The Cyclical Bear Market II Jude Wanniski August 11, 1998

HOW FAR DOWN? It is all up to Fed Chairman Alan Greenspan. How far does the stock market have to run down to discount an economy weak enough to satisfy the Fed? Will a DJIA of 7500 forecast a long enough unemployment line to cheer the FOMC, which meets next week to ponder the inflation only it sees? Or will there have to be enough blood spilled to make absolutely sure? How about 7000? The bond market is now pricing in a Fed decision to shift to a “neutral” stance next week, although the two monetarists on the FOMC, Jerry Jordan and Bill Poole, will yell and scream about the need to raise interest rates, because their boss (see below) sees a bubble on Wall Street. If the Fed does not at least shift to neutral, more blood will flow on Wall Street. It will take a shift to an anti-deflation posture to encourage markets around the world that our central bank has had enough “commodity deflation,” as some earlier skeptics are now calling what should be obvious is a general deflation. 

GREENSPAN: Our clients ask “Why won’t he budge from his anti-inflation stance, cut interest rates, and save the stock market and the world?” It is because nobody who counts is demanding that he do so. Nobody who counts is arguing that Greenspan’s monetary deflation is strangling the world economy. Because he has been deified, he and the Greenspan standard are untouchable. And without any criticism, the Fed Chairman is holding tutorial sessions at the Fed for friendly journalists to parcel out blame around the world for what’s gone wrong. We would expect that The Wall Street Journal would have long ago come crashing down on Greenspan for his misfeasance as Fed chairman, but it decided to follow his line of reasoning and blame the commodity deflation on the Asians. The fact that the WSJ criticizes IMF Director Michel Camdessus for assisting in the process and Greenspan does not is beside the point. There is no establishment news medium pinning the tail anywhere near the real donkey. Conservative columnists and editorialists -- including some who should know better -- are beginning to blame the market decline on President Clinton’s problems. Of the Republican presidential possibilities, only Steve Forbes and Jack Kemp have gently advocated monetary ease, but not so anyone would notice. 

MILTON FRIEDMAN: In the August 19 issue of The New Yorker, the resident PhD economist, John Cassidy, a Brit, compares the stock market of today with that of 1929. The piece is hopelessly Keynesian but worth reading if only to get the views of Professor Friedman, who tells us that stocks are as overvalued today as they were in 1929, that both should be considered “bubbles.” Friedman criticizes Greenspan for not pricking the bubble several months ago, by raising interest rates, and cheers on his two protégés who have voting rights at the FOMC, Poole and Jordan, urging a better-late-than-never interest-rate hike. Cassidy also quotes MIT’s Paul Samuelson and Harvard’s J.K. Galbraith, two other bubble folk who generally enjoy the spectacle of Wall Street crashes as positive proof that the market is inefficient. While I’ve known for 25 years that Friedman is the ultimate statist when it comes to monetary policy, I’ve never before seen him so specific in attributing the ‘29 Crash to an inefficient market, a speculative bubble. Author Cassidy also repeats the argument made a week ago by David Wessel of the WSJ that the Fed now knows how to pull the economy out of Depression even if there is a Crash: It need only flood the financial system with liquidity, as it did after the 1987 Crash (which Greenspan helped trigger with a statement to Fortune that the dollar would have to be devalued by 2% a year for years to come). This is more monetarist myth-making. Flooding the system with unwanted bank reserves had zero effect on the economy and the reserves were quickly drained.

CLINTON: I don’t know any more than I read in the papers, but I will hazard a guess that when the President is asked next week about his statement in the Paula Jones deposition: “I have never had sexual relations with Monica Lewinsky. I’ve never had an affair with her,” his defense, if he needs a defense, may be that he did so to protect Monica. He might say he knew through Bruce Lindsay that she intended to say she had no sexual relations with him and thus would be subject to perjury charges. Why do I hazard this guess? Because of the statement Clinton issued when Monica was given total transactional immunity by the Special Prosecutor, saying he was glad things worked out for her. That is, the President could say he had to be silent for several months while she maneuvered into a position to win total immunity from Kenneth Starr, who was trying to get her to say Clinton had encouraged her to perjure herself. Mr. Clinton has seemed too self-assured over these many months about the obvious contradictions in these stories. I’ve had to suppose he had an escape hatch, and this one is the best I can come up with. I certainly don’t think the matter carries the kinds of risks that are now spooking Wall Street. 

IRAQ AND AFRICA: I don’t believe the acts of terrorism in Kenya and Tanzania were state sponsored and generally reject the idea that “rogue” governments are ever official sponsors of terrorist acts against a major power like the United States. The cost/benefit ratio is ridiculously high. The United States would never alter a just and fair foreign policy because of an act of terrorism against it. Because I believe U.S. policy toward Iraq since the Gulf War has been unjust, plainly designed to starve the civilian population into removing by their head of state, acts of terrorism against U.S. embassies abroad or symbolic sites at home have been predictable. In a political organism, for every action there is a reaction. For every cruel act of injustice our government carries out, there will be some fruitcake who will try to get even, with a very satisfying cost/benefit ratio. The idea of preventing terrorism by making embassies impregnable is nonsensical. Terrorists will simply wait for the U.S. ambassador to leave the compound and then strike. There now is no reason to continue the sanctions on Iraq. The policy is unjustifiable when UNSCOM Chief Inspector Richard Butler says we must leave the sanctions in place until Iraq gives him satisfactory evidence that it has no more weapons of mass destruction, as Iraq has claimed without proof to the contrary since 1991.

TAXES: When House Speaker Newt Gingrich says he will try to get a $700 billion tax cut after Congress returns but may only get a $70 billion cut, consider this bullish news for the market, not reason to weep. The lower number is sufficient to contain a 15% capital gains tax cut and some odds and ends to bring the Democrats and the President along. There are still long odds against it, even at the lower number, but it will be of great benefit to the Republican Party to get its act together enough to put a bill on the President’s desk. GOP Senators are afraid Newt’s tactics will lead to another government shutdown, but Gingrich won’t lose that game again. 

Y2K: Our first state-of-the-world report on the Y2K problem will be complete late this week or early next. The report is designed to suggest guidelines for Y2K reporting and reading, to condense key reports on the readiness of institutions critical to investment, and to leaven these findings with our own political, financial and technical insights. It’s not too late to jump on board. We guarantee satisfaction.