$400 Gold
Jude Wanniski
January 29, 2004


The stock and bond markets reacted negatively to the Fed`s decision to drop the phrase "for a considerable period" from the FOMC statement yesterday, while leaving the funds rate at 1%. The sharp decline in the gold price to $400 today is the far more positive signal, at least within the framework of a floating dollar. It may seem silly to accept a 150-point drop in the DJIA and a 20 basis-point rise in the 10-year bond yield as a good price to pay for $400 gold, but if investors want to have a U.S. economy and world economy that build on a solid foundation and not simply on dollar inflation, there can be no argument. The bull market in US stocks since March of last year looks much less impressive when converted into ounces of gold or into euros.

If the Fed had gone the other way, leaving in "considerable period," we would have expected a flurry of buying of stocks and bonds, but a jump in gold and further decline of the dollar versus the euro and yen. Because the Greenspan Fed is going to continue managing the dollar based on statistical signals that have no direct connection to commodities, there of course will be "good" management decisions and "bad" management decisions. These few word changes in the FOMC statement have to be accepted as positives, but the markets are still left with enormous uncertainty about where the Fed goes from here. At the next FOMC meeting will the Fed underscore yesterday`s signal that deflation is not a problem and inflation is a problem? Will statistics of yesterday's policies begin showing up as being "inflationary," leading the Fed to raise the funds rate by a quarter point? If yesterday's little head-fake, "for a considerable period," has gold tumbling $15, how far will a quarter point take it?

These questions are exactly why a gold target would bring uncertainty to the lowest level. If the Fed statement had said it was taking gold into consideration as the purest signal of incipient inflation or deflation, its further statement about the "considerable period" would have had much more favorable effects in the equity and fixed-income markets. In other words, the markets know "optimum policy" even though Greenspan & Co. do not, and when they see the Fed getting closer to it, they respond accordingly.

Bottom line: The Fed's Open Market Committee has now learned more than it knew on what would happen with this teeny change in its posture. The market did it a favor by knocking gold down to $400. We have had little luck in educating that Fed governors on the importance of the gold signal in managing the supply of liquidity. The market may have better success.

* * * * *