Clouds on the Horizon Jude Wanniski February 18, 2004

CALIFORNIA: We have not forgotten California, but there has been nothing much to report as we await the results of the Schwarzenegger bond issues on the March 2 ballot. It is time to start worrying that ballot initiative #57 may not be approved, which would mean the state would run out of money sometime in June. The state’s bond rating, already near junk status, would be dropped further and Schwarzenegger would seem to have little choice but to ask for a federal bailout. The state’s economy has been picking up a bit with the help of the rest of the country, but the state’s still-lackluster job front is one reason that the national job statistics are still lagging. The Governor is awaiting proposals from the Democratic legislature to reform the Workmen’s Compensation program, which continues to bankrupt companies, but there the Democrats do not seem in any hurry to get to work on that program. There are no recent poll numbers available, but there is concern that Schwarzenegger, who should be barnstorming to drum up support for the initiatives, so far has been relying on TV spots paid for by supporters of the measures. Politicians in both parties who are planning to run against Schwarzenegger when he is up for re-election in 2006 are either opposing the initiative or sitting on their hands. We will have a report next week hoping for better news. If the initiatives are approved, we might then expect to see the tide turn and California again help the national economy. By this I mean support for Wall Street, federal revenues, an increase in the demand for liquidity that would help curtail the falling dollar and rising gold price.

WORLD ECONOMY: With gold creeping back up following Fed Chairman Alan Greenspan’s happy talk last week about inflation being contained, it is perfectly clear to financial commentators that the glowing expansion in the world economy may be entirely dependent on the Fed maintaining the 1% fed funds rate. An excellent article in yesterday’s New York Times, "Good Times Roll on for Developing World, for Now," points out that all it took a few weeks ago was for the Fed to drop its promise of low rates for a “considerable period” to send developing-country debt into a nosedive. It quoted William Rhodes of Citigroup: “It was a warning shot of what’s to come when interest rates go up.” Most analysts still do not understand the mechanism, which is that a higher funds rate will cause a decline in the Fed’s need to add liquidity to sustain the 1% rate, and this will bring pressure on the gold price and all other commodity prices. This is a cloud I do not worry about much yet because the Greenspan Fed now has demonstrated how easy it is to manage market expectations. If gold creeps up, it will mean the dollar will fall against the euro and the yen and Greenspan or the other key Fed governors can “make a face” or arch an eyebrow and speculators will react accordingly. Interest rates do not have to go up so high that a new bout of deflation kills commodity producers and sinks the developing world.

PRESIDENTIAL POLITICS: There is little to say at the moment about the Democratic primaries in connection with the economy or the stock market. The strong showing of North Carolina Sen. John Edwards in the Wisconsin primary yesterday and the implosion of Vermont Gov. Howard Dean bring to mind the victories of Jimmy Carter in his march to the nomination in 1976. He had several much better known contenders who had each read the polls and decided to put forth specific plans to tax the rich and nationalize the oil companies. The peanut farmer and former Georgia Governor was all smiles, never saying anything quite so specific, instead hinting that he might not tax the rich or nationalize the oil companies. How could he be winning primaries when he was so “fuzzy” in his thinking,” was the common complaint from the rest of the field. This seems to be what has kept Edwards in play, always smiling, never taking shots at the others in the field, and mostly staying “fuzzy” on what he would do if elected. The big reason John Kerry of Massachusetts came back from the dead and overwhelmed Dean was that he not only became more passionate in presenting himself, but also remained fuzzier on just who would be the big losers if he became President. It will be some months, I think, before the various wings of the Democratic Party hammer out a platform for the ticket, which for the moment seems likely to be Kerry-Edwards. It does seem unlikely that there would be two Senators on the ticket and no governors. Either New Mexico’s Bill Richardson or Virginia’s Mark Warner would be more logical choices than having another Senator. However, if Edwards does as well in the remaining primaries as he did in Wisconsin, this would be a major consideration in the final selection.

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