Political and Financial Puzzles Jude Wanniski January 15, 2004

GOLD PUZZLE: We admit to getting nervous when the dollar gold price came close to hitting $430 oz two weeks ago. It should not have been moving up that fast, which left the puzzle for us on what was going on that we were not catching. With all the forces working on the supply and demand for dollar liquidity, it made sense that gold would creep up as long as the Fed had to supply more liquidity than the market needed in order to keep the fed funds rate at 1%. But with the continued expansion of the economy and prospects for new tax cuts on the horizon associated with Foreign Sales Corporation (FSC) legislation, we have been expecting a gradual "U-Turn" for gold and the dollar’s weakness against the euro and yen. With gold sliding back to $410 this morning, it is easy enough to spot the beginning of the decline at the point where the European Central Bank first publicly warned that the divergence in the dollar/euro rate was proceeding at a "brutal rate." The dollar strengthened against both the euro and gold and did so again yesterday when the ECB again publicly fretted about the dollar/euro rate. What remains puzzling about the $14 slide today is that it was not accompanied by much change in the dollar’s forex position. Gold fell in the three major currencies, which is good news, as we still believe it belongs below $400. The only explanation that makes sense is the Fed Chairman Alan Greenspan's visit to Berlin this week to meet with ECB officials contained some handshake agreement. The ECB surely watches the euro/gold price and would resist a devaluation of the euro by pumping liquidity into the euro economy. That would get the euro below $1.20, but would push the euro/gold price up. Europe would be importing the Fed’s incipient inflation, which it does not wish to do. The market is either getting information on such an accord among the central bankers or simply suspects the gold run-up has ended for the time being and long positions are being closed out. 

JOB PUZZLE: How come the economy is growing at a smart pace and new jobs are not being created? The unemployment rate dropped to 5.7% during December, but only 1,000 net new jobs were created when most economists were predicting between 150,000 and even 250,000 net new jobs would be added. Some 300,000 people who were looking for work supposedly were discouraged and stopped looking for jobs, so they are no longer counted as being "unemployed." If you recall, we had argued seven months ago that the economic expansion spurred by the cuts in capital taxation, plus the end of monetary deflation, would produce a labor tightening by the spring of 2004, but not as many new jobs would be needed. That is, because the capital/labor ratio would be much improved, households could make ends meet with one breadwinner instead of two, or two instead of two and a half. The early statistics on real wages are not showing much movement on the wage front, but remember that the wealth of older households has increased dramatically since March when the Dow Jones Industrial Average was at 7,500. The papers were filled with stories of retired seniors coming back into the world force to supplement their depleted pension funds with wages and of others about-to-retire deciding they had to work longer. The 3,000 points added in these 10 months has reversed that process. As equities continue to advance, this phenomenon will continue, with younger workers able to attract higher real wages from the more productive, capital-intense economy as older workers head back to the golf course. In other words, the work force has not shrunk to 130 million because of discouragement, but because of productivity.

IOWA PUZZLE: Suddenly the Zogby tracking poll shows Massachusetts Sen. John Kerry taking the lead by a smidgeon over Howard Dean and Richard Gephardt among voters most likely to vote in Monday’s caucuses. What’s going on? First, the Democratic establishment -- voters who are active party members and who follow the party line -- dominates the Iowa caucuses. These voters had been in the "undecided" camp while waiting for the party line, which clearly has come down the grapevine for Kerry. Union activists are still with Gephardt. Dean has lost some ground because of his poor performance in the Iowa debate on Sunday. His hapless economic platform is catching up with him: "My highest priority is a balanced budget" and "I am not going to cut the defense budget." This was Newt Gingrich in 1995! Kerry meanwhile has stopped talking defensively about why he voted for the Iraqi war and is speaking with some passion about why he will not let that happen again if he is President, a more effective stance. Of course, Dean still can pull out Iowa with a big turnout. It also would be harder for Kerry to overtake Dean in New Hampshire the following week. It is not a caucus state and ordinary voters may have more or less made up their minds. Wesley Clark, though, has been picking up steam there and could force a three-way contest with Kerry into the next batch of states. Dean still is favored to win the nomination but has come down a peg in the last several days, getting tangled up in "fiscal conservatism" that does not play well with Democrats. He needs help. The advisors I see associated with him are hapless themselves: Harvard’s Jeffrey Sachs, Columbia's Joe Stieglitz, Princeton’s Alan Blinder.

BUSH PUZZLE: We never have seen President Bush run for re-election as President, but we are seeing it now and never know what to expect from day to day. First he is going to give a general amnesty for several million illegal aliens. Then he is going to spend $1.5 billion counseling husbands and wives on how to get along with each other. Now he is going to spend a zillion dollars to put a man back on the moon as a way station to Mars. Ronald Reagan proved that deficits do not matter, Vice President Dick Cheney supposedly told former Treasury Secretary Paul O’Neill. It is quite an astonishing performance with Karl Rove, his political counselor, clearly encouraging Mr. Bush to be all things to all people, patterning his fourth year after JFK, LBJ, Jimmy Carter, Ronald Reagan and Bill Clinton (the latter having planned for "regime change" in Baghdad). Will Congress rubber-stamp all these initiatives? Probably not, and that is why conservatives who are horrified at this second coming of the Great Society are still only grumbling. 

MEXICO PUZZLE: If you would like to know why Mexico’s most important export industry is illegal aliens, you can find the answer at my public website, in the memo on the margin, "The Mexico Summit," is written as a letter to Mexico President Vicente Fox, who after four years still can’t figure out how to get his economy out of the dumps. While you are at the website, please register to receive these public commentaries as they appear, if you wish.