Fedwatch: October Surprise?
Jude Wanniski
September 19, 2000


If you put yourself in Saddam Hussein’s shoes, you might decide this is the perfect time to pull the tiger’s tail. Remember he has been suffering under the burdens of what we believe have been unjust and unwarranted economic sanctions for almost ten years now. Unless he takes some risks, poking the Superpower in the eye when the time is right, Saddam would cause his own citizens to wonder if he had decided to sit things out until Allah called him to his reward, which could be another 20 years. When he invaded Kuwait in August 1990, Saddam thought he had permission of the U.S. government, as it seemed clear to everyone in the Middle East that the Emir was not only stealing oil from Iraq by drilling into Iraqi fields across the border, but also pumping much more oil than he had agreed upon with his OPEC partners. Iraq faced bankruptcy. Those of you who have forgotten all the work I’ve done in backing up this history check out our archives. I’ve not the slightest doubt that the sanctions have been retained not only in order to keep Iraq weak relative to Israel, but also to keep the oil price higher than it might be if Iraq -- which has the second highest reserves in the Middle East -- were able to produce at optimum rates.

We last week advised that Iraq is now the swing producer in the world, as its 3 million barrels a day is higher than the total unused capacity in the rest of the world. We are still seeing expert oil analysts talking about an 8 million bbl surplus in Saudi Arabia alone. We wish. At best it has surplus capacity of 1 million bbl and that may be fiction too. The Saudis have unlimited pools of oil underground, but it would be illogical for them to be developing oil fields for production years, decades, before the oil would come onto the world market without driving down prices on a curve of diminishing returns. It would be the equivalent of Exxon building gas stations in empty fields, expecting the suburbs to come out to meet them. So, Iraq is in an incredibly powerful position. It can pull our tail and sit and watch Washington squirm. What does President Clinton do? If there is a military response from Washington, the price of oil will skyrocket. Forget $40 a barrel. We can imagine $60 or $80 a barrel with a sudden squeeze, going into a winter in North America. This is why the bond market is being pummeled, we think. It isn’t worried about inflation in the system, with gold at $271. Even Alan Greenspan did what he could yesterday to indicate there are plenty of productivity pluses to offset the tightness in the labor markets. If there is an economic decline, the bond market has to assume Greenspan will try to inflate us out of it. I rather doubt he would, but the bond market has to discount that possibility.

If oil skyrockets to unprecedented levels, there would be global recession, as the organic whole of mankind would be forced to push Iraq out of its swing position by causing a decline in the demand for oil. Either that, or our commander-in-chief would decide to send in the troops to take out Saddam once and for all. This is a distinct possibility, as the daily news reports indicate increased maneuvering by Saddam and increasing warnings from the administration.

If this happens, the Federal Reserve will be under incredible pressure to flood the banking system with liquidity in order to ease the pain of recession. When this hue and cry was raised in 1990, the Fed hunkered down and rejected all the appeals for monetary ease. The board of governors back then was not rattled and refused to bow to demands that it print money to offset the “tax increase” represented by higher oil prices. The bond market collapse did not last long, as Saddam did not have the military strength or a corner on the oil market. Today, he has enough military strength to deal with the small U.S. force of 20,000 still encamped in the area, and he is the swing oil producer. On top of it all is the likelihood that George W. Bush will needle Gore if there is no military action, and the Democrats will needle Bush because his daddy did not march to Baghdad to finish off Saddam.

The NYTimes should have had all this on its front page today, but the only story is a little one on C4 of the business section, “Oil Prices Hit New High on Fear of Persian Gulf Strife,” by Neela Banerjee, actually a very informative piece. “Rather than invade Kuwait again, Iraq has implied that it is willing to reduce or halt oil exports to apply pressure on the United Nations on the eve of a critical discussion about reparations Iraq must make to Kuwait... A UN commission on reparations will meet later this month to settle a $15.9 billion claim brought against Iraq by Kuwait. Iraq is slowly rebuilding its economy from the proceeds of moderate sales of oil permitted by United Nations sanctions... Analysts said Iraq was incensed at the idea of paying such large reparations to Kuwait. Moreover, Iraq fears that if this claim is successful, it will open the gates to others that would collectively ruin the country’s economy and Mr. Hussein’s regime.”

As this story unfolds in the weeks ahead, one big question remains about how the Republicans in general, George W. Bush in particular, would react to a show of force by Clinton/Gore, or inaction. In 1996, when Clinton bombed Iraq to kick off his campaign, with no good reason for the bombs, GOP nominee Bob Dole quickly supported Clinton and other hawks complained that Clinton did not bomb enough. The same national security advisors who were on the Dole campaign, Richard Perle and Paul Wolfowitz, are now in the inner circle of the Bush campaign. The addition of Richard Cheney to the team was positive, I noted at the time, because Cheney has been in a key position of the oil industry these past five years and has gilt-edged contacts in the Arab League. The problem could be solved by diplomacy, but that requires a willingness to acknowledge that Saddam Hussein will not be hustled by dishonest diplomats as he has been in the past. He will allow UN inspectors into Iraq, but the sanctions have to be lifted, and if there is money to be paid out to Kuwait, it would have to come from the $9.5 billion the UN has siphoned off in allowing Iraq to sell some oil for food. If Bush consulted Cheney and Colin Powell, I think they would recommend diplomacy at this point. It could decide the outcome of the presidential election. If Bush decides to pound on Clinton/Gore for being sissies and not using force, my guess is he would open up the gender gap by another 10 points and lose in a landslide.

[I’m leaving for a two week vacation in Europe this afternoon. Patricia will not allow me to take a computer or call the office. I leave the fate of western civilization in the hands of my capable staff.]

TAX SHOWDOWN: Our best GOP source in Congress tells us, as of this morning, “The taxes that will be cut this year are only the one's that Clinton will sign. We will have the small business cuts (such as they are) that go with minimum wage, we will have the IRA/pension cuts (Clinton will try and cut down the size of the IRA changes that Roth wants), some long term health care stuff, possibly the New Markets/Community Renewal tax cuts.” In other words, the Friday report we sent from Karen Kerrigan’s reporting from several sources still seems solid, even with the confusion over taxes and debt reduction.