produced sixty television spots for Congressional candidates and may produce more. This will help enormously.

2. Reagan has to go after the black vote. Sen. Bob Packwood once remarked that the easiest way to get people to vote for you is to ask them to vote for you. So far, the Reagan-Bush campaign has not asked the black community for their votes. With 95 percent of the black community being polled in Mondale's favor, this is the greatest source of what strength he has. It seems to have led the President's strategists to more or less concede this vote, an impression felt by blacks when in June he turned down an invitation to address the Urban League. Blacks, though, are more impressed with the Reagan economic expansion than they will publicly concede, perhaps even privately to each other. And they are more suspicious of the Mondale high-tax, balance-the-budget program than is obvious. But because they have not been asked for their votes, they suspect the Republicans do not want them. Suspicions are fed by Mondale assertions that a Reagan second term will bring higher taxes on the poor and deep cuts in social spending. It would be easier for the President to accomplish these alleged aims, blacks believe, if he had neither asked for nor received their votes. A direct Reagan appeal, via paid TV spots, would allay these suspicions and give blacks the feeling their votes have a value that will keep Reagan from betraying them in the budget considerations of his second term. A surrogate appeal, from a Muhammad Ali or Roosevelt Grier, would gain nothing. A direct appeal from the President, reinforced by the congressional campaign committee's media efforts, could crack loose an important segment of the black vote. Even if the campaign only causes blacks to refrain from voting, out of indecision, it could make the difference in marginal races.

3. The commercial television campaign has to aim at Democrats and independents in an appeal for party conversion. Voters, of course, will not switch party registration in the next month. But they have to begin to identify with "Republicanism" instead of merely Ronald Reagan. Reagan is doing this very effectively on the stump, recounting his own conversion from the Democratic Party and the trauma involved. But that appeal is only reaching a handful of potential converts. Mondale is being demolished on the economic issues because of the clear distinction with Reagan over taxes and growth. Congressional candidates are steering clear of Mondale's tax hikes, but the Democratic platform did not. TV spots that highlight the economic planks of the two party platforms would lengthen the Reagan coattails.

4. The Mondale campaign has to continue to let itself be fooled by its issue polling. Mondale and the Democrats have dug themselves deeper and deeper into a hole with the notion that the voters agree with them on the issues but somehow haven't gotten the message. As a result, they get louder and more shrill. Who is more likely to keep us out of war, Reagan or Mondale? The polls say Mondale, which leads his strategists to think they're on the right track, when all the voters are saying is that Mondale is more likely to surrender. Who is more likely to deal with the deficits? Mondale again is the "winner," but the Mondale camp reads this positively when almost certainly the people polled and the electorate generally do not want the deficits dealt with the way Mondale promises. In 1980, President Carter made the same mistakes in his reading of the polls. A last-minute Mondale conversion — a la Hubert Humphrey's 1968 Salt Lake City speech against the Vietnam war — would mitigate the Democratic losses. But it seems far more likely that Mondale will get louder still in shrieking his austerity/peacenik message in hopes the message will get through by November 6.

As of October 1, the IPAA's Anderson forecasts a Republican Senate pickup of one seat, a House pickup of 38 seats. This would be enough to interest the boll weevils in a conversion. At the very least, this would build pressures inside the Democratic ranks to dump Speaker Tip O'Neill in favor of Majority Leader Jim Wright of Texas, to prevent Republican House control.

GOP House control, for the first time in 30 years, or even major gains that would revive the GOP-boll weevil majority coalition, would have clear implications for fiscal policy in 1985. The young Republican House members who will arrive in January as a class will be committed to no tax increases and further economic expansion — an addition to the "Kemp wing'' or Opportunity Society Young Turks. Chances of a 1985 tax hike, even as a "last resort" would fade to the vanishing point.

Outside of the President's control, the one big question mark hanging over this landslide projection is the "feel" of the economy on November 6. As the news of economic slowdown piles up and as the stock market declines, it becomes increasingly difficult for the President's central theme of growth, expansion, opportunity to ring quite as true as it has. An October stock market rally would dispose of this problem. But this requires either a definite easing by the Fed or the clear sense that the Fed will move quickly after the elections to prevent the slowdown it has engineered from turning into recession.

* * * * *

Will the Federal Reserve ease or tighten after the elections? The question is tied to November 6 because of the probability that Paul Volcker and the Fed have strained to avoid any policy moves that in retrospect could be interpreted as favoring one party over the other. Volcker said as much on July 25 when he appeared before the Senate Banking Committee. The net effect of this delicate approach, though, has been to take greater risks with the supposed "soft landing" that the Fed has been attempting. Had there not been politics to take into account, it's likely the Fed would have taken the signs of a deflating economy in the last two months as reason to increase bank reserves. As it is, there are now the first murmurings of a "growth recession" in 1985, a rate of expansion insufficient to keep the unemployment rate from climbing back over 8 percent. Before too long, we will hear murmurings of a 1985 recession.

There are always mixed signals when the economy is in transition from a growth to a recession path, and vice versa. There's always a debate on which ones to act on and which to ignore, which is why the Fed should not be expected or allowed to fine tune the economy. But in recent months the signals have been mixed in bizarre fashion, confusing markets and policymakers no end.

The declines reported in July and August of the leading indicators of economic activity should have been enough to alarm the Fed about trouble ahead. But a Catch-22 situation developed. The financial markets greeted the signals of economic decline with a rousing 90-point splurge on the Dow.

Surely the news of decline would prompt the Fed to ease, the markets seemed to be saying, and the expansion could resume. The declines in corporate profits that would show up at the end of the year would be offset by heightened expectations of another business surge in 1985 and climbing profits.

But the market advance in and of itself altered the landscape. The business community takes a market advance as a positive signal and alters production and inventory behavior. Consumers feel the wealth effects of a rising market. Critics of the Fed, who had been urging an easing precisely because of the deflationary signals find their position undercut: How can things be getting worse if the market is rising? And the market splurge is added into the new figures for leading indicators, which were reported on the rise in September. The markets in turn take this rise as news that the Fed will not ease (having found the path to "sustainable growth") and the prospects of declining corporate profits suddenly loom larger. The Dow hits the skids. The process repeats itself, maddeningly, as we can expect the October report of leading indicators to reflect the recent stock market decline and once more point down. Catch-22.

We can assume, at least, that Volcker knows what's going on and that there are problems ahead. The markets are tantalized whenever they see that the Fed funds rate dips below 11%. But Volcker's in a political straitjacket that may be keeping him, until the elections, trapped inside the Fed funds target range of 11-to-12 percent. At least we can see the Fed's bias in the last month. It has moved to add reserves to keep Fed funds close to the bottom end of the range instead of bumping 12 percent.

Even if the Fed eases after November, the Catch-22 problem will not be resolved. The assumption that the economy should only grow at a 3 percent rate may induce the Fed to lower short rates briefly, as it senses the economy moving toward stagnancy. But a 3 percent rate is much too low a growth path for the U.S. economy, given the fact that potential capital and labor have been so underutilized in the last several years.

As Alan Reynolds points out, we can now expect aflat 1984 fourth quarter as a result of the Fed's excessive tightening of the last year. This could, without immediate relief, deepen and spread into the first quarter of 1985. And while an easier Fed policy following the elections could bring a rebound by spring, there's no evidence Volcker and the conventional economists who are cheering this strategy wish to see a renewal of robust economic growth at all. At the first sign of easing, then, we could expect to see a rally in the financial markets, as they look to the other side of the no-growth pause in the economy ahead. But this could again signal the Fed to tighten, keeping the economy wobbling along on a 3 percent path at best.

At this rate, the economy isn't growing fast enough to cut into a 7-to-8 percent unemployment rate. It isn't fast enough to bring down the budget deficit. And most importantly, it isn't fast enough to absorb commodity imports from the Third World, the only way it can acquire the dollars to meet its debt obligations to our banks. First Chicago's third-quarter $70 million loss because of $279 million in loan writeoffs is further evidence of the spreading effects of the Fed's deflation (do all the money-center banks have "bad managers"?). The dollar, still overvalued relative to gold at $345 or so, would remain continually overvalued relative to foreign exchange as well, keeping alive and even compounding the international debt crisis. The next year could be a terrible year for U.S. banks. A Fed easing sufficient to put the economy on a growth path of 5-to-6 percent would have to put the gold price back over $400. Probably nothing less would bring relief to U.S. banks and the economy in general.

 1 Jude Wanniski, Political Realignment: 1936 & 1984, March 2, 1984.

* * * * *