The Corporate Terrorist Tax Jude Wanniski July 11, 2002

There is absolutely no doubt that the beating Wall Street is taking is the result of the frenzy in the U.S. Senate to make it a crime to do business in the United States. The 97-to-0 vote in the Senate to criminalize “accounting fraud” was an act of stunning stupidity by the greatest deliberative body on earth. At first I thought it a joke until it became clear Senate Minority Leader Trent Lott had been sucked into a “clever strategy” to cut the GOP’s political losses by aiming for a “reasonable” compromise with the House. This is exactly how the Smoot-Hawley Tariff Act passed, except then it was the House in 1929 that voted it through in the expectation that it would be killed in the Senate. We said two weeks ago when Worldcom blew up that by itself it would not do great damage to the economy, but that the congressional response to “fix” capitalism was the big worry. Our Chris Ecclestone wondered if “George W. Bush would become the Hoover of this era.” 

That’s exactly what is happening, as the two political parties compete to see which can force more morality on the American businessman. As if there is not already incredible risks in doing business in the United States, the government proposes to put businessmen in jail for up to ten years if their accountant makes a mistake. This is the equivalent of the tax of political terrorism that struck on 9-11. When the government makes it more difficult for business to be transacted, less business will be done. Capitalism cannot function when senior management of multi-billion dollar corporations face hard time in the slammer if there are challenges to the way they are managing their finances. Those in the line of fire might as well take what is left of their stock portfolios and go fishing. If this legislation passes as is, we could easily see the DJIA sell off another 1000 points. This means we have to pray the House of Representatives ties up the legislation in conference for a long time – or that President Bush threatens to veto a bill that has gotten out of control. 

We cannot expect much from the Bush team, though, as this legislative crisis is exposing the weakness of the team. On an MSNBC “Townhall” show last night, Treasury Secretary Paul O’Neill denied that the legislation had anything to do with the decline on Wall Street! And when asked, O’Neill said he was “not concerned that the Senate would go too far.” He would only be concerned if the legislation was left “ambiguous,” which could mean the Department of Justice and Security & Exchange Commission should “shoot to kill.”  Commerce Secretary Don Evans was no better. On the same show, he said the market might be falling because it is concerned about the “partisan politics” being played on Capitol Hill. This also smacked of 1929, when Republicans complained the market was crashing because the Democrats were dragging their feet on Smoot-Hawley. 

The SEC scramble to save Chairman Harvey Pitt has also become part of the problem. It has put out an order that by August14 any publicly traded company with revenues greater than $1.2 billion during the last fiscal year must submit written statements under oath from the principal executive officer and the principal financial officer that all their statements are accurate. We will see as a result myriad adjustments and restatements of earnings that in no way violate any law, but the proponents of “fixing capitalism” will not let the news play that way. In an effort to be very safe, corporations may report so many qualifications and restatements that it will seem the legislation would have to be tightened even further, with Sen. John McCain [R AZ] calling for capital punishment of CEOs and CFOs. In the weeks ahead, the volatility of the equity markets will be dominated by the statements and maneuvers that surround this legislation.

Throughout the last 18 months, I’ve treated Secretary O’Neill as a passive participant on the Bush team, the equivalent of an appendix in the human body that has no active function. When he last night rambled into a discussion about how he improved the safety record of the workers at Alcoa when he was CEO it was clear he is hopeless in his job and should take what is left of his portfolio and go fishing. President Bush is suffering without a creative finance minister – and so are the rest of us. When I met with him early last year, the very first thing I told him was that the inflations and deflations we were experiencing showed that capitalism could not function with a floating unit of account. That is what is broken. Not the accounting rules. If you did not see it, here is my letter the Financial Times published Tuesday: Martin Wolf's "Rescue Plan for Capitalism," (July 3) begins with the observation that "the trickiest question in capitalism is how precisely companies can be controlled." Perhaps, but the question becomes trickiest in a capitalist system with a floating unit of account. The floating dollar is at the core of the problem in America today.

The simple reason for the accounting miseries now surfacing with Enron and Worldcom et al is that we are not on a gold standard -- and for the last 30 years have been struggling through inflations and deflations. The U.S. Savings&Loan crisis of the 1980`s was the result of the inflation, which made it impossible for creditors to recover their assets. An S&L needs a gold footing so it can borrow short and lend long. When those who made the worst loans faced bankruptcy, they made riskier and riskier loans, trying to make up for the losses. Those who were caught went to jail. Those who survived then benefitted from the deflation that followed, where customers were required to give the S&Ls more in real terms than they had borrowed.

This is what has happened in the current monetary deflation, which has transpired over the last five years, with gold falling from $383 to as low as $253, now at $310. For the economy to recover, gold would have to be at $350, and it cannot get there as long as the Federal Reserve is not (and has no means) to target gold. At the margin, those debtors who could not pay their debts juggled the books, hoping for economic recovery that was promised by the Bush tax cuts and the Greenspan interest rate cuts, neither of which can solve the monetary deflation. When the recovery did not come, the jugglers at Enron and Worldcom, etc., had to come clean. It is something like the otherwise honest bank teller promising to return the cash as soon as his luck improves at the race track. 

Note the gold price has been in decline these last few weeks. This, I believe, is the result of the lower risks of political terrorism, as there has been progress toward diplomatic solutions in the Middle East and on the subcontinent. When there is increased risk of doing business, there is less demand for dollar liquidity, and if the Fed does not drain it off, the gold price rises. When the risk declines, there is more demand for liquidity and if the Fed does not supply it, the gold price falls.

This is a nonsensical way to manage a domestic monetary regime, let alone a global capitalist system. No amount of new rules and accounting procedures can keep pace with such monetary turbulence in the unit of account. Unless the United States takes the lead in re-establishing a dollar/gold foundation to the world economy, it will have to be done elsewhere. Either Europe or Greater China have the economic mass required to anchor the world monetary system to their currencies, as the United Kingdom once did.