It's still touch-and-go with the radical Reagan recovery program. Now Arthur Laffer, one of the economists who helped draft the program, with so-called "supply-side" federal tax and budget cuts, says the administration is thinking of another step: returning to the gold standard.
"I think the administration is going to go back to gold convertibility," he told the Morgan Guaranty Survey, prepared monthly for the Morgan Guaranty Trust company. "I think it is going to do it sooner rather than later."
Wall Street is yet to be sold on the Reagan recovery program. The package passed through Congress with a display of presidential power and virtuosity that amazed old-time politicians. The financial community generally supports the conservative views of President Reagan. But it isn't quite certain yet that the tax and budget cuts are going to bring economic prosperity without inflation.
Evidence of this uncertainty has been seen this past week, as the Dow Jones industrial average, which measures the behavior of stocks on Wall Street, plunged. It had risen on Mr. Reagan's election and reached 1,015 on March 25. But five months later, by Aug. 24, it had dropped to 906.76, reaching an eight-month low. This drop of over 100 points on a scale of about 1,000 represents anxiety that the United States may be heading into a recession -- or may not be able to control inflation.
So-called supply-side legislation passed through congress, giving prospective cuts in taxes to businessmen, corporations, and those who normally invest in securities. But the buoyant sequel hasn't appeared yet on Wall Street, where stockbrokers are simply keeping their fingers crossed.
Wall Street's tentative mood is also seen in bond transactions. Bond prices sank to record lows Aug. 24, in what many observers termed "almost a rout." This development could severely curtail the ability of states and cities to raise money for local services.
High-grade industrial issues are at extraordinary discounts. Example: a $1, 000 Bankers Trust Company bond due in 1999 and paying 8 1/8 percent is selling for around $600. This means a yield to maturity of about 14.5 percent. Why is there this discount? Because the investor can buy a new bond with a 14.5 percent coupon.Inflation is usually considered one factor in today's high interest rates. With the basic inflation rate running around 9 percent, the actual return on the bonds is only around 5.5 percent.
The administration hoped that bond prices would rise with enactment of its new tax package. So far Wall Street watches and waits.
President Reagan explained his tax cut proposals to the nation on TV July 27 with charts declaring that there would be another large deficit in the present fiscal year, ending Sept. 30.
"But with our program in place," he said, "it won't be quite as big as it might have been, and starting next year the deficits will get smaller until in just a few years the budget can be balanced."
Latest figures, however, indicate that instead of a deficit of $42.5 billion at the end of the fiscal year, as officially estimated, it will be some $20 billion higher. Business Week for Aug. 31 remarks editorially that "a somewhat more realistic note is creeping into government arithmetic."
The problem is how to stimulate the economy by tax cuts at the same time that defense expenditures are raised, and while the Federal Reserve System keeps money "tight" to prevent inflation.It is because the "Fed" has limited the supply of new money, and interest rates of around 20 percent have resulted, that talk is being revived of going back to the gold standard.Is there a better way of keeping the value of the dollar stable than through high interest rates? Few people currently believe that America will undertake the complicated process of "returning to gold." But few people three years ago believed that America would try the Kemp-Roth program of supply-side economics.
The supply-siders who persuaded President Reagan to seek a balanced budget by cutting taxes argue that there are these difficulties still in the way -- difficulties that make the stock market and the bond market unresponsive:
1. The tax cut is too small. Irving Kristol of New York University, and a senior fellow of the conservative American enterprise Institute, argues that the just-voted individual tax cuts merely "freeze" real tax levels at their present level because of inflation shoving people into higher tax brackets.
2. Inflation. Why should investors be enthusiastic over bond issues with nominally high interest, it is asked, if the dollar is simultaneously losing its value?
3. The Federal Reserve Board. the Fed polices the money supply and is supposed to stabilize the dollar by deciding how much money shall be in circulation. But by allowing interest rates to be extraordinary high it has discouraged many people who want to borrow money to buy automobiles, homes and the like.
Though Reagan is exuberant on the West Coast over getting his economic package through Congress, some people here debate whether the country is heading for a recession. Administration advisers agree nothing will stop more deficits except big new cuts in civilian, and perhaps military, expenditures.
So why not try "returning to gold"?
The theory of the gold standard is that it fixes the value of the dollar by making it redeemable in a constant weight of gold, perhaps at the rate of $400 an ounce. A supply- sider like Rep. Jack Kemp (D) of New York, co-author of the original Kemp-Roth tax cut program, advocates the proposal. Arthur Laffer of the University of Southern California, a consultant to the US Treasury, urges it. The political argument goes back as far as William Jennings Bryan's challenge to the gold standard near the end of the 19th century. Conservatives then (and now) argued that a gold standard prevented inflationary increases in the money supply.
In 1934 President Roosevelt "went off gold" to stimulate American trade, and President Nixon took another step away from gold in 1971 in order to make dollars cheaper.
Observers think the possibility of early action by President Reagan to restore gold is virtually nil. But with economic problems ahead, Mr. Laffer declares that he expects President Reagan to act sooner or later. He says the President has made it "very clear that he believes very much in a convertible currency."
Mr. Reagan appointed a gold commission to examine the issue and it has now begun its analysis.