Terrorism, Taxes and the FSC Jude Wanniski March 12, 2004

The terrorist attack in Spain yesterday was a grim reminder of how difficult it is to stop a determined and organized group from causing enormous damage to the world economy with a few well-placed bombs that kill a relatively small number of people. When it was assumed that local Basque separatists sponsored the attack, there was much less concern on Wall Street than when the separatists took no responsibility and Al Qaeda stepped forward later that afternoon to say that they did it. My first thought was that this was punishment to Spain's government for Prime Minister Aznar's aggressive support of the Bush Administration's pre-emptive war in Iraq. The sell-off on the news reminds investors that militant Muslims have not decided to concentrate all their poison on Iraq and are probably now engaging in long-term plans to make further statements in the U.S. and who knows where else? On the other hand, Wall Street's rebound today reflects the fact that no other terrorist shoe dropped overnight. Unless there terrorist strikes of the Madrid magnitude here and there around the world in bang-bang fashion, world commerce will adjust to the irritants and so will investors. Notice that gold jumped to $404 on the Al Qaeda report and today resumed its slide back toward $395.

The market`s recent weakness has much more to do with presidential politics and the goings-on in Washington over budgets, jobs, taxes and spending. The best guess as to the market`s big dip Tuesday was the Senate vote to require pay-as-you-go votes for tax cuts as well as for spending increases, which would make it extremely difficult for President Bush to make his tax cuts on capital permanent. We never have expected success in that realm, this year at least, and there is so much time before the cuts in capgains and dividends are sunsetted that we cannot see how the market can have already capitalized permanence into equity prices more than a smidgeon. In any case, House Republicans now have announced that they will dig in their heels when the legislation comes to conference and will kill the Senate pay-go move.

We are more disappointed in the FSC fix that was supposed to be well underway by now, with provisions that would even in a worst-case scenario provide another jolt to capital formation. Because Chairman Bill Thomas of House Ways and Means still does not have the votes he needs for his version of a fix to the Foreign Sales Corporation, the impetus was to have come March 1 when the World Trade Organization followed through on its warning that without a fix it would have to begin imposing the first of $4 billion in penalties to specific U.S. industries. The first round of penalties, including higher tariffs on roller skates, was meant to nudge Congress into action instead of creating a major kerfluffle. But so far it seems to have rekindled hopes in those industries that benefit from the "illegal" FSC that action might be delayed another year, while they collect megabucks in export subsidies one more time. Senate Finance Chairman Chuck Grassley does seem to be serious about moving the legislation this year and Chairman Thomas has been sounding optimistic about getting it done in the period just ahead. If it can be moved, we should soon be testing the market top again and hoping for more progress in the Middle East morass than we have been seeing lately.

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