A Three Ring Circus Jude Wanniski May 23, 2001

The decision of Vermont Senator Jim Jeffords to leave the GOP, become an independent, and caucus with the Democrats adds one more major variable to an already crowded list of political uncertainties confusing the financial markets. Panic at the White House at what this might do to the President’s tax bill seems to have abated as Jeffords this morning decided to hold off on his announcement until tomorrow. This would let the tax bill clear the Senate today so it could be zipped through a House-Senate conference controlled by the Republicans and sent to the White House for the Bush signature. If Jeffords had decided otherwise, the Democrats would have appointed the conferees and reshaped the bill to their liking, or even sent it back to the Finance Committee for major surgery. The tax bill was not all that good to begin with, but it is at least fortunate that it will not be watered down further. Here are some thoughts on other animal acts in this circus:

A 2ND TAX BILL: Unless the Republicans can persuade a Democratic senator to switch parties in the next few months, chances of a second tax bill that includes a lower capital-gains tax will be much reduced. The White House strategy of pushing its tax-cut campaign promises in this reconciliation bill, requiring only 50 votes, leaving capital gains and pension items for a second bill, which would need 60 votes, required control of the Senate floor. The new majority leader, Tom Daschle, can be counted upon to shape such legislation to the tastes of his party caucus, if a second tax bill even gets that far. Then again, with the Senate being on this knife edge, GOP efforts to get Georgia Democrat Zell Miller to come over to their side might be successful if Daschle becomes too partisan on tax issues for Miller’s taste. What the economy looks like in another few months, after the summer recess when a second tax bill could come out of the Republican House, will bear upon these maneuvers.

OIL POLITICS: Israeli Prime Minister Ariel Sharon’s decision to use F-16s to bomb Palestinian installations has the whole Arab world up in arms. Putting the pros and cons of this new war aside, at the very least the political leaders of the non-Arab world have to consider a further squeeze on world energy supplies. It does not take much, especially as the expectation has been that OPEC might crank up production a bit. The Arab political leaders privately may be willing to do what Washington asks, but they must contend with an Islamic population that is aflame with reports of Israeli “atrocities,” backed by Uncle Sam and his F-16 fighter bombers. Criticisms of Yasir Arafat for not keeping his people under control -- The Wall Street Journal editorial page, for example -- do not consider the fact that a great many Muslim “McVeighs” are running around the region. It has been my belief for many years that secular leaders will not be able to bridge these last gaps in the negotiating process, but that Christian, Jewish and Islamic religious leaders will have to find common ground for reconciliation. See our website today for a memo to Senator Lieberman on this subject.

DEFLATION: The run-up in the price of gold to the $282 level from $265 seems to be a one-time adjustment, a “bit of relief” as we put it last week. We have no way to quantify the reasons for the adjustment, but the market’s shift in sentiment regarding Fed concerns about economic weakness played a role, as there were at least a few days when more liquidity had to be added than was being demanded at the 4% funds rate. We also believe the watering down of the supply-side effects of the tax bill put a damper on the demand for liquidity, which caused gold to rise when the Fed did not drain the surplus. The spike to $298 represented a momentary exuberance in the market unrelated to the hard facts that we still are in a deflation mode, with no shift in Fed policy and a continued drag on profits. Please note Steven Roach of Morgan Stanley now seeing corporate profits squeezed so sincerely that labor will have to take pay cuts! Roach is rarely on target on macro-economic issues and does not understand the deflation argument, but with all the data coming across his desk, he does see this reality on the near horizon. So do we.

GOLD: Where will the gold price be in six months? Our four analysts who think about this topic were asked to come up with a number, based on all the variables. Two of them said $290. One said $296. One said $300. Check us out on November 23. The reasoning behind the numbers is all over the lot. My $300 is the most optimistic, not only because I’ve said I would not even begin to feel comfortable until it gets to that number, but also because I think it might get there on a positive avenue, with both an increase in the demand for liquidity and an even greater increase in the supply of liquidity. My optimism is based on the trickle of information I get from folks in Washington who gradually are beginning to understand the deflation arguments and know they eventually may have to act on that understanding. The idea has penetrated the higher circles of the administration and some folks on Capitol Hill in both parties that the high oil price today is the result of the low oil price two and three years ago, when investment in the oil industry stopped cold. It is only a short step for them to see that the Fed was in many ways responsible for the 1997-99 collapse in oil and commodity prices by being stingy with reserves.

NUCLEAR: There is a new push for nuclear power growing out of the California energy crisis. Vice President Dick Cheney leads the way. The shift in sentiment is positive, not only because it is logical to use nuclear power where it makes economic sense, but also since there is so much nuclear fuel on the world market because of the end of the Cold War and the downsizing of missile systems. On "Meet the Press" last Sunday, Cheney even used the term “reprocessing” and said it deserved a policy review, as the recycling of spent fuel was made illegal in the Carter administration, back when President Jimmy was totally confused and doing everything wrong on economics, the environment and foreign policy. Cheney is making a mistake, though, in citing Global Warming as a reason for building new nuke power plants. Having been persuaded that there is zero chance that mankind or animalkind contributes to any warming of the planet that might be taking place -- and the evidence is more likely that it has been cooling -- any use of the “problem” as a crutch for other policy will eventually lead to costly policies that really do become a burden to all mankind. Once major corporations can make profits out of Global Warming, they will finance the science to prove it and the politicians to enact it.