Gold and the Fast Track Jude Wanniski July 29, 2002

The rally on Wall Street today is almost certainly the result of the surprise 215-to-212 House vote early Saturday to give the President "fast-track" negotiating authority on trade. It seemed wholly improbable to us that the White House could pull this vote out at a time of economic weakness in the equity markets and on the ground. This does not mean US Trade Representative Robert Zoellick will soon be cutting deals left and right that will open up foreign markets and lower tariff and non-tariff barriers along the lines of the North American Free Trade Act (NAFTA). The deals he can negotiate will still be subject to up-and-down, no-amendment votes in the House, and these will definitely be hard to move unless the stock market is reflecting renewed growth in the deflated economy.

It is definitely a triumph for Mr. Zoellick, an old friend. In 2000, I had urged him to seek a more promising role in the Bush administration than the USTR, as I was sure he would break his pick on that hard assignment. He`s now the big winner on the administration`s economic team and becomes an obvious candidate for Treasury to succeed Paul O`Neill when that happens. In the last Bush regime, Zoellick was Jim Baker`s right hand at Treasury, then at State and then as deputy chief of staff at the White House. USTR really becomes a lesser post once the fast-track is in hand. It was Zoellick who wrote Baker's 1987 speech to the International Monetary Fund recommending a commodity/gold-based international monetary reform. If Zoellick were No. 1 or No. 2 at Treasury, we could imagine policy moving in that direction. The President`s Council of Economic Advisors, chaired by Glenn Hubbard, is entirely composed of men who are at least sympathetic to a gold-based monetary reform.

The bad news is that we are back on a Catch-22 -- with a return to a monetary deflation we had priced out of the stock market when gold was at $325 and the Dow Jones Industrial Average was at 9500. In the absence of a gold-based system, when there are reduced risks to doing business or increased rewards to doing business, the price of gold declines if there are no additions to liquidity to keep it from falling. There are any number of possible explanations for gold`s decline to $304 per ounce, including a diminished prospect of a war with Iraq, a better corporate governance bill than had passed the Senate, another nice delay in the bankruptcy bill that makes deflation even tougher for consumers, and passage of fast-track authority itself.

Our Michael Darda had supposed the decline was part of a short-term scramble for cash and cash-equivalents as it was occurring in every currency. Now, though, with the dollar breaking out against forex and equity prices stabilizing, the regulatory fast-track link become more persuasive. Both increase rewards to the U.S. economy more than it does to the world in general. We were surprised by the Saturday vote, but the market was changing the odds of passage as it observed the President involved in the lobbying, which meant a close vote. In 1929, when trade legislation went in the opposite direction, the decline in equities began gently the day the Senate returned from its August recess after Labor Day. This once again proves that the market of tens of millions of participants is more on the ball in changing the odds minute-by-minute than a small number of analysts can. At $304 gold, the price is 13% below our $350 equilibrium level, which means the 8600 DJIA is below a parallel point at 8700. In other words, the equity market itself still does not have a deflationary drag, although the economy the market foreshadows still has deflation adjustments to make. Darda points out the CRB spot index is trading at 235, which is very close to historical "equilibrium" with gold at $304.

The real wild card is the Middle East, especially Iraq and the GOP War Party's plans for military intervention. If you listen to the Pentagon intellectuals and their allies in the press, you would think the bombs will start falling right after Labor Day. The NYTimes this morning adds another twist to the leaks coming out of the Pentagon, with a story about an "inside-out" attack on Baghdad that would not require 250,000 U.S. troops converging from "outside-in." This may be nothing more than The Big Bad Wolfie huffing and puffing about blowing Saddam's house in. Certainly the gold price would not be in decline if the risks of a Middle East war were increasing rather than decreasing. Sunday's Washington Post quotes several anonymous top brass in the Pentagon who disagree with the need to topple Saddam`s regime, saying he poses no threat to anyone and can best be contained. Yet another note came from John F. Burns, the best foreign reporter on the NYT roster, who quotes a leader of the Iraqi Kurds as saying they were promised there would be no military action until next year.

In my "Supply-Side University" lesson over the weekend, I wrote about the economics of war, which most of you are familiar with, having gotten it in bits and pieces. The cost of unilateral intervention would be measured by the markets against the risks of not intervening. This is why the opinions of the Joint Chiefs is so important, as the case to be made is farcical. On "Meet the Press" Sunday, William Safire argued that if Saddam is not replaced asap, in no time flat he will have nuclear weapons that will threaten Detroit, Chicago and all points east and west. It has been my understanding that it would be impossible for this to happen without our military intelligence knowing about the project practically from the day it began.

The only nation in the world who seems to agree with the idea of a regime change is Israel, which only needs to be protected against Iraq if it is determined to prevent a satisfactory resolution of the Palestinian issue. The lead editorial in the Jewish weekly Forward this week is as hard as I`ve seen on the Likud government`s bombing of the Gaza family, which was launched hours AFTER the leading Israeli newspaper reported the Tanzim terrorist organization voted to declare a unilateral cease fire. The Forward clearly means to say the Likudniks will do whatever is necessary to prevent genuine movement toward a two-state solution. If there were a two-state solution, Israel would no longer worry about Iraq as a threat, with or without Saddam Hussein. In any case, Israel has a nuclear arsenal. Iraq does not, and has no prospect of acquiring one unless the whole Islamic world gets fed up with Israel`s behavior toward the Palestinians and the Iraqis and feeds Iraq the Pakistan nuke as a counterweight. This is what Safire, the press secretary to the Republican War Party, has in mind.

On this issue there are almost no doves in the GOP. Even Colin Powell is keeping quiet. But the Bush team now has a leading Democratic presidential contender for 2004 arguing against a go-it-alone attack on Iraq with no clear provocation. That`s another surprise for me this week. I never thought I would be happy to see Al Gore back in the political swing.