Bullish Up to a Point Jude Wanniski October 4, 2001

On September 10, when the Dow Jones Industrial Average was at 9600, we were forecasting it would decline to around 8500 by the end of March 2002. The horseback, back-of-the-envelope guess took into account several variables, positive and negative, with the monetary deflation the overwhelming determinant. When September 11 added the “terrorist tax,” the DJIA swiftly went to 8500 but has been creeping up ever since, as Secretary of State Colin Powell has been winning the debates inside the White House on how to deal with the issue. The market obviously prefers diplomacy over force, especially if force might produce more terrorism. At 9100, the DJIA has still a way to go to get back to 9600, but if September 11 had not happened, deflation already would have knocked 150 points off the DJIA and it would be at 9450. It might be down a bit more if it had been as clear as we believed that auto sales would have taken a bigger hit than expected with the new models piling up in the car lots. On the other hand, the risk of doing business in the U.S. has lowered the demand for liquidity, and as the Fed did not mop up the surplus, gold is up by 7.5%, substituting a little more contraction for a little less deflation. In a separate report by our Michael Darda, you will see graphic evidence that it will take another 15-20% rise in the dollar/gold price to get us out of the deflation woods.

This numbers game is meant to get you thinking in the rough ballpark of where we are now. The numbers would change for the S&P 500 and the NASDAQ, because other variables are involved. But you see we only can be as bullish about diplomacy trumping force up to the point where we bump into that remorseless deflation process. One of the many negative side effects of September 11 has been the loss of the little bit of focus on deflation we had hoped to get out of the Bush administration. Recall that Jack Kemp in late July had written the WSJournal op-ed about the deflation, urging a shift in monetary policy that would take gold to $325 (then, without any offsetting “terrorist tax”). Because I had first alerted Vice President Dick Cheney about this phenomenon early in January, he now would be receptive to a suggestion by Kemp that Treasury study the matter. They had a meeting scheduled for September 17 which was supposed to get that ball into play, but of course that never happened. And now, nobody is interested in monetary policy, as conventional wisdom believes the Federal Reserve has done all it can do, with no noticeable effect. The Bush economists still think their effects will “kick in” sometime after Christmas. Sorry, Santa.

The right kind of supply-side tax cuts will always provide a temporary pull in the correct direction and Wall Street is happily celebrating the end of lock-box economics. We still may not see a cut in the capital-gains tax, as the Bush administration has no supply-siders in senior economic posts. Only supply-siders seem to understand that it is always good for capitalism to have a lower tax when risking after-tax income on new investment. Many superb high-tech infant companies are being strangled in their cradles by the one-two punch of deflation and September 11. There are advocates for advancing the marginal rate cuts on income, helped now by Felix Rohatyn, the Democratic wise man who urges this idea in combination with infrastructure spending. Sen. Phil Gramm [R-TX] is the point man in the Senate for his push. The White House opposes the GOP farm bill that would spend $171 billion over ten years on farm subsidies, but does not see that the pressure comes from the monetary deflation. If the President would sign the executive order to stabilize gold at $325, the farm problem would be solved as prices of farm commodities would soon rise by 15% or so. To those of you who are still skeptical about the deflation process and its continued drag on the markets and the economy, please spend a minute or two with the Darda charts that follow. If you know anyone in the White House, especially the President, please send them along to him, as his economists do not have a clue to what has been going on around them. Also, for weekend reading see my “Deflation Monster” in the American Spectator.