Tax Bill: Bolt from the Blue
Jude Wanniski
March 8, 2002

The news that a trimmed-down "stimulus package" now is almost certain to pass into law, perhaps be next week, has scrambled the variables we watch here and in Japan. The package does contain positive supply-side tax changes affecting capital investment. The financial press says it will not have much to do with helping the economy, but that is because it has very little in the way of Keynesian aggregate demand. In our model, it will increase the demand for liquidity, which is why the dollar/gold price has trickled back below $290 per ounce. All this means is that the deflationary drag will be slightly more pronounced and will be delayed over a longer time frame. The "W" dipper we characterized earlier this week will be a little more drawn out in length, but there is still no escaping the correction that must come when earnings do not match expectations in the market. The recent Wall Street rally, built on good news about inventory rebuilding, has been a P/E rally, as prices have gone up, but not earnings, which are merely expected to follow.

Japan`s stock market has continued to climb, up more than 14% in the last several weeks in dollar terms, but we predicated that on the dollar`s decline against gold, which meant the yen would decline against gold in parallel. As gold has shed $10 via the monetary dynamics related to the tax legislation, there has as yet to be any adjustment by the Bank of Japan (BoJ) to the dollar. If the yen remains at 128 and gold at $289, yen gold remains at 37,000 per ounce. This is still well above the 28,000 that was crushing yen debtors a few months back, which is why the Nikkei has been advancing so smartly. But the optimum gold price in Japan, we believe, is 42,000, and it almost got there last week, at 40,000, before the tax bolt-from-the-blue. We will have a report next week, perhaps by Monday, on how the BoJ is dealing with these sudden changes in the forex picture.

The drop in the unemployment rate today, by a tenth of a percent, should not have been a surprise, given the fact that there has been a small rebuilding of inventories in anticipation of renewed economic growth. The addition to the work force of 66,000 in the month to the 131 million already employed -- an increase of 0.05% -- is hardly a clear sign, given the warmest weather on record. Overall, manufacturing lost another 50,000 jobs. Here is the official summary: "While the over-the-month change was positive for the first time since July 2001, much of the gain was due to special circumstances. Unusual seasonal employment patterns in retail trade, favorable weather for construction, and a return from temporary plant shutdowns in motor vehicle manufacturing were important components of the February report. In the goods-producing sector, manufacturing lost 50,000 jobs in February, compared with average losses of about 111,000 in the prior 12 months. Motor vehicle employment rose by 26,000, as most of the plants that had been temporarily shut down in January to reduce inventories were operating in February. Large employment declines continued in electrical equipment (-22,000) and industrial machinery (-14,000). Aircraft manufacturing lost 8,000 jobs in February; since September, employment in this industry has fallen by 33,000. Employment in printing and publishing fell by 13,000 in February and has declined by 107,000 over the year."

Meanwhile, all these expectations of economic advance are chilling the bond market. Fed Chairman Alan Greenspan was more upbeat in his comments on the economy before Senate Banking Thursday, compared to his testimony last week. The Fed chief`s optimism has driven up expectations of 2002 rate hikes by another 75 basis points, with the December eurodollar futures contract now pricing in a 3.5% funds rate by year end. This has sparked a nearly 50 bps sell off in the two-year treasury note, with steep declines across the rest of the treasury yield curve. Greenspan`s cheerfulness reflected the small signs of growth that came in during the past few days, but he was not all that cheerful. He did note that business leaders are more skeptical of recovery than economists, and he did not take a position on where he stood in that division. We will only know when it becomes clearer whether pricing power for goods will permit justification of the prices of equities. The Wall Street Journal points out today that, while retails sales of discount items are booming, speciality (non-discounted) sales continue to disappoint. Future disappointments on the economic and corporate profits front likely would lay the foundation for treasury yields to fall. With gold sinking instead of rising, the deflationary drag goes up, not down. Not by much, but any amount hurts.