Market Cross-Currents
Jude Wanniski
June 11, 2003


If you are confused by the market gyrations in recent weeks – even with the help of our analytics – you can be sure you are in good company. There are an unusual number of political variables pushing the value of financial assets in different directions. At least be assured that the new federal tax structure in place is and will remain the dominant force, overriding the negatives that remain from the last several years of monetary deflation. These include all the regulatory paraphernalia imposed on the economic system in the name of “corporate governance,” including criminal penalties for chief executives for not realizing their books were being cooked. These all have nuisance value of one degree or another. Here are some of the pluses and minuses passing on our screen at the moment:

Expensing Options: I’ve devoted several hours to tracking down the status of this dog, which I credited with taking a bite out of equities last week when it became clear the Federal Accounting Standards Board (FASB) is barreling toward a hard-and-fast rule. The issue gets so little attention because its victims will be unborn businesses in the high-tech realm. Rep. David Dreier [R-CA] has introduced legislation to deal with the corporate greed issue by having Congress require full transparency in corporate reporting of stock options, so investors can decide for themselves on a company’s practice. The legislation would provide for a three-year moratorium on the FASB rule. In a House hearing last week, FASB chairman Robert Herz denounced the Dreier bill as an interference. Dreier believes the economic impact of expensing is a public policy issue that is appropriately addressed by policymakers, not accounting-standards. Herz has stated that FASB will not consider any issue other than the technical accounting issues of expensing. There is some time to head this off as FASB has indicated it will go through a process of hearings on the draft it made public yesterday. Indications are it would be next spring before the final rule goes into effect. 

Gold: There are two distinct forces tugging at gold from different directions. There are increased demands for liquidity slowly but surely coming to market as the nation’s economic actors respond to the lower after-tax costs of capital. Then there is the Federal Reserve’s fascination with deflation, which is leading it in the direction of another inflationary impulse that would send gold up. (There is the third risk of political terrorism, which would send gold up if there were a major incident, but that seems lower than it has been since 9-11.) In the Fed’s current model, inspired by Governor Ben Bernanke, the Fed could lower the funds rate to as low as 0.75% from the current 1.25%. If it decides “deflation” is still a problem showing up in the statistical measures, it would then shift purchases of Federal securities to the top of the yield curve. If it did so, it would in the first instance send yields down and gold up. However, if this process went far enough, inflation expectations then could push long yields higher, thereby canceling the initial effect. Our Michael Darda believes there is enough of an expansion underway so the statistics will head off such an inflationary episode, but the possibility is now felt by a gold price higher than it would otherwise be.
Milton Friedman: “Hold on to your hats and prepare to be amazed: Milton Friedman has changed his mind.” So begins an article in today’s Financial Times by its correspondent, Simon London. "The use of quantity of money as a target has not been a success," concedes the grand old man of conservative economics. "I`m not sure I would as of today push it as hard as I once did." What a confession, which leads me to confess I believed Friedman would go to his Maker trying to persuade Him on the validity of the quantity theory that he used to persuade Richard Nixon to float the dollar instead of sticking with gold. As London puts it: “Those under the age of 40 are probably unaware how consequential Milton Friedman has been. His mild recantation on monetary targeting would have caused a sensation - and perhaps saved a lot of grief - had it been uttered 20 years ago. In the early 1980s, both the U.S. and the U.K. set interest rates according to Friedman-style targets for money-supply growth. The common aim was to bring down inflation without the pain of recession.” It would have been nice if the FT had asked the 91-year-old Nobel Laureate if he thought that meant it would be a good thing to refix the dollar to gold. This though is an important step in getting there. It frees his many students and their followers in the GOP think tanks from having to defend the float and reconsider new monetary mechanisms and targets. 

Middle East:  This morning’s headline in the New York Times was clearly a positive market force: “Bush Rebukes Israel for Attack in Gaza.” Putting aside all the claims of the Israelis and Palestinians about who struck first in the latest round of violence, the Bush “rebuke” to the Sharon government for its attempted assassination of a Hamas leader was the first real test of his “road map.” The fact the Times could report that National Security Advisor Condi Rice and Secretary of State Colin Powell joined in the rebuke was also welcome evidence that “even-handedness” will be the rule in the management of the road map. The rebuke did not stop the violence, but if there is going to be progress down the line this development will be noted throughout the Middle East. 

Tax Squabbling: The Democrats may be pretending they are enjoying the squabbling between the Republicans in the House and Senate and between House Majority Leader Tom DeLay and the White House. The issue is the “tax cuts” for low-income families that was stripped out of the tax bill that went to the White House. The President is demanding the House pass a separate bill that he could sign and is also demanding quick action on prescription drugs for seniors. So Mr. Bush looks like he has his heart in the right place. DeLay is firing back with “tough cookies” Mr. President. We were not sent here as rubber stamps or potted plants. If the legislation does worm its way into law, clearly the Democrats will only be able to get what they insist upon by agreeing to a broader tax bill than they had bargained for. It really does not matter that much to the macro economy how it turns out, unless in some final deal there are more supply-side growth elements than we can see at the moment. It is simply more evidence the Democrats don’t know what to do when confronted with the “good cop-bad cop" routine.  

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