Nibbling Away at the Bull Jude Wanniski November 19, 2003

There is no need for us to point out that the dollar sagged against the euro and the yen yesterday when news came that the Bush administration was capping imports on China textiles and apparel. The financial press was quick to point out that connection. It does equate trade issues with forex movements. On the other hand, there was no mention I saw anywhere that the news also sent the price of gold up $6. And it was scarcely noted that the Dow Jones Industrials, the S&P 500 and NASDAQ were all flat at 1:30 when the wires carried the first reports of the China move. The decline in all three ensued, with each closing at their worst levels: the DJIA down almost 1%, and the NASDAQ down 1.5%. 

The news does not seem quite as alarming today, as the proponents of harsh protectionist action to stem the flood of Chinese imports are complaining that the move does not go nearly far enough and is just another political band-aid to get President Bush past the November elections with the Carolinas in his column. Equities and the dollar have perked up again, and gold has backed off a bit.

What continues to worry us, though, are the repeated bites and nibbles being taken out of the bull market by these White House political considerations. Yes, the burdens placed on the dollar by various legislative and regulatory actions that we have cited again and again have had the pleasant side effect of ending the monetary deflation. There can be too much of a good thing, though, and with gold closing in on $400, we have clearly reached the point where the pleasant “reflation” can turn into an unpleasant “inflation.” 

Given our optimal benchmark of $350 gold, a price above $400 takes us 15% above the optimum. The tax cuts passed last spring are still tugging as best they can in the other direction, by increasing the demand for liquidity. If it were not for this positive force, gold would long ago have zipped past $400 and we would now be seeing carnage in both stocks and bonds as CPI and PPI numbers were being reported up and up. Without the tax cuts, we would still be in a bear market, even with an end to the deflation. The Federal Reserve would be hard pressed to help the economy by lowering interest rates below 1% and would be under pressure to fight the inflation by raising interest rates. That is where we will be anyway if “trade war” breaks out because of U.S. flaunting of rulings by the World Trade Organization. There will always be diplomatic attempts to avoid WTO penalties at the last minute and we hope this continues. There is such widespread hostility abroad to the U.S. over Iraq, however, that European governments may not have any choice but to carry through on their stern warnings of stiff penalties on U.S. exports. 

It would help if the President were to lift the steel tariffs while he is in London visiting the Queen. He has again hinted he might. This would give him some elbowroom to work things out with Congress in February over the Foreign Sales Corporation (FSC), another headache with the WTO. This would chew up some of the excess liquidity pushing up gold and help lift equities. Every little bit helps when we are on a knife-edge between expansion and stagnation.

As we noted Monday, it did not take more than a warning from al-Qaeda to the Japanese government to send Asian markets into their steepest one-day decline this year. The Bush Administration had invested considerable effort into persuading Japan to send 2,500 “troops” to Iraq to assist in the reconstruction. When the Iraqi guerrillas learned where the troops were to be posted, they blew up enough of the place to get Tokyo to reconsider. On his Asian tour, Defense Secretary Donald Rumsfeld stopped in Tokyo last Friday and persuaded the government to say it would try and find a place where their “troops” would not have any security problem. That’s when an al-Qaeda warning came, suggesting the troops might be safe, but Tokyo would not. It took only a few fanatics with box cutters to bring down the Twin Towers and cause at least a trillion dollars worth of losses to American commerce, directly and indirectly. Look what a well-timed threat from an anonymous terrorist can do to market caps all across Asia.

As long as the Middle East in general remains under siege, Wall Street has to live with the idea that guerrilla war fought by Muslim fanatics can foil even the best growth policies of western governments. Despite news reports that the Bush administration has altered its strategy in Iraq to speed up the “Iraqification” – that is, turning political power over to a properly elected democratic government – there really has been no fundamental change. The original plan of the Pentagon warhawks was always to occupy Iraq permanently, with a friendly government in place to secure the Middle East with Baghdad as the anchor in a U.S. imperium. Not only will a theocratic state not be permitted in the envisioned democracy. The Ba’ath Party or its equivalent will not be permitted to participate. If the administration relinquished transition authority to the United Nations, we might be able to imagine an end to the losses in blood and treasure. On the current track, there seems no end.

This brings us back to the primary source of these difficulties, the never-ending conflict between Arabs and Israelis over the Palestinian issue. In London, President Bush put on a helpful display of “even-handedness” in stating his displeasure at Israel’s handling of its security problems, particularly its fence-building in the West Bank and Gaza. There also been encouraging news in Israel, with more voices speaking out on behalf of the kind of deal President Clinton tried to pull off at Camp David. It would be nice, but beyond his rhetoric, there is no sign from Mr. Bush that he has climbed out of Ariel Sharon’s pocket, and the Likud Party remains as opposed as ever to the kind of deal the Labor government came close to making with Yasir Arafat in early 2001. 

There are other issues we would normally be digging into in a better time. The struggles on Capitol Hill over the Medicare and energy bills would be among them. Given the likelihood that one or the other or both will remain dead letters in this session, with Congress bent on adjournment before Thanksgiving, we have decided to keep as much focus on the major threats to our little bull market coming from other directions. 

* * * * *