Dow Back Under 10,000 Jude Wanniski July 22, 2004

The market swoon yesterday and today, which has sent the Dow back under 10,000, can be attributed in part to the widespread interpretations that Alan Greenspan’s testimony signaled interest rate increases for the balance of the year, starting with a quarter point in August. While the futures market did increase the likelihood of a half-point hike in the funds rate by year-end by a few basis points, the September market is down by a few basis points from where it was before it heard the Fed Chairman Tuesday and Wednesday. Unless Wall Street gets some good news in the next three weeks that sends equities up, the FOMC again will be thinking of skipping August, which they should do anyway. Greenspan simply is wrong in saying that we all know that one and one-quarter percent is below some mythical “natural rate” and will cause inflation if it remains there.

The big hit that the market took Wednesday was far more likely tied to the gridlock over the tax extenders, which means those tax cuts the market had been counting on as sure things before the break for the Democratic National Convention are being shelved, perhaps awaiting the outcome of the November elections. Greenspan did not say anything on Tuesday before the Senate Banking Committee that warranted a positive response on Wall Street, but the House and Senate had worked out a successful compromise on the tax extenders. The deal blew up because the White House insisted on a five-year extension of lower rates that are scheduled to expire at year-end. The Democrats had agreed to a two-year extension of these “middle-class tax cuts” without having to pay for them with lower spending or higher tax rates elsewhere. Senator Kerry had indicated the deal was fine with him.

This caused heartburn in White House political circles, which as I wrote two weeks ago had worried that Democrats would get too much credit for their votes, thereby taking the edge off the President’s mantra that Democrats want to return to tax-and-spend policies. As Edmund Andrews wrote in today’s New York Times: “Republican Congressional officials said the administration did not want to accept a deal that Democratic lawmakers might vote for, giving them a tax-cutting credential too.” I am sure that this is the political thinking at the White House, because I got it originally from administration sources that were fretful about this line of strategy. With the President’s re-election chances being hurt by the continuing problems in Iraq, the economy is the best hope he has of defeating Kerry, and throwing a cloud over the tax extenders – which do have positive supply-side elements to them – will not help going into November.

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