Political/Market Watch Jude Wanniski December 8, 2003

In order of importance…

FED: The open-market committee meets tomorrow and cannot avoid noting the absence of deflation and the clear signs of continued economic expansion, with a tightening of the labor market in sight. The Fed statement has to begin speculation that it might be raising the 1% funds rate at its next meeting in late January, not waiting the next FOMC meeting in March much less allowing it to sit there through 2004. Gold closing the week at $404 should have given Alan Greenspan the grit to regain control of the Fed from the demand-side Phillips Curvers. The right moves will get gold back below $400 and the Euro back below $1.20. Keep your fingers crossed.

GENEVA ACCORD: The initiative in Switzerland last week by Israeli and Palestinian citizen diplomats would have sunk without a trace, but Secretary of State Colin Powell kept it alive with a pat on the back. The “accord” has been condemned by the neo-cons because it upsets their plans for the Middle East, which does not include a Palestinian state. It does fill the vacuum created with the collapse of the official “Road Map” talks by essentially going back to the 2001 negotiations at Taba, Egypt, where Israeli (Labor Party) and Palestinian negotiators finished 95% of the work on a final solution. (Their work went down the drain a month later with the election of Ariel Sharon.) The Geneva Accord is a complete, 100% agreement that is now being endorsed by world leaders, from former U.S. President Jimmy Carter to Nelson Mandela. It now only needs to get pats on the back from Democratic presidential contenders to cause real problems to the extremists in Israel and Palestine. Yasir Arafat is not endorsing it so far, only because it is being condemned by Israel as a non-starter, but Arafat already opined publicly three months ago that he wishes he had signed on to Taba when it was only 95% complete. It is a very hopeful development.

CALIFORNIA: The breakdown in budget negotiations between Governor Schwarzenegger and the Democratic legislature on Friday is a major setback for the governor, who really doesn’t have to time take his focus on spending caps to the people next November. There is still the possibility of a last-minute deal in the week ahead as the gap between the GOP and Democrats is not that wide, the GOP wanting spending increases to begin from a base of $84 billion, the Democrats wanting $73 billion. Schwarzenegger indicated a willingness to go part way, but not all the way. The weakness in the governor’s plan is that there is nothing in it that would begin to reverse the state’s outflow of financial and intellectual capital. Cutting a few billion from state spending reflects the Old Guard advisors in his camp. Rep. David Dreier (R-CA) had urged the governor’s team to include a commitment to lowering the capital gains tax to 5% from its current 9.3%, which would add a Reaganesque growth element to the overall plan and actually would provide an immediate boost to state revenues. Wealthy Californians who are moving to states without a capgains tax to realize those gains would more likely stay. It would even make sense for Schwarzenegger to give the Democrats their $84 billion base in exchange for the 5% capgains rate. Stay tuned on this.

IRAQ: The situation on the ground has improved in recent weeks, with attacks on U.S. convoys down sharply from the November levels. There are predictions from some U.S. military that fighting will get worse before it gets better, perhaps with another wave in January. On the political front, it may be time will be on the President’s side, as the criticism of his handling of Iraq from the Democrats now turns on his failure to seek internationalization of the post-war effort. Sen. Hillary Clinton (D-NY) was on three Sunday talk shows saying she does not regret her vote for the war, but thinks the President must win the legitimacy of international support for the nation-building process. I found her performance on Meet the Press very impressive. We can expect Mr. Bush to make more concessions to the UN and NATO allies as the presidential campaign unfolds, with the implicit promise that there will be no more pre-emptive wars of the kind that produced an Iraq that was clearly not an imminent threat.

DEAN MACHINE: With little more than a month left before the Iowa caucuses, Dr. Howard Dean is sailing along above the rest of the pack, and is showing no signs of faltering. His strength is due to his correct assessment of the situation in Iraq prior to the President’s war decision while the other contenders for the nomination either supported the decision or garbled their message. Dean trails by 10 points in a match-up with President Bush, but there are still only 43% of the voters saying they are “likely” to vote for Bush’s re-election, with a sizeable undecided. A likely running mate for Dean has been General Wesley Clark, but he now seems to be getting tangled up in details of domestic policy and may not seem as attractive when Dean makes his pick. Of course, Hillary Clinton would be available and would be a formidable addition to a Dean ticket. She would not lose her Senate seat if the ticket lost as she is not up for re-election until 2006, and her national exposure would make her the early favorite to win the presidency in 2008 after eight years of Bush.

WEN JIABAO: The Chinese Premier will be in Washington for four days this week, showing off his “compassionate conservatism, China-style,” as the Los Angeles Times calls it. Wen’s visit is especially important because of the confluence of economic and national security issues that confront Mr. Bush and which touch upon China. The negotiations with North Korea are high on the list, with Wen in a position to deliver a resolution of the potential crisis with Pyongyang in a way that enhances the President’s use of diplomacy over force in resolving conflict. In exchange, Wen wants a clearer signal from the President that he won’t play the Taiwan card at a time when Taiwan’s president Chen is trying to provoke a dynamic regarding “independence” from the mainland. In the soup are several economic issues involving trade and the Chinese currency. There is the potential here for the President that goes beyond a photo-op. After several years of keeping a low profile and tending to its economic knitting, China is now clearly being seen as the dominant Asian power with a new willingness to use that standing to influence world political and economic affairs.

* * * * *