Patience Jude Wanniski April 2, 2004

I heard Thursday afternoon on Bloomberg Radio that 72 economists surveyed had predicted that were would be an increase of 120,000 jobs in this morning’s report, a woefully small number. Some went as low as 40,000. I braced myself, wondering how I could have been so wrong last summer when I advised clients that it would be the spring of 2004 before the tax cuts on capital formation would really begin to tighten the labor market. Spring is here, I thought, so where is that tightening?

As you might expect, there was considerable celebration at Polyconomics this morning when the Bureau of Labor Statistics (BLS) said that there were 308,000 new jobs in March – way above the top estimate of the top 72 economists – along with upward revisions to January and February data. The unemployment rate actually rose from 5.6% to 5.7%, as more people outside the labor market decided to come back in and look for work. Why? Because whether the numbers show it yet or not, real wages are rising in line with the heightened productivity inspired by the 15% tax rates on capital gains and dividends.

This brief is not simply to crow about our research, although please allow for a little of that. It also is to remind you we indicated that as this process unfolded, there would be a decline in the price of gold. This is because the market would realize immediately that the Federal Reserve governors would be as surprised as the 72 economists, and begin thinking about why they may have to raise the fed funds rate from 1% sooner rather than later. They may NOT actually have to do so in order to move down the gold price, but as long as the market thinks that they are thinking about it, gold will behave. That is because the tightening of the labor market will invite further expansion of the economy, increasing the demand for monetary liquidity. Note that within minutes of the jobs report, the dollar-gold price fell $9 (from $428 to $419). As I write, it has moved back to $422, but it remains clear to me that this is the direction of the aggregate forces working on the markets.

As an important ancillary effect, a lower dollar-gold price causes the dollar-oil price to behave, which in turn will bring relief to gasoline consumers. This is because the world’s suppliers of oil, OPEC and non-OPEC producers, along with the intermediate industry that holds inventories of oil, will sooner sell for a dollar that is stronger relative to gold than a dollar that is weaker. Supposed, April 1 brought a tightening of production by OPEC, but there will be more leakage as long as gold behaves.

We note also on the forex market that the yen, which had been appreciating steadily against the U.S. dollar during the past week as the dollar-gold price rose, reacted just as gold did with the jobs announcement. However, when we do the math, we find that the yen actually is steady against gold at ¥44,000 per ounce, which is exactly where it should stay for the most positive effects on the Japanese domestic economy.

It has taken longer than anticipated to see the gold price move lower, dragging oil with it, because of the failure of Congress to deal with the Foreign Sale Corporation (FSC) issue, which will drag on at least through the spring when we believed that it would be wrapped up before Easter. If this can be dealt with in the period before the political conventions, it would add to liquidity demands and hasten the gold decline. There is plenty of room for gold to fall before it swings in a deflationary direction, so this will not be a concern.

In the best of all possible worlds, the Fed would decide that even with the tightening of the labor market, there are no inflationary pressures calling for an increase in the funds rate. There is no reason that funds should be higher than 1%, as long as all the other fundamentals are desirable and the yield curve does not steepen appreciably. Fed Chairman Greenspan may even begin to discuss gold again in this light. If he does, the effect would be to stabilize the bond market and the yield curve. At least that is what my juggling of the variables suggests.

Take it easy, as I suggested a couple of weeks back. Be patient.

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