Interesting Times Jude Wanniski November 5, 1997

Several issues having to do with gold and oil, Asia and the Middle East, Iraq and Israel, trade and currency, all mixed up together are swirling around the financial markets. Let’s start with gold:

Conventional wisdom continues to dismiss gold at $315/oz. as the product of prospective central bank gold sales. The Swiss now say they will unload 800 metric tons during the next several years. We dismiss these arguments out of hand and believe if all the central banks sold all their gold reserves it is more likely the dollar gold price would rise sharply, with the markets assuming the central banks collectively had taken leave of their senses. Would you believe $10,000 an ounce? The highest dollar gold price in history, $850/oz., occurred in intraday trading on February 1, 1980, despite President Carter’s program of actually selling gold bullion out of Fort Knox as the Keynesians and monetarists cheered. If the Swiss begin actual sales, it will only be because they see continued dollar deflation by the Federal Reserve. Inasmuch as they began talk of selling gold when it was closer to $380, they should now realize they missed the deflation boat. At $315 per ounce, 800 metric tons will fetch only $9 billion. All the gold mined in the history of the world would bring only $1 trillion, less than 1% of the world’s total wealth today.

If gold is down, why is oil not following in train? Our best guess is that oil remains politicized, with the world oil market glued to the developments in Iraq. When the gold price began its rise in 1967 from $35 an ounce, oil was at $2 a barrel. When the dollar/gold link severed, gold quadrupled to $140 by 1973 while oil went only to $2.50/bbl. This is because a small number of producers controlled the market, and they were selling oil cheap, but in ever increasing volumes. When the adjustment came, it came with a fourfold increase in oil, to $10/bbl. Other commodity prices rose as the gold price rose, because there were myriad producers, no organized monopolies able to dominate zinc and copper, etc. In the present circumstance, we have a symmetry, with gold going down in a monetary deflation, not up in a monetary inflation. Oil is hung up at $20/bbl. and is not coming down as long as the producers can keep Iraqi oil off the market. If Iraq could sell its oil freely, the other Mideast producing countries would have to cut back on their production or see the price drift to $18 or lower. As it is, the longer they can keep the sanctions on Iraq, the more they can earn at Iraq’s expense.

The contretemps over the American arms inspectors on the U.N. inspection team is Saddam Hussein’s latest attempt to call international attention to his situation. Recall that prior to the U.S. elections last November, Saddam sent ground troops into the Kurdish area of northern Iraq, at the request of the duly-constituted Kurdish provincial government. The problem was a threat from the Iranian-backed Kurds, out of power, against the Kurds in power. Both groups were running out of food, because of the U.S. embargo. President Clinton dropped some bombs in the Iraqi desert to remind Saddam who was boss. I predicted at the time that as soon as the elections were over, there would be a relaxation of the embargo, to allow Iraq to sell just a dribble of oil, enough to buy calories and medicine that the U.N. would distribute to those favored, after taking a big slice of cash to pay themselves for their trouble. Our government, of course backed by both Republicans and Democrats in the power establishment, is incessantly trying to increase the sanctions on Iraq, trying to force Saddam’s downfall. On CNN’s “Crossfire” Monday, Ed Peck, ambassador to Iraq in the Carter administration, said we have to accept the fact that Saddam is very popular with the Iraqi people, who blame the United States for their misery. How will this play out? At some point it simply will come to be too embarrassing for the United States to continue this charade, with no support from any member of the U.N. (except the Brits) to use the force and spill the blood necessary to end Saddam’s reign.

The U.N. special mission is meeting with Saddam in Baghdad today, to find a way out of the corner into which this bad little guy has painted the world’s only superpower. There are supposed to be no negotiations, but we should expect that Saddam will agree to some sort of public display of contrition, in exchange for some private guarantees that his oil will flow. Is he hiding weapons of mass destruction? Former Ambassador Peck says if we have not found any in six years of looking, maybe there aren’t any. My assumption is that if there are weapons he might have, the best way we can force them into the open is to goad him into using them, which some of our tough-talking politicians seem to favor. It might cost several million souls, but what the heck? Earlier this week, I sent an open letter to Chairman Jesse Helms, suggesting he hold hearings on the Islamic world’s place in our New World Order. I’m not holding my breath.

The Israelis and the Palestinians are now meeting in the White House, under President Clinton’s auspices. For the first time in memory, the Palestinians seem to have a slight edge in American public opinion, based on the Likud government’s failed attempt to assassinate a leader of Hamas. Israeli Prime Minister Benyamin Netanyahu, interviewed on PBS on Monday evening, is making an interesting argument about abandoning the Oslo accords and moving directly to negotiations on a final settlement, “putting everything on the table.” Except the status of Jerusalem. The problem is that the incremental Oslo accords were supposed to wrap up everything but the most delicate issues, involving the status of Jerusalem, which would then be on the table. Netanyahu makes the point that if he can win a package for the center-right, he can sell it on the left. He asks for more than Yasir Arafat can sell to the Palestinians with his offer. My belief is that there can be no movement without the region’s religious leaders, the rabbis and imams, finding a creative way to live together in Jerusalem. I have no hot ideas.

The dollar inflation against gold plateaued at about $600 in 1980, then began a decline to a new plateau of $350, which lasted from 1985 to late 1993. It then moved up to a higher plateau of $385, where it remained until last November, when it began its decline to the current level. Oil has followed this trek, except for this most recent dollar/gold deflation to $315. It would follow if the politics of the Middle East can be sorted out. We would still prefer gold back at $350. This would stabilize oil and prevent financial distress throughout the commodity-producing nations -- most of whom are the poorer developing nations. As David Gitlitz discovered in August, the Consumer Price Index came into equilibrium with gold right about $350, by which we mean all the price lags caused by contracts unwinding had ended and we were in perfect statistical balance of inflation and deflation. We get a rough confirmation by computing the average price of gold since January 1975, which turns out to be $350.05. If the Greenspan Fed were now to insist upon a new plateau of $315, oil, commodities and nominal wages would have to deflate as well, all around the world.

This ties into the controversy now before Congress, the “fast-track” authority for the President’s trade negotiations. He now seems likely to get Senate approval, where management has more clout, but may not succeed in the House, where labor has more influence. At $315 gold, I’d vote against fast-track and tell the President to do slow-track, for the very reason that labor is hurt worse in a deflationary scenario. If Alan Greenspan could get gold back to $350 and lock it in there, I’d vote for fast-track. At least in my mind, this is how it all connects together in these interesting times.