Year-End Notes Jude Wanniski and David Gitlitz December 31, 1998

CLINTON: Democratic Senator Tom Harkin of Iowa doesn’t know why the President and his lawyers don’t want a Senate trial to go to a direct vote on whether Mr. Clinton is fit to remain in office. If Senators are forced to stand up and say it is fine with them for a President to commit perjury and obstruct, there may be not be enough to stomach a vote and the President soon would be gone. All the maneuvering around a procedural vote to interrupt the process and lead to a censure is to provide Democratic Senators a way to avoid that direct vote. As far as we can see, there will be a direct vote and Senators will be forced to vote their conscience -- which is why we continue to believe the process is on a conviction track. Note how the President’s defenders had been attacking Senate Majority Leader Trent Lott for a speech he gave in 1992 to a virulent racist group, as NYTimes columnist Anthony Lewis put it, trying to paint Lott as a racist bigot. As far as I know, the only Republican who has gotten a higher percentage of black votes than Lott in a statewide race in the last 20 years is former New Jersey Governor Tom Kean. As soon as Lott hinted he might be willing to short-circuit a direct vote on the impeachment articles, the NYTimes this morning devoted its lead editorial to celebrating his wisdom and greatness.

IRAQ: The daily reports of Iraq confrontations with U.S. and British airplanes that are trying to enforce the so-called “no-fly” zones represent a stalemate in the chess game between Saddam Hussein and the U.S. foreign-policy establishment. As long as there was a chance to get the sanctions lifted, Saddam did not contest the “no-fly” zones, but now that the U.S. ended the charade that it is willing to lift the sanctions under any circumstances, and will bomb Iraq at will, Saddam sees nothing to lose and everything to gain by challenging the no-fly zones. With no appropriate response from the White House and zero support in the Pentagon for returning to a bombing mode with no strategy in sight, Saddam is in his strongest position to date to negotiate an end to the sanctions in exchange for a return of the arms monitors under the direction of UN General Secretary Kofi Annan, whom Baghdad respects. This is the plan offered by the French. It also is the plan endorsed in the latest edition of Foreign Affairs, which concedes that the eight-year policy of trying to bring down Saddam with the sanctions has failed. The article by three expert policy analysts of the Rand Corporation, the Defense University, and the Council on Foreign Relations, shreds and ridicules the arguments advanced by the advocates of the Iraq Liberation Act. In other words, the U.S. foreign-policy establishment has now taken a big step toward accepting the policy first advanced a year ago by Jack Kemp, who was alone among Republican leaders in supporting Kofi Annan’s diplomatic efforts and who denounced the recent bombing of Iraq as being unjustified. The Republican hawks in Congress will not give up without a fight, but at last there will be a genuine debate between hawks and doves on how to manage the so-called rogue nations going into the next century, that is, what mixture of force and diplomacy.

 Jude Wanniski

FED BUBBLE?: Desperate as they see their monetarist model once again go up in smoke, Friedmanites on Wall Street are now propounding the idea that the price inflation we should be seeing has instead gone into asset inflation. Pay no attention to falling commodity prices, gold below $290, and renewed widening in credit quality spreads -- which are wholly inconsistent with excess liquidity. The “M” monetary aggregates, they say, are sure indications excess liquidity has been bidding up equity prices for no good reason and a bubble has developed!  Even in the Fed’s own numbers, we see only indications of liquidity scarcity even after the past three months and 75 basis points cut from the funds rate. Since the September 24 statement week -- the last full week prior to the first rate cut -- the Fed’s balance sheet has grown by about $18 billion. For the same period, though, currency in circulation -- which is totally demand-driven -- has risen by $19 billion. In other words, there is $1 billion less in bank reserves in the financial system, which is why the gold price is down. For the commodity deflation to reverse, the Fed has to add more reserves than banks are currently demanding. No doubt, fears of a “liquidity bubble” played a part in last week’s FOMC decision to stand pat at 4.75%. Fortunately, that session also marked the conclusion of the 1998 FOMC membership rotation. That means the panel’s only true monetarists -- the St. Louis Fed’s Bill Poole and Jerry Jordan of Cleveland -- now shift to non-voting status. Among those moving to voting slots on the committee in the new year is Dallas’s Robert McTeer, president of the only supply-side oriented bank in the system and a man who appreciates the gold signal. There is still no indication from Fed Chairman Alan Greenspan that he appreciates the need to switch to a commodity signal instead of targeting the funds rate. 

REBOUNDING BONDS: Last week we posited that the collapse of Japanese government bonds offered an inadequate explanation for the decline in U.S. Treasury prices, and found that a continued sell-off in JGBs probably augured well for dollar bonds (“Japanese Bonds Not Contagious,” December 23, 1998). This week the slide continues in Tokyo, with the benchmark 10-year yield rising above 2% for the first time in more than six months, while the U.S. Treasury long-bond has rallied from above 5.2% to below 5.1%. We do not believe arbitrage between Japanese and U.S. bonds is the primary factor explaining the Treasury market recovery. The rebound should be seen first as confirming that 5.2% yields present irresistible real value in a deflationary environment. At the same time, we see nothing to dissuade us from the proposition that the narrowing spreads between JGBs and Treasuries suggest growing support for U.S. bonds, at the margin, from yen-based investors. That includes this week’s dip in the dollar/yen rate, which appears primarily due to year-end funding pressures among Japanese banks. Indeed, it would come as no surprise if Japanese portfolios now are taking advantage of the yen’s levels above ¥120/$ to augment their Treasury holdings in expectation of the dollar’s subsequent appreciation against the yen. 

David Gitlitz