Finding the Bottom
Jude Wanniski
May 20, 2002

As you might expect, the handsome rally in equities last week generated many phone calls from clients and much discussion by our team on whether we had hit bottom the week before. We`d had these discussions before during the various bear-market rallies, and our conclusions were always easy. When the dollar/gold price was at $265 or $275 or $290 or $300, the deflationary drag was a big enough force to overcome that we stuck to our guns and remained bearish in all the sectors except for gold itself. With gold at $316 now, still with an upward bias, we are getting closer to a point where other forces may be enough to overcome what remains of the deflationary drag. This will at least prevent the nominal equity indices from falling another 10% before they bottom. On the other hand, be assured there are no bulls on the Poly team, at least as far as the U.S. financial markets are concerned, as the monetary deflation is ending because of contractionary forces. Rallies will be hard to sustain. The best upside opportunities are now surfacing in Asia, we think.

At home, I won`t feel comfortable with the size of the deflationary drag until gold gets to $330, but to get there in the absence of a presidential directive would require more bad news on the fiscal front or specific setbacks on the terrorist front. The risks of doing the kind of added business that can bring productivity gains to the bottom line are still going up, which militates against a bull market even with an end to deflation. On several weekend talk shows, Vice President Dick Cheney practically advertised another 9-11 just around the corner; this may have been merely gratuitous, given the flap over the failure of the White House to alert the nation last summer when it knew something was up. At the margin, though, it does discourage business activity, and we note stocks of airlines and hotel chains were not happy in today`s trading and Cheney definitely moved the gold market. For what it is worth, I think it is less likely we will see another terrorist attack here now that the Bush administration has made some progress with Colin Powell`s Mideast diplomacy. The 9-11 attack was to get the attention of the superpower, not to punish or exact revenge. As long as there is now a bit of progress toward a Palestinian state, with the President making an effort at playing honest broker, there is less likelihood of attack here. Israel is another matter, as the Likud government drags its feet.

In Washington last week for a dinner honoring Bill Buckley, I spent an extra day to meet with a few economic types, a Fed governor and a few White House advisors and some front-rank journalists. The deflation idea is out there, although not always perfectly understood. I readily agreed that gold is not on anyone`s radar screen but ours. Yet I also found serious interest in my arguments and no hostility to the idea of a gold dollar, should it pop up on the radar screen. The Fed governor told me I had a political problem if I was serious about doing gold, because even Jack Kemp and the WSJournal have stopped talking about gold. It wouldn`t take much, I said, just a little crisis will do. Three months before Nixon went off gold in 1971, Milton Friedman said he did not expect to see a floating dollar in his lifetime. It`s been floating ever since, and Professor Friedman is still kicking.