Approaching June 30th Jude Wanniski May 19, 2004

Two very important political events will occur on Wednesday June 30, six weeks from now, both having great significance for financial markets at home and abroad: Uncle Sam will transfer limited sovereignty to an interim government in Baghdad and the Federal Open Market Committee (FOMC) will decide whether to raise the 1% federal funds rate to combat incipient inflation. There are plenty of other variables bearing down on Wall Street from one direction or another, but these two events deserve our special attention.

First the Fed. In today’s New York Times account of President Bush’s reappointment of Alan Greenspan to a fifth term as Fed chairman, Edmund Andrews noted almost in passing that “almost certainly” the Fed will begin the process of raising interest rates at the June meeting. The economics correspondent for the Times in Washington, Andrews is a very careful reporter, one of the best at what he does, and I would gather that he is reflecting a consensus view among Fed watchers that is approaching unanimity. Indeed, it is being said that if the Fed fails to act on June 30, bad things will happen, such as a collapse of the dollar against the yen and euro, an outbreak of inflation, and a surge in the price of gold and other commodities. It is practically the Fed’s patriotic duty to raise the funds rate by at least a quarter point, with some inflation hawks demanding a half point.

We still are rooting for something to happen that will cause the Fed to stay its hand on June 30 and wait for clearer signals, pushing off a rate hike to the August FOMC meeting. During the next six weeks, it would be nice if OPEC’s meeting in Amsterdam produces an agreement to raise production. That might keep the lid on $40 oil while we await better news from the Middle East. The next six weeks also should make it clear whether or not Congress passes a corporate tax bill. The tax bill would increase the demand for liquidity and put further downward pressure on the gold price, which we assume Greenspan is watching out of the corner of his eye. If the next six weeks at least produce confusing statistics on the “inflation” that Richmond Fed President Alfred Broaddus still sees as threatening, there could be a decision to hold off until August. If that happens, we might be able to get through the year with the 1% Fed funds rate intact.

A measly quarter-point means so much to world markets because the People’s Bank of China (PBoC) remains on a dollar standard, adding or subtracting liquidity to keep the yuan at 8.3 to the U.S. dollar. The fears of inflation in Beijing, which reflect gold’s climb to $430 in February, had led it to threaten higher interest rates along with targeted credit tightening. There now has been enough relief from those price pressures with gold in the $375 to $380 range that China has announced it will not have to raise rates, resulting in a relief rally throughout Asia. If the Fed does a quarter-point on June 30, it certainly would not be tragic. However, as the U.S. economy continues this healthy expansion and asks for more liquidity to meet expanded transaction needs, it does not need the Fed having to feed even less liquidity into the banks. In any case, we should not expect several quarter-point hikes during the next year, which also is the conventional wisdom. Even a few hikes would smother the expansion in a new bout of deflation and extend the unemployment lines.

Now onto Iraq. The power transfer in Baghdad on June 30 had been planned originally to give those Iraqis who had fought the Ba’ath regime over the last quarter century all the levers. These include the Iraqis in exile who were either non-combatants in the Iran-Iraq war of 1980-1988, or were active opponents of Saddam in that war. The latter include those Kurds, about 15% of the total, who fought on the side of Iran. The Pentagon civilians who planned the war had hoped to do business with the top Shia cleric al-Sistani. There was a point where that might have been possible, but now that the Iraqi population has been outraged by the tactics of the occupying forces, including the scandals over prisoner torture, Sistani’s Iranian birth has become a distinct political disadvantage, while fellow Shia cleric al-Sadr, who supported the war against Iran, has become the leader of Iraqi’s newly minted nationalism. That is, Iraqis who have in the past been divided politically because of their religious differences, are now converging on a simple target: Preventing the U.S. from installing what they see as a “quisling” government and instead working toward elections next January that would almost certainly invite the U.S. to go home.

Having studied Iraq far more closely in the last 14 years than has President Bush, Condi Rice, or the Pentagon civilians, it is my educated guess that the pre-emptive war and what has followed has unified Iraq in a way that would lead to a government that would not need American soldiers hanging around. The administration warriors and their neo-con supporters in the press warn of chaos and civil war if the U.S. leaves, even if an elected government said so. While this probably would have happened if Saddam had not been successful in getting effective control of the country in 1974, it is no longer the case. All we need expect of a government in Baghdad would be that it not acquire WMD, not play around with al-Qaeda, and not threaten its neighbors (i.e., Israel). With hindsight, that is what we had with Saddam in his toothless condition after a dozen years of embargo and arms inspections. At least the superpower will have learned something useful about the management of global affairs.

If the “limited” transfer of authority on June 30 goes well under the supervision of the Brahimi task force, there still would be several months before the elections in January. There probably would be no respite from the continued attacks on Americans, military and civilian. It will be quite some time before the Iraqi people think pleasant thoughts about Americans. On the margin, though, the prospect of self-governance and the departure of coalition troops in 2005 will reduce the threats of terrorism that are keeping the price of oil over $40. Iraqis will blow up their own pipelines when they see the benefits going to the “quislings.” They will protect those resources when they see ownership returning to the nation. In the Gulf War of 1991, the oil fields the Iraqi military fired upon in their departure from Kuwait were those they believed belonged to Iraq, snatched from Baghdad’s control by the British imperial force that created Kuwait so it could provide the U.K. with cheap oil. In last year’s war, the Pentagon worried that Iraq would fire its own oilfields, which only showed how little they knew about Iraq.

Six weeks from today, an important date. Lots can happen between now and then, good things as well as bad. I’m banking on more good than bad. It’s about time.

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