Waiting for a Dead Cat Bounce Jude Wanniski December 23, 2000

The market slide will end one of these days, probably on the last trading day of this year when year-end tax-selling pressures must end. Spencer Reibman, who teaches supply-side economics at Georgia State University, reminds us of the colorful phrase to describe a market settling into a new, lower equilibrium. He expects to see a “dead-cat bounce” in January, a brief market rally that cannot really extend itself because of the monetary deflation that afflicts us. The tax selling we spotted here last March reached its climax on Friday, April 14, the last day taxpayers had to raise cash to cover their giant tax liabilities -- draining capital from the private sector to pay down national debt. The current tax selling, to which Reibman alerted us, involves tax selling by New Economy workers. They exercised options earlier this year when the market was high. Now they must sell before year’s end to avoid paying income tax on the option strike price -- even though the value has since evaporated to a fraction of that price. As rallies occur in the next week, this reasonable thesis suggests, there will be final selling waves until the process concludes next Friday.

The “dead-cat bounce” would occur because the new year brings with it a “tax cut” in those pension plans, such as the Roth IRA, where individuals can invest another $2,000 with favorable tax consequences when investments are realized. The cat would have a better bounce if the GOP Congress had not scrapped the tax bill in its lame-duck session hoping for a better one next year. A more generous Roth IRA would have offset some of the continuing drag on the economy of $265 gold -- which we are afraid will exact a price from the market and the economy until the adjustment to it is complete. The earnings decline in the corporate sector soon will be followed by higher unemployment as wages must be adjusted to the deflated dollar. There will be some relief to the economic system as a whole when the Greenspan Fed lowers the federal funds rate, but there will be no relief to the deflationary adjustment process. That will require an addition to monetary reserves over and above what now is being demanded by the banks -- a “reflation.” There is no chance of that happening until the people in our power structure, Alan Greenspan most of all, face up to the distress created by seeing an imaginary inflation when deflation is weighing on the markets like a lead balloon.

In 1982, when we faced a similar deflation paradox, we were “rescued” by Mexico, which had borrowed $80 billion from our banks to finance an expansion of its petroleum industry. They could not pay when the oil price collapsed in the wake of gold’s plunge -- and the Fed then had to monetize $3 billion in Mexican peso bonds. The fresh liquidity sent gold soaring over $400, instantly relieving debtors of the deflation and sending stocks and bonds skyward. In other words, a crisis forced a breakthrough of wrong-headed economic theory. There is no such BIG crisis looming, but an equal unwillingess to understand the current deflationary drag. On Tuesday, President Bill Clinton personally assured President-elect George W. Bush that economic growth of 2.5% is in the cards for next year, because 49 out of 50 of the “blue chip economic forecasters” say so. GWB thinks he will be able to head off recession with his promised tax cuts, and that Chairman Greenspan will help by lowering interest rates if the unemployment rate inches up. Yes, these would be positive forces relieving stress in the overall economy, but they still do not confront the drag of $265 gold. Nominal prices must adjust to gold even if it takes the entire four years of the Bush administration for the general price level to slowly spiral down.

Much of the Bush tax plan will have little effect on this drag, but even if it would include a much-needed cut in the capital gains tax, the net effect would be a further increase in the demand for liquidity which the Fed will not supply. We could imagine gold below $250 with no trouble at all -- and the blue-chip forecasters dismissing the decline as of no importance. The report today that the Clinton White House is accusing GWB of “talking down the economy” in order to pave the way for his tax program is further evidence of how little the problem is understood. We feel sorry for Paul O’Neill, who will leave the relative comfort of Alcoa to manage the Bush Treasury in an environment totally unfamiliar to him. As a good manager, he knows what he knows and knows what he does not know -- and will look for help in dealing with that realm. But the deflation realm is one he does not know that he does not know -- the dark side of the moon, one might say.

It is now clear O’Neill was the first choice for Treasury by both Vice President-elect Dick Cheney and GWB, who has known him as a friend of his father’s. He is being portrayed in the press as an “independent” thinker who at times departs from GOP orthodoxy, but the principal example is not encouraging, as he seems to believe mankind is contributing to global warming and the solution is higher gasoline taxes. The NYT also informs us that because he has had to do deals in different countries, he knows the effects that currency-exchange rates have on the economy! Then again, the 65-year-old industrialist already has announced that he will not trespass on Fed Chairman’s turf. I’m afraid Mr. O’Neill would have a greater chance of success if Mr. Bush would ask him to play shortstop for the Texas Rangers. Of course, there is always the chance that he will bring in a few deputies who know what is on the dark side of the moon and will be able to help him navigate. Thus far, the entire economic team the President-elect has assembled is so conventional in its Keynesian conservatism that we hold out little hope they will permit a supply-side maverick to get anywhere near Mr. O’Neill -- who has been told that both he and the White House have a veto on the deputy positions. They both must agree.

Those of you who have asked about the number 7500 on the Dow Jones industrials, which we have equated with gold at $265, should be comforted by our high degree of confidence that there are enough people who want GWB to succeed who will steer him and his team in a more promising direction. O’Neill was a done deal the moment his name surfaced, which allowed no time at all for a vetting process. Industrialists have never been successful at Treasury, but we must reserve judgement until the Senate Finance Committee puts him through his paces at confirmation hearings. At the moment, though, young Mr. Bush seems to be brimming with confidence that he has it all figured out and will succeed as long as he does not break his campaign promises on taxes. He believes his father would have been re-elected if he had not been talked into a tax increase when he had promised to hold the line. Like a general’s son who is fighting the war his father lost, GWB does not yet see that the problem the country faces is a different one today, a monetary drag that is slow, silent and relentless, invisible to the blue-chip forecasters who have long ago dismissed gold from their analytical frameworks. In that sense, O’Neill has lots of company. Ludwig von Mises noted more than 50 years ago that monetary deflations occur so rarely in human history that when they appear, almost nobody recognizes them. We’ll know this one when the dead cat bounces.