Please Do Not Feed the Bear Jude Wanniski July 23, 2002

There may not be many good reasons for the stock market to rise, but it will not be for a lack of cheerleading by the President and Republican leaders. “The market has no place to go but up,” House Majority Leader Dick Armey told the Sunday talk shows. Prosperity is just around the corner, Wall Street was told Monday by the President on a trip to Illinois. He continues to say the corporate governance bill now in Senate-House conference will restore faith in capitalism. When it does, he says, Treasury Secretary Paul O`Neill, who is in some other hemisphere, should get credit for the return of good times in the stock market when they arrive. Since being named Treasury Secretary in January 2001, O`Neill has watched the DJIA drop 2,500 points. One of the few things the President could do to cheer the market would be to replace the passive O`Neill with a new man who might grab the bull by the horns and bring it back into play. If not replacing O`Neill, then what about Larry Lindsey, the hapless director of the White House national economic council? Or over-the-hill Federal Reserve Chairman Alan Greenspan, who tried to cheer the market last week and got a raspberry when he urged that greedy executives be given hard time? The political commentators who are watching for signs of blood in the water say there may be change after the November elections, but that it would look bad if the President made changes in his team now. It might spook the markets!

As noted in Monday`s morning client brief, I spent the weekend trying to encourage someone in a position to do so to throw a monkey wrench into the conference report on corporate governance. To be fair to Greenspan, this is the one time when this administration should be listening to Alan`s warning to comb through this minefield before making it law, and yet it ignores him. Because there is no real good reason to rush to conclusion by this Friday, the markets now must worry about concerns the President wants to clear the decks of legislation now so he can devote the period between Labor Day and Election Day to his plans for war with Saddam Hussein. When Chairman Joseph Biden of Senate Foreign Relations last week said he planned hearings on Iraq during the August recess, it was first assumed administration witnesses would testify, but now he says there are no plans to have either the Defense Secretary or Secretary of State come before the committee to even discuss the nature of the threat they all agree Saddam has become. I’ve continued to hope this is all a bluff, to get a political win out of resolving the issue of weapons inspections. If it is, it is such a good bluff that it helps feed the bear. It is a serious risk burden as it would at the least add $100 billion to the fiscal 2003 budget, already moving toward $200 billion in deficits. At worst, of course, it would invite new terrorist attacks of the 9-11 variety.

Assuming the best in the Middle East, investment risks would be reduced.  The economy went to full employment in WWII, ending the Great Depression, but it was not until the early Eisenhower years of the 1950s that the DJIA got back to where it was before the Crash of 1929. It was the Kennedy tax cuts that fed the first serious postwar bull market. There is now no real possibility of a supply-side tax cut in this congressional session – unless there were a new economic team, or if Greenspan could be persuaded to argue for a cut in the capital-gains tax. He has stuck his nose into fiscal affairs during his 15 years at the Fed. He is not the man to replace O’Neill at Treasury, as some are suggesting, but he could do more at the Fed to help put some rational exuberance back into Wall Street. Should the President call him directly for advice, he should definitely recommend serious hearings on the corporate governance legislation instead of having CEOs walk through the minefield to clear it with their own bodies. We are assured that there are no tax consequences to having the International Accounting Standards Board (IASB) and the FASB require the expensing of options, which is where they are headed with a push from the Senate bill. At the very least, though, the federal financial support for the FASB should be stripped from the conference report. A Washington Post account of the conference this morning is worth reading.

There is lots of talk on Wall Street about how there would have to be a “selling climax” before the market turns around, but this is not that kind of market. Every time it appears the government is going to stop feeding the bear, another reason appears for it to cook up a fresh meal. At 7800 on the DJIA and gold at $320, there is still deflation in the economy, but none the market has not priced in. It is the secondary effects of that deflation which continue to plague the economy. What continues to hurt the markets are the implications of budget deficits at all levels of government and the likely responses involving tax increases and cuts in public capital spending projects that have positive ROI’s. As bad as they are, they will be even worse next year, the kind of vicious cycle that keeps feeding the bear market. The rising price of gold is nothing to cheer about because it has only climbed because of added state and local tax hikes, tariff increases, political risks, and now a wider regulatory risk structure. If you want to see gold at $400 or $500 an ounce, encourage the President to invade Iraq as soon as possible -- the advice he is getting from Dick Morris, Larry Kudlow, and the WSJournal editorial page.

Instead of spending $100 billion on Iraq, that amount could easily be spread over the next two years in block grants to the states to use as they wish. Democrats would jump on that idea in a minute and would also agree to a capgains cut, which would actually help finance the outlays. This is the kind of thing a new Treasury Secretary could come up with, but which is outside the competence of O’Neill or Lindsey. Supply-sider Bruce Bartlett suggests the President dissolve Bill Clinton’s creation – the National Economic Council. This would then elevate the importance of Glenn Hubbard, the competent CEA chairman whose views are smothered by Lindsey’s. Can we expect this kind of change? Not if the President is anything like his father, who stuck with his best buddy Nick Brady, arguably the worst Treasury Secretary of the 20th Century.

Meanwhile, all we can expect are little rallies that are breathers before the bear’s next meal. There is not only no leadership inside the government at the moment, there is none outside it. It may sound like a broken record, but there is nothing that would help the market more than a gold-based monetary reform that would remove massive risks to the world economy. If some prominent businessman or financier made some noise, there would at least be a discussion, but there is only silence on that account. A year ago, through a client, I tried to warn Citigroup's Sandy Weill what he would face, but I assume he brushed me off on the advice of his vice chairman, Bob Rubin. His woes now are entirely due to deflation`s fallout. The world will have to put up with the vagaries of a floating unit of account until that silence is broken, and the bear will continue to nibble on the DJIA.