Market Notes (Re: Animal Spirits) Jude Wanniski August 3, 2004

By opening down 55 points on the DJIA Monday morning and finishing up 39 points, Wall Street demonstrated its ability to read through the six pages that The New York Times devoted to the threat of an imminent terrorist attack and find nothing of substance to back up the warning. Lo and behold, the Times this morning practically tells its readers the warning was a spoof, not much more than an air-raid drill, with a front-page headline: “Reports That Led to Terror Alert Were Years Old, Officials Say,” with a sub-head, “Even If Dated, Material Is Called Troubling.” The story effectively knocks down the entire rationale for the Sunday alert by stating it was almost entirely based on material three years old that had been gathering dust in the Intelligence Community. Yet there are another six separate stories about the terrorist threats to New York, Washington, and the Prudential Building in Newark as if the intelligence was fresh. What is going on here?

We should soon learn that someone high up in the Bush Administration personally called someone high up at the Times, which does set the pace for the entire news media – print and electronic – and the word was passed down to news editors to pull out all the stops. The editors have no choice once they get direction on something like this but open up a news hole six pages deep and assign reporters to fill it, even if there is nothing much there. The administration, through Homeland Security Secretary Tom Ridge, can explain all he wants that it was essential to alert the public, but there is now the assumption in political circles that the decision has been made to base the President’s re-election bid on the “war against terrorism.” Ridge could not have been clearer when he ended his Sunday press conference by saying, “We must understand that the kind of information available to us today is the result of the president’s leadership in the war on terror.”

The thinking has no doubt been based on polling that shows the President’s approval rating below 50% in practically every category except his ability to counter the homeland terrorist threat. The mere fact that there has been no follow-up to 9/11 during these last three years will produce positive numbers for the President relative to Senator Kerry, who as a Senator has had little or nothing to do with the execution of the laws passed and monies appropriated since 9/11 to counter terrorism. Whether Mr. Bush is successful or not in keeping the focus on the “war against terrorism” and not the mess in Iraq or the wobbly economy, orange and red alerts obviously add to the burdens of the business community. At the margin, they quench some of the animal spirits that are otherwise trying to reap the benefits of the favorable tax climate and interest rates that are still about as good as they can get absent a formal gold standard.

The cost is merely added to the market’s apprehension of the Federal Reserve’s bent toward leading the economy away from an interest-rate schedule that is great for business toward one that is not so great. I still hear talk from supply-siders who advocate a significantly higher funds rate that 1.25% is a negative real rate (i.e., lower than the rate of inflation), but with gold trading below $395 and the yield curve fairly steep, I am not so sure it can be said that the overnight funds rate is negative. The threat of higher rates next week and through the rest of the year is in itself discouraging animal spirits, reducing the demand for liquidity, and putting upward pressure on gold. It would be helpful if the Fed were to pass on another quarter point when it meets next week, giving the markets more time to fix whatever embedded inflation remains in the system.

We are hearing much better reports out of Washington on the corporate tax bill, with the possibility it can get passed after the GOP convention in early September. That would be a big help to the sluggish market, which at these levels is forecasting sluggish growth rates and the lower tax revenues that go in tandem.

What effect is the possibility of a Kerry presidency having on the business community’s animal spirits? He certainly had a successful convention, delivering an acceptance speech that was stylistically better than anyone expected. While the public opinion polls still show him with a small lead over Mr. Bush in the popular vote and the Electoral College if the election were held today, it could widen or disappear in the hundred days remaining. I still bet his lead will widen, based on the palpable fact that his supporters tend to be passionate in their support in their anger at the President while the President’s supporters are struggling to find rationales to continue their support. I heard a report that anti-Bush bumper stickers in the state of Washington outnumber pro-Kerry stickers by 49-to-1. To return to the question, my guess is that the market does not have enough information on which to base a judgment on a Kerry presidency. It will know for sure that he would propose an increase in taxes on those with taxable incomes above $200K, but we do not know what form the proposal would take and how it would be received by a Congress that will almost certainly be in Republican hands, at least in the tax-writing House.

One thing to watch for is a new proposal by House Speaker Denny Hastert that Congress next year tackle fundamental tax reform. He has a new book out tomorrow that recommends the outright elimination of Internal Revenue and replacement with simple national consumption taxes or VAT taxes. It does seem he also leaves room for a flat tax, which is a lot of room. This suggests the idea has been in the works for some time, scheduled for publication between the two conventions, and probably has the blessings of the White House and key GOP House members, at least as a trial balloon. What will Kerry do if the balloon goes up at the GOP convention? Lots can happen between now and November 2, maybe even a terrorist attack.

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