Watching Gold's Moves Jude Wanniski July 9, 2004

There is little doubt that gold`s $15 jump in the last two weeks is the result of a decline in the demand for dollar liquidity, not additions to supply. The economic expansion of the last several months has already lost some of its zip as economic actors contemplate higher interest rates as far as the eye can see. Then there are the official warnings of a possible terrorist attack in some unspecified corner of the USA, which seemed to spur gold`s jump yesterday, especially when Homeland Secretary Tom Ridge backed up Attorney General John Ashcroft`s warning that Osama bin Laden has something in the works.  A few weeks back, remember, Ashcroft issued a similar warning, which has as its most immediate effect a marginal increase in the risk of doing business. The price of gold jumped then too, but fell back the next day when Ridge seemed to contradict Ashcroft,  less certain about the available intelligence. Even though Ridge yesterday left the color code at orange, he got behind Ashcroft`s warning, which can only have a dampening effect on economic activity. This would recede with time if nothing happens -- or if whatever happens does not strike at an economic nerve center.

Meanwhile, there are secondary consequences that are worrisome. The one thing I don’t want to happen is another Fed move at the August FOMC meeting. Other supply-siders point to the $15 rise in gold since the last FOMC meeting as evidence that the quarter point hike in funds to 1.25% was insufficient. If the Fed bumps the rate again next month because gold and commodities are moving up and a pre-emptive strike against inflation seems persuasive, the most likely outcome would be another increase in the dollar/gold price. The only reason this might not happen is if the markets concluded it would be the last hike, not the second of many on a climb to a “natural” rate somewhere above 3 ½%.

In other words, when the national economy of 285 million producers and/or consumers is advised the Fed wants the economy to slow down to fight inflation, there would not be an increase in the demand for liquidity, would there? There would absolutely be a decline, and unless the higher funds rate could only be maintained by draining the surplus liquidity from the system, the dollar gold price would rise again! The other supply-siders who argue for higher rates are correct that they would reduce the flow of fresh liquidity into the banking system, but they don’t seem to believe there would be any decrease in demand for the existing pool of liquidity. My sense is that we would be spinning our wheels at best, with a good chance of going backwards – slowing the economy and increasing the rate of inflation.

The “best-case scenario” we presented in April has not held up very well. The corporate tax bill should have been in the bag by now, driving up the demand for liquidity; it has passed both houses, but Senate Minority Leader Tom Daschle won’t name members to a conference committee and the White House is not making an issue of it. The inflation statistics rolling in have been slightly above what we’d hoped for, primarily because the $40 oil price is stuck where it is because of geopolitical risks associated with the Middle East. The transfer of power to the interim government in Iraq has been accomplished without a hitch, but oil supply lines have not been secured as we had hoped. The economy, at least, is performing as we had hoped, throwing off so-so signals instead of robust numbers that could excite the Fed into a less “measured” posture. Most disappointing at this juncture is the total absence of discussion about monetary policy at the political level. Kerry/Edwards and Bush/Cheney have simply decided to let Alan Greenspan do anything he wants to do and Congress has fallen into line. We simply have to wait for something unexpected to change the picture, or gold will continue to drift up and the dollar drift down against the euro and yen.