Geopolitical Risks Up; Wall Street Down Jude Wanniski August 6, 2003

There are no economic reasons for the stock market to be in decline these last few days. Trying to pin the decline on higher interest rates does not make sense when the 10-year bond is at a mere 4.4%. There are no plans in Republican Washington to raise tax rates when Congress returns; indeed, it is more likely there will be more supply-side tax cuts in conjunction with repeal of the Foreign Sales Corporation. The price of gold near $350/oz. indicates there is neither inflation nor deflation in the offing. And practically all of the news coming out about the real economy including manufacturing has been modestly upbeat. The reason for the gloom, we think, is on the geopolitical front, where the news from the Middle East gets worse every day. Indeed, the steep decline in the Dow Jones Industrials Monday morning occurred with the first report that Secretary of State Colin Powell was quitting.

No matter the story in the Washington Post more or less repeated the assumption that Powell had only signed on for one term. The very idea that the one peacenik in the administration was not going be around much longer left the impression the warhawks are already in total control of foreign policy and Powell has nothing more than a fig leaf to cover his defeats. The market recovered during the course of the day as Powell denied there was anything to the story and announced everything was hunky dory, but the news Tuesday confirmed that President Bush is in Israeli Prime Minister Ariel Sharon’s back pocket, as he has always been. The opportunities for even teeny tiny progress on the Powell Road Map to a Palestinian state has been thwarted by the Presidents total inability to stand up to Sharon, which is the only way the Road Map leads anywhere at all. I’d felt a glimmer of hope when I read the interview Sharon gave to the Washington Post’s Lally Weymouth in describing the fence being built as a security fence, not a political border. The New York Times Tuesday morning at the tail end of an article made it sound as if the fence had crept a few yards into Palestinian territory. Then I saw a map of the fence at a link sent by a friend and realized Sharon was kidding. There are fences and more fences planned. Take a look for yourself.

Interviewed July 30 by Maariv, an Israeli newspaper, Powell already knew he had lost the fence fight: The President accepts that the party has a right to put a fence up. When pressed, he allowed that Mr. Bush doesn`t like fences and he wished it wasn`t there. Nevertheless, Israel has a right to put a fence up. You can`t say you can`t put a fence up. The fence worked in Gaza, as the Prime Minister always responds. The question is, and this is where the President has a problem, and he said so when Abbas was here and he made it clear yesterday as a problem, when the fence is no longer just on your land, but the fence essentially, because of the way it`s being designed or built, it starts to infringe and take over Palestinian land. It takes some very interesting loops and it cuts through some very interesting territory. And so there is a nice little Palestinian village and it`s got farmland around it and it`s got access, and suddenly it`s there, it`s got nothing. This is what is causing the President concern and me concern, all of us concern, particularly if the fence is producing fait accomplis with respect to what a state might look like. And the next phases of the fence as it goes around Jerusalem and further south could make things more complicated. So what the President was saying to the Prime Minister is that this is a problem and we have to continue discussing this.

Before the market opened yesterday, the futures were in slightly positive territory, and once again I was feeling maybe there was some hope in the Oval Office. Tucked into a corner of the front page was one paragraph with a headline U.S. Pressure on Israel, referring to a story on page 3 reporting the administration is considering a cut in $9 billion in loan guarantees for Israel as a way to press for a halt in construction of a barrier separating Israelis from Palestinians. It was not until early afternoon that Reuters reported: A U.S. State Department official on Tuesday downplayed as premature reports that the Bush Administration is planning to cut loan guarantees to Israel to match the cost of the security fence east of the Green Line. Now it looks like there is no question will get all the money it wants, as long as it does not use any of the money to build more of the planned fences. It will have to use its own money.

It is of course no wonder now that Mahmoud Abbas called off a planned meeting with Sharon scheduled for today. In addition it was learned Monday that Sharon’s promise to release 540 of the 6000 Palestinians it holds as political prisoners was only going to involve 344. For all of Powell’s effort to deep-six Yasir Arafat on the grounds that Sharon simply will not meet with him, in favor of Abbas. It is evident to anyone who looks that Sharon and his government have no intention of delivering concessions to Abbas to make him look good to Palestinians who never trusted the maneuver. The three-month ceasefire Abbas extracted from Hamas and Islamic Jihad seems to have produced relative quiet, but that will not last with these kinds of humiliations.

Once again, it should be understood that our financial markets would not be all that concerned with another round of failed initiatives in a process that began more than a half century ago, if it were not for the increased risk to the American economy, really to the world economy. Our Michael Darda notes the debt markets in the developing world had been in an upswing with tax cuts and reflation, which also corresponded to the sense that there were movements along the Road Map. The unraveling began as it became clear the President was folding under the pressure from Sharon and from House Majority Leader Tom DeLay, who flatly opposes a Palestinian state if it inconveniences Israel in any way. With the terrorist bombing in Indonesia at a Marriott Hotel in Jakarta Monday, it is clearer than ever that geopolitical risk has gone up a notch or two and will not be offset by statistics on housing starts or consumer confidence. As long as the President was clearly pressing for a Palestinian state, the Islamic world would give him the benefit of the doubt, even as it wondered about his justification for the pre-emptive war in Iraq. If there now appears to be no serious move by the White House to pressure Israel to get serious about the road map, we would have to expect more than orange and red alerts from Homeland Security. Al-Qaeda would be motivated to do something serious.

President Bush has to do this on his own. He`ll get no help from his Cabinet or his political counselors or congressional Republicans or Democrats or Democratic presidential contenders. This is a much harder decision for him than Iraq, especially if he wants this crisis to end peacefully.

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