Puzzling Market Variables Jude Wanniski October 14, 2004

There are so many active things going on in the world affecting the prices of equities, bonds and commodities that we often must puzzle through the disorder. When the stock market suddenly swooned yesterday afternoon, beginning at 12:45 p.m., with the Dow Jones Industrial Average running off a hundred points in an hour, Bloomberg analysts quickly concluded that it was related to the sharp decline in industrial metals, particularly copper and aluminum. At the same time, though, we noted the price of oil, which had been gently declining from the first of this week after hitting record highs last week, also jumped by $1.50 bbl over the same track of time. The Bloomberg analyst covering the oil market quickly surmised that it was sudden concerns of a colder winter that caused the market rise, back almost to its $54 peak.

We rejected the idea that declining prices of industrial metals could possibly cause a sell-off in equities, except of course for the companies producing those metals. Industries using those metals would benefit. Nor would oil suddenly reverse course because the world market was suddenly struck by the thought of lower temperatures in the Northeastern U.S. The only solution for the puzzle had to lie in the geopolitical realm. This led me to check through the wire reports and find that at 12:43 p.m., the Associated Press carried a story out of Baghdad, with interim Prime Minister Iyad Allawi warning the insurgents of the rebellious city of Falluja that they must hand over foreign militants or face a military offensive. There had earlier been unconfirmed reports in the Los Angeles Times that Allawi and the Bush administration have agreed on such an offensive after the November elections, one that would extend to several restive urban centers in the Sunni Triangle, but now Allawi openly warns of such an offensive. Of course, his conditions won’t be met.

Maybe there will not be a further escalation of what already constitutes a civil war in Iraq, but the tight oil market had to discount accordingly, with equities following in tandem. Gold last week climbed to $425 oz in sympathy with oil, as higher oil will slow the world economy and reduce the demand for dollar liquidity. This week, the most prominent news coming out of Iraq was Moktada al-Sadr’s decision ordering the militia in Sadr City to turn in their heavy weapons. The news accounts yesterday afternoon indicate the U.S. coalition forces have already begun an offensive in Falluja and it is not a pretty one. U.S. jets continue to drop “precision” bombs on the city of 300,000 in hopes of killing the most-wanted insurgent leader, Jordanian Abu Musab al-Zarqawi, but every strike winds up killing dozens or scores of civilians. American military spokesmen say the strikes have killed at least six of Zarqawi’s network, but there are plenty of reports that foreign militants continue to pour into Iraq to replace those fallen.

There is little actual “news” of what’s going on inside Falluja, as reporters for the western press are now reporting they are unable to venture far from their compounds inside Baghdad’s walled “green zone,” which is no longer secure. There are reports today that while al-Sadr’s militia have been turning over small arms for cash, no large weaponry has been turned in and the program is faltering. News from Falluja reaching the militiamen in Sadr City along with Allawi’s threat of a military escalation can hardly be an encouragement. The notion of January elections being pulled off under these conditions now seems futile, and it seems out of the question that should voting occur anywhere; the beneficiary would be Allawi and his slate of candidates.

Elsewhere in the Middle East, there is also plenty of news to unsettle the oil markets along with some hopeful signs. There is always the chance, however slight, that Israel will make good on its threat to “take out” the Iranian nuclear power plant at Bushehr. Secretary of State Colin Powell, though, now at least has the Bush administration on the diplomatic track of working with the International Atomic Energy Agency and the Europeans, instead of undermining their diplomatic efforts. As for Israel’s stance on the core complaint of the Islamic world, the never-ending struggle with the Palestinians, there may be some cracks developing. The Associated Press yesterday carried a report leaked to it in Jerusalem by the Israeli Foreign Ministry that warns unless there is a Palestinian settlement; Israel will find itself as isolated as South Africa was in its apartheid government. The Israeli Foreign Ministry, it should be noted, has taken every small opening it sees to promote such a settlement. In the hawkish Likud government of Ariel Sharon, the Israeli diplomats have as little influence as Colin Powell has had when going up against the Vice President, the neo-cons and the Pentagon.

Against this backdrop, the presidential election in less than three weeks will have a significant influence on how these geopolitical issues unfold. If Senator Kerry has a slight edge in the polling of the battleground states, it is because he does represent a fresh diplomatic track in the Middle East and in Korea. What I almost certainly expect is that he would, even as President-elect, discourage a lame-duck military offensive in the Sunni Triangle. In re-building a coalition with the NATO allies, a new administration would be asking the advice of the U.N. Security Council and Secretary General Kofi Annan on how to pacify Iraq – and the first thing they would all agree upon is that U.S. fighter jets should stop bombing Iraq’s defenseless urban population. The strategy may have worked in Israel, where the number of suicide bombings has sharply diminished as Palestinian militants have been taken out in bombing runs of neighborhoods of the West Bank and Gaza. In Iraq, a country of 23 million people with most of them having assault weapons and many having access to heavier stuff, that option seems doomed to failure.

President Bush, who had his best night of three in his debate with Kerry last night, may win re-election by the skin of his teeth. Could he diffuse the time bombs sprouting over the Middle East because of the mistakes he made thus far? Of course, but that would mean changes in personnel and philosophy that will be difficult for him to manage. Difficult, but not impossible.