Dow's Back at 10,000;
What Next?
Jude Wanniski
May 11, 2004


Wall Street’s sharp decline Monday surely was related to fears of an interest-rate hike at next month’s FOMC meeting, but we think that the market got confirmation from Bob Novak’s weekend column, which went beyond a quarter-point increase. Here is the item, news that probably circulated through other venues once it got to the White House:

The Bush Administration has been alerted that Chairman Alan Greenspan will guide the Federal Reserve Board to a small interest rate boost before the presidential election, and President Bush is reported to be satisfied. According to these sources, the central bank this fall will raise the federal funds (interbank lending) rate from the current historic low of 1 percent to 1.25 percent. The Fed is expected to push the rate to 1.5 percent later this year after the election, and up to 2 percent early next year. Typically, Greenspan`s public statements have been so difficult to interpret that Fed-watchers have disagreed in their predictions of future action. But the administration has been assured that interest rate increases will not affect the election outcome.

I have not spoken to Novak, but while I am sure he has it right that Greenspan has somehow conveyed to the White House that there may be a small hike in the funds rate before the elections, I seriously doubt that Greenspan said it would definitely happen. Notice also there is no mention of the June meeting in the item, which means the Fed may hold off until August, which means there may be no increase at all. Novak’s item discussing rate increases after November are not drawn from the same source, but simply repeat market chatter that “the Fed is expected” to push the rate to 2% early next year. Greenspan would never say such a thing, and I doubt that he believes it will have to happen that way, given his recent comments that already note the decline in commodity prices.

With the dollar/gold price now down $55 from its peak in February, when the Fed sent out its first signal that the 1% funds rate might not be permanent, the economy clearly is expanding to a point where a higher rate would be necessary if economic growth caused inflation, which it does not. If the Fed were to go ahead with a rate hike in June on the presumption that inflation remains the problem, it could very well affect the election outcome. As the economy continues to expand, with increased efficiency the hallmark of the expansion, it already is eating away at the gold price as the increased demand for liquidity is not being met even with funds at 1%. If the corporate tax bill now survives -- as it seems quite likely it will given Senate negotiations underway -- there will be even greater demands for liquidity pulling down the gold price as the leading edge of a new monetary deflation. Gold could easily be down to $350 by July even without a funds increase in June. The President’s approval rating, now at 46% and trending lower, would not improve if the Dow Jones Industrials trend toward 9,000.
At some point soon, we should see this issue discussed, either because Greenspan himself becomes troubled at the market’s behavior, or because Treasury Secretary John Snow begins to hear from second-tier people at Treasury that deflationary problems are developing, or because Senator Kerry wonders why the President is happy with an increase in interest rates to fight inflation where there is none to fight, or if Karl Rove begins projecting these calculations into defeat in November, unless corrected soon. There is a political vacuum here and nature abhors a vacuum. Clients are calling about my forecast of 12,000 on the DJIA by year’s end, wondering if I am sticking to it. Yes, but someone with political authority has to break the ice and raise these simple questions. Once raised, Greenspan might have to allow that maybe the funds rate at 1% can stay there indefinitely, until we see gold and commodity prices headed up. If that happens and the corporate tax bill makes its way not only past the Senate this week, but also to the President’s desk in the weeks ahead, a DJIA of 12,000 is doable, and then some.
In a related subject, China comes up daily in questions from clients, and I continue to see stories about Beijing making one kind of move or another to combat the inflation that accompanied the yuan/dollar/gold run-up that topped out in February. The report in The New York Times today that “price controls” were decreed in certain sectors and certain regions looks worrisome, but on a close reading it seems another small, even cosmetic move. The inflationary pressures should be subsiding in China already, and if gold continues to fall, Beijing will sooner or later be wondering what to do about falling commodity prices as they affect state bank loans. Check recommended reading on our home page today for a Bloomberg column out of Singapore, discussing talk of an Asian currency that will come up in the South Korea meeting of the Asian Development Bank this week. The rest of the world will put up with the exigencies of a floating dollar only until they figure out a way of doing it better themselves.

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