Memo: To Website Browsers, Fans, Prospective Clients
From Jude Wanniski
Re An update on our domestic track record
For almost 20 years, Polyconomics has been advising financial and industrial clients on the economic climate we see on the horizon and over the horizon. Our business is anticipating the direction of the financial markets and the real economic activity that these markets foreshadow. Because the political and economic markets are intertwined, our method is to assess the impact that political and policy decisions will have on debt and equity markets in the United States and the countries we believe are of most interest to our clients. As 1997 began, we forecast a Dow Jones Industrial Average of between 7500 and 7800, a long bond of 6%, and a dollar/yen exchange rate of 130. We hit all three. Here are several other examples of the effectiveness of our particular analytical model of the U.S. political economy.
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Prior to October 1997: The gold price fall indicates an increased demand for dollar liquidity. On October 27, 1997 in "Discounting a Serious Deflation," we note, "The decline in gold last week was almost universally ascribed to a committee of the Swiss government, which was said to be thinking of selling 1400 metric tons of gold from its monetary reserves. Never mind that the price of gold would not decline by one penny per ounce unless the gold were actually put on the market at takeaway prices. The government has been talking about selling 400 tons over a period of several years, presumably when the price is right. — not 1400, which is half the Swiss reserves and 50% of annual world gold production. The Swiss government again has made this clear. Prices of base metals dropped sharply in London today in the wake of the gold-price plunge. Copper for three-month delivery fell $34, 1.7%, to $1,992 per ton. Three-month aluminum also dropped $34, 2.1%, to $1,562 per ton. Lead fell 3.6%, $22 per ton, to $589. Prices of zinc, tin, and nickel also were all in decline...No, gold is falling in price because of an excess of demand over supply of dollars."
Debunking the flight to quality myth. On November 21, 1997 in "Bond Yields Still Have Room," we note, "Various market pundits persist in retailing the story that this rally can be explained as a "flight to quality," with jittery global investors parking capital in the supposedly "safe" haven at the long end of the Treasury yield curve. Actual movements along the curve, however, expose this as the sort of simplistic blather unworthy of a high school-level economics course. No flight to quality has ever produced the sharp yield curve flattening that the Treasury market has experienced recently, as the whole point of such trades is to embrace the relatively low risk found at shorter maturities. No rational investor whose first priority is short-term risk avoidance would hold a 30-year Treasury yielding first priority is short-term risk avoidance would hold a 30-year Treasury yielding 6.05% (or a 10-year yielding less than 5.85%) when a much lower risk two-year note is yielding about 5.7%. These, by the way, are the narrowest bond/note spreads since just before the conclusion of the Fed's 300-basis point tightening episode a little less than three years ago."
Alerting our clients to the worldwide negative impact of the gold price collapse. On December 3, 1997 in " Gold Below $300 ," we consider the implications of the falling gold price, "...in warning of a dollar deflation all year, primarily based on the judgment that the gold price would fall as an indirect result of a budget deal between the White House and Congress, one that would include a cut in the capital gains tax. The tax cut would cause an increase in the demand for dollar liquidity and when the Fed would not meet that demand, gold would decline. When gold got to $320 in July, we warned July 9 that unless Fed Chairman Alan Greenspan found a way to talk the Fed into cutting interest rates, to supply the demanded liquidity, there would be financial distress throughout the world: "One of the worst effects of gold at $320 is that the Fed's monetary error on the deflation side is being transmitted to all countries of the world, to one degree or another."
Identifying a shift in expectations of ease. On December 29, 1997 in "Fedwatch: Early Stirrings of an Expectations Shift," we posit, "While at just under $295, the gold price continues to discount for significant future deflation, the more-or-less steady rise since bottoming out on December 9 at least points in the direction of some expectation of Fed relief. Indeed, after meandering in a 13-15 basis points range the previous several weeks, within two days the 10 yr./2 yr. curve commenced its most recent flattening, and the long bond yield finally broke below 6%."
Market Direction: On January 2, 1998 in "Thinking About 1998," we forecast a Dow Jones Industrial Average of 9000 by the end of 1998 and a long bond of 5.5%. Our client letter of that date can be read in its entirety in our archive.