A Few Market Negatives Jude Wanniski September 25, 2003

There really are no serious threats on the economic landscape that might do major damage to Wall Street, but clearly the bulls have run out of energy at these levels. Here are a few brief observations:

FTS: We had hoped that by this time might see a compromise emerging from the House Ways & Means Committee on a package of tax cuts to offset the phased abolition of the Foreign Sales Corporation – as required by the rules of the World Trade Organization. The package presented before the August recess by Ways & Means Chairman Bill Thomas would easily invigorate the bulls on Wall Street if any significant part of it made it to the Oval Office for the President’s signature. And we had reported at least “rumors” of negotiations between Thomas and the bipartisan version favored by the manufacturing lobbyists, as expressed in legislation proposed in the House by Reps. Charlie Rangel [D-NY] and Phil Crane [R-IL]. The Senate Finance Committee is going ahead with a similar bipartisan proposal by Chairman Chuck Grassley and ranking Democrat Max Baucus, with the blessing of Minority Leader Tom Daschle. With tax increases to “pay” for its static revenue losses, it is so far from the Thomas version that it seems highly improbable that it could ever make it through a conference committee, let alone through the Senate. Meanwhile, Thomas is so consumed with Medicare reform that FSC has been shelved, with gloomy predictions at the staff level at Ways & Means that legislation may not be possible this year. And that would mean threats from the WTO of penalties to be exacted against a long list of American manufacturers. The gridlock is not helping prospects for continued economic expansion. Thomas needs to deal with Rangel and Crane.

GOLD: We could explain gold’s rise to $375 from $325 over the last several months and see it as a positive development in that it ended the monetary deflation. With this pure inflation/deflation signal now topping $390, it has become a small but significant negative factor for the U.S. economy and the world economy. The U.S. is directly affected by inflation’s effect on the real rate of taxation on capital, which is not protected the way incomes are through indexation. We attribute the latest run-up over the last week to the demands of Treasury Secretary John Snow that China and the other Asian economies appreciate their currencies so U.S. manufacturers can compete. The culprit is the National Association of Manufacturers (NAM), which has been campaigning for the last several months at the grass roots to get relief from wherever it can for members demanding protection from cheap imports. As far as I can tell, the Bush economic advisors are not behind the campaign, but Snow himself is reflecting the pressures he gets on Capitol Hill and from the NAM lobbying effort at the grass roots. Gold has been climbing in all currencies, but fastest in dollars. Which brings us to…

OIL:  The decision by the OPEC countries to knock 900,000 barrels a day from production of about 25,000,000 would not have been made if the gold price had not risen so sharply this year. To a degree the process is one where gold and oil feed on each other, which is something we learned in the 1970s. It was only when gold quadrupled to $140 from $35 per ounce that OPEC announced a quadrupling of the oil price in 1973, arguing dollars had lost purchasing power in other commodities. The oil price hike hammered American business and put added upward pressure on gold as the demand for dollar liquidity fell. The process continued through the Ford and Carter administrations as gold and oil played leapfrog, ending only with the Reagan tax cuts that increased the demand for liquidity and set up the 1981-82 deflation. Will a similar leapfrogging taking place now, will a continued rise in gold lead OPEC to tighten the spigots again? The factors are different, as we do have in place a tax structure that is much improved from where it was in those earlier years, and that structure would improve if Congress dealt successfully with the FSC issue this year. A decline in gold would result and there would thus be less pressure within OPEC to make profits by selling less for more inflated dollars. Cheating by OPEC producers on their pledged caps would prevent oil from going up and even get it back on track to equilibrate with gold as OPEC saw it could make profits by selling more for stronger dollars. It was Snow who led us to throw in the towel on Newmont Mining, which we had begun to recommend as short sell at $375. We would hope this would be temporary.

IRAQ: It would be helpful if Iraq could be stabilized quickly, but that does not seem likely. The current instability hurts all the way around. Iraq’s vast oil reserves were supposed to be up-and-running by now, but only a dribble is coming into the market as Iraqi opponents of the occupation blow up pipelines as soon as they are repaired. Then there is the cost of US occupation, with the latest $87 billion price tag to get us through the next several months causing negative complications. Before the $87 billion was announced, for example, I could hear talk of some “dynamic analysis” to bridge the gap between the two FSC proposals. That now seems out the window as Democrats argue the President should be levying taxes on the top 1% of American taxpayers to pay for Iraq. In other words, the ground has shifted there too, with the markets now having to worry about adverse tax policies if revenue projections worsen for Iraq and all else in the federal budget.

CALIFORNIA: I watched the debate last night, at least for the first hour before boredom set in. The best possible outcome for the state would be for the recall to be successful. Governor Gray Davis has contributed to the national economic distress with his tax-and-spend policies, which would not get any better. If his lieutenant governor replaces Davis, though, chances are things would get even worse, as Cruz Bustamante plans further tax increases to meet the budget crisis. Arnold Schwarzenegger has been spinning his wheels, listening to so many different advisors on how to behave and what to propose that he has been losing ground to Davis. He did not seem to make up any ground last night in what became a ludicrous free-for-all. And his Wall Street Journal op-ed this week was conceptually neat on lowering taxes, but contained no specific proposal or timeframe – which I think he would need to energize voters on his behalf. His campaign co-chair, Rep. David Dreier [R-CA], tried to get him to specifically call for a cut in the state’s 9.3% capital gains tax. This would have had the desired positive effect, but it did not make the cut. Schwarzenegger would still be best for the economy, I think, and he certainly could win it October 7. But we can’t count on it.

PRESIDENTIAL RACE: It looks like I will have to spend another evening at home watching politicians yell at each other, with the 10 Democratic presidential aspirants debating tonight. The focus will be on economic policy, with primary interest in seeing how retired General Wesley K. Clark does in a free-for-all. He has already unveiled an economic program that specifically repeals all the Bush tax cuts for people with incomes above $200,000, with the revenues directed at federal public works projects. I don’t expect to hear anything plausible from any of the ten candidates, but am prepared to be pleasantly surprised if I do. It is time for some market positives.