Those Bad News Bears

By Charles Alexander

Two key Wall Street sages raise concern over the supply-side program

Wall Street had more topsy-turvy times last week. On Monday the major banks raised the benchmark prune interest rate they charge many business clients a half point to 19.5%. Immediately the Dow Jones industrial stock average fell 13 points to 963, continuing its drop of 61 points in less than a month. But later in the week the Dow rallied 23 points to close at 986. Bond prices, which had plunged some 7.5% since the end of March, also slumped on Monday but came back to finish up about 2% for the week.

The spark for the late-week recovery came from Washington as the White House, increasingly alarmed about the disarray in financial markets, tried to restore confidence among moneymen. President Reagan abruptly abandoned his pledge to spare Social Security retirement payments from the budget ax; he proposed reductions in old-age and other benefits that will trim Social Security payouts by 10% and shave $46 billion in the next five years. Lawrence Kudlow, chief economist at the Office of Management and Budget, promised that more spending cuts and deferrals were on the way and hinted that the Administration might scale back slightly its request for outsized increases in military spending. Said he: "Nothing is untouchable, including defense." Perhaps most important, White House spokesmen said that the President might be willing to make a compromise with Democrats in Congress who want to reduce the size of the threeyear, 30% tax rate cut plan that is the heart of the Administration's supply-side economic strategy.

These actions may have been a tentative--and no doubt reluctant--tip of the hat in the direction of a group of vocal Wall Street critics who have been arguing all spring that inflationary pressures were still strong and were likely to intensify as a result of Reagan's combination of large tax cuts and hefty boosts in defense spending. The most prominent of these skeptics are a pair of bad news bears: Henry Kaufman, 53, chief economist for the investment banking house of Salomon Bros., and Albert M. Wojnilower (pronounced Wodge-nee-lauer), 51, who holds the same post at the rival First Boston. They are two of the most respected oracles in the financial community; their ability to analyze and forecast money market trends with unusual accuracy has attracted legions of loyal followers.

While other forecasters were predicting earlier this year that weakness in the economy would drive interest rates steadily down, Kaufman and Wojnilower strongly dissented. In March Wojnilower warned: "An embedded inflation rate of 10% now has little chance of receding, and it's only a matter of several weeks or months until economic strength translates into greater monetary growth and higher interest rates to restrain it." On April 22, Kaufman criticized parts of Reagan's economic strategy in a speech to the National Press Club. Said he: "The Administration's fiscal policy is exceedingly expansionary and does not pursue a course that fights inflation vigorously." As a result, he contended, the prime rate would start rising. As Kaufman spoke, the prime stood at 17 1/2%.

Kaufman and Wojnilower had correctly foreseen that unexpected vigor in the economy would inflate the U.S. money supply. In April it grew at a surprising, and alarming, annual rate of 21%. Last week the Federal Reserve reported that the supply of money increased by $3.1 billion in the first week of May, a gain that was more modest than expected. To prevent an acceleration of inflation, the Federal Reserve Board has been draining reserve funds from the banking system and driving up interest rates.

Many economists believe that these latest turns of the money screw will be enough to cool off the economy gradually, but Kaufman and Wojnilower insist that any interest rate relief will be temporary. Their reasoning: unchecked Government borrowing and huge deficits will keep heavy pressure on the price of money. To prove his point, Kaufman notes that for fiscal 1982, which begins on Oct. 1, President Reagan plans to slash nondefense spending by $40 billion but boost military outlays by $30 billion and cut taxes by $56.6 billion. The net result of those three steps would be a $46.6 billion shot in the arm for the economy. Kaufman asserts that such a stimulative fiscal policy will force the Federal Reserve to fight inflation alone, and the result will be record interest rates.

Administration officials argue vehemently that their Wall Street critics underestimate the President's brand of supply-side economics. Big cuts in personal tax rates, they say, will spur people to work harder and save more, thereby generating more money for the capital markets and more revenues for the Government. Grumbles Treasury Secretary Donald Regan: "Wall Street is full of Keynesians. They still cannot understand how a tax cut will be anything other than inflationary. I'm going to educate them."

Kaufman and Wojnilower will be obdurate pupils. Says Kaufman: "I am not convinced that there is real historical evidence to suggest that across-the-board tax cuts will quickly encourage Americans to work harder or to save more." Adds Wojnilower: "There is no salvation on the supply side. Politically, the Reagan program has been well tuned, but economically it's cacophonous."

These two men share a distaste for easy solutions to complex problems in part because nothing has ever come easily for them. They are both European-born Jews whose families fled the Nazi Holocaust in the 1930s. Kaufman came to the U.S. from Germany, Wojnilower from Austria. Both became exceptional scholars of economics. Wojnilower was first in his class at Columbia College; Kaufman earned a doctorate in finance from New York University.

Of the two, Kaufman is more of a public performer who relishes making dramatic speeches to packed audiences of edgy moneymen. When he furrows his brow and speaks in slow, solemn tones, the markets often quake. Early last year he told a group of bankers that the U.S. was "lurching toward a national economic emergency." That same day the Dow Jones index dropped 18 points. One day last week bond prices rallied, in part on the rumor that Kaufman was turning optimistic, only to lose momentum when the story proved to be false. Kaufman believes in personal as well as financial discipline: he has no hobbies and rises regularly at 5:55 a.m. to reach his office by 7:30. But he still has hints of flair, including a taste for mod double-breasted suits, gourmet restaurants and vintage wines.

With his disheveled hair and dark-rimmed spectacles, Wojnilower looks more like a physicist than a financier. An intensely private person, he shuns speech-making and generally reserves his opinions for clients and superiors at First Boston. Says he: "I play something of a court jester role here. Anyone else who told the truth would lose his head for sure."

Like many members of the business community, both Kaufman and Wojnilower support the Reagan Administration's austere economic policies but are somewhat skeptical about some of its supply-side assumptions. They doubt that the large tax cuts will result in a burst of saving and growth, believing rather that the outcome will be a still fatter federal deficit. Therefore, they are calling for tougher fiscal and monetary policies. Kaufman contends that across-the-board tax cuts should be postponed and the federal budget should be balanced by next year. Woj ilower advocates placing controls on the amount of credit that banks can issue. Wall Street is unlikely to regain its composure fully until the Reagan Administration takes some policy steps in those directions. --By Charles Alexander. Reported by Frederick Ungeheuer/New York

With reporting by Frederick Ungeheuer

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