Murphy's Law Jude Wanniski November 13, 2000

The story on page C-1 of today’s Wall Street Journal, “Market Woes May Outlast Election,” has it right. The continued slide on Wall Street is not entirely due to the recount in Florida, which looks worse for the Bush team by the hour. Murphy’s Law seems to have taken over as everything is going in the wrong direction at once. The partisan ugliness over the presidential fight of course is threatening the tax cuts in the budget negotiations that are to resume this week. But even if the Bush and Gore teams sort things out this week and the tax cuts are signed into law before the end of the year, the monetary deflation will continue to drag down nominal dollar earnings and invite the bears to mark down nominal asset values. This negative force is inexorable, almost mechanical, with nothing on the horizon to stop it, as it would require the Federal Reserve to push more reserves into the banking system than are being demanded at the present time. It gets more worrisome as the gold price continues to move downward, indicating a continued accumulation of deflationary monetary errors by the Federal Reserve.

When the Volcker Fed was in this fix in early 1982, as the gold price tumbled to $310 from $620, it was Mexico’s inability to make payments on its multi-billion-dollar debts to U.S. banks that brought about a correction. Volcker was forced to monetize $3 billion in Mexican peso bonds, sending a flood of reserves into the banking system. Gold quickly shot up above $400 and stocks AND bonds rallied as the deflation ended. There now is no precipitating event that could end the current deflation.

This is the same problem we see in Japan, which could not reverse its yen deflation even by bringing overnight interest rates to near zero. It requires a different monetary policy entirely, one that actually targets a higher gold price -- here and in Japan -- in order to end the punishment to dollar and yen debtors. In other words, even if the Fed lowers interest rates the next time it meets, and the time after that, the deflation does not end unless the operating procedures cause the gold price to rise as an indication the Fed is supplying more reserves than are being demanded. There is no reason for that to happen unless Fed Chairman Alan Greenspan himself decides it is time to admit he has made a series of deflationary mistakes and the chickens are coming home to roost. Those who expect a lower oil price to fix things up once we get past this winter have to assume the world energy industry will be eager to invest in exploration and production with prices this high, but as long as gold is at $265, the smart oil money at the margin will have to assume that the oil price will fall of its own in a world deflationary recession.

These are really big forces at work. The contest in Florida over 25 electoral votes and the presidency is of great importance, but it is not really clear that it would make a great difference to the value of stocks and bonds however it turns out. There would be a rally whichever way it goes because the uncertainty would no longer be a factor. Otherwise, given the GOP’s narrow hold on the Congress, there is not a lot Bush or Gore could do to make much of a difference unless they confront the economic problems that they ignored during the campaign. The floating dollar remains a major problem here and to the world. The demographic problems with Social Security and Medicare are others. At the moment, though, everything is going Murphy’s way.