We must assume that the Fed will hike the funds rate in three weeks by a quarter point, but there still is a chance that it will not. Greenspan’s statement yesterday was interpreted immediately as a signal of more aggressive tightening to come, but I watched the speech as he delivered it and saw it as another head fake. You will recall that as other Fed governors indicated less concern for inflation during the past week, the price of gold drifted up to $393 from $388. However, by sounding tough without his words actually suggesting that tough action was in the works, the Maestro sent gold down by almost $7, where it sits now at $385. The last sentence says it all: "...the FOMC is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability so as to ensure maximum sustainable economic growth." That can mean anything at all.
Whether he meant to do so or not, Greenspan bought a little more time for the inflation indicators to turn down, perhaps enough to justify holding to the present course with a 1% funds rate. With oil down $5/bbl to $37 since the end of last week, for a variety of positive developments, another three weeks could produce a new consensus that obviates the need for a tightening, perhaps with a statement by the FOMC at its June 30 meeting that it stands ready to tighten at a moment’s notice.
The variety of positive developments pushing down oil include the lowered geopolitical risk of oil disruptions that I noted last week, with President Bush forced to concede more power to the United Nations Security Council (UNSC) than the neo-cons wished to give. The 15-to-0 UNSC vote on the Iraq Resolution is counted as a diplomatic victory for Mr. Bush, and it does make him look better than he has in a while. While he still trails Senator Kerry in the match-up polls, by as much as six points according to Gallup, he has had a much better week or two than the avalanche of bad news from Iraq during the previous month. The UN vote is much more clearly a diplomatic victory for France, Russia, China and Germany, which wrung several critical concessions from the administration. These I believe undermine any hopes that the GOP warriors may have of establishing a permanent imperial outpost in Baghdad. Given the commitments on sovereignty and to an election timetable, there should be no U.S. troops at all in Iraq by the end of 2005. The only reason to stick around will be to have more Americans killed on a daily basis by suicidal Iraqis who may be happy with their new government, but still want the U.S. boots on the ground either gone, or underground. Senator Kerry has now said that while he would like to see more troops in Iraq for the transition, he hopes to bring them all home ASAP.
A client e-mail this morning asked why I hope to avoid a hike in the funds rate simply because it would cause a lower gold price and induce another round of deflation. The client noted that gold is only $385, while I still believe $350 is the optimal price. The reason is that raising the funds rate means a tightening in the supply of liquidity just when the economy is steadily expanding and asking for more. It is the wrong way to get to the optimum price. If there were more patience, the economic expansion would get us back to $350 gold without disturbing the current yield curve, which is about as good as it can get. Even if the Fed notches up one time, it then seems most unlikely it will have to do so again this year. You may have noticed on Bloomberg this morning that Bear Stearns analyst Frederick Leuffler is saying U.S. prices may fall to $20/bbl. by early next year as producers pump more oil onto global markets. According to Leuffler, oil inventories, which were at a 28-year low of 263.7 million barrels in January, may exceed 340 million by the end of September, and would cause oil prices to fall sharply. He noted that the last time inventories reached 340 million barrels was in April 1999, when oil cost $17.30 a barrel. While Leuffler’s comparison is flawed to a degree, because he does not seem to know how oil got to $17.30 in 1999, we still think that oil could get to $28/bbl. by year’s end as oil hoarding diminishes amid declining risk.
We continue to keep an eye on the corporate tax bill, which gets messier every time we take a look, because it alone could kick up the demand for liquidity in a positive way, bring gold down to $350 and scare the Fed out of raising the funds rate when that would clearly only contribute to a nasty deflation. House Ways and Means Chairman Bill Thomas hopes to mark up the messy bill tomorrow, and there remain high hopes of getting a bill through Conference and to the President’s desk before the break for the Democratic convention in six weeks. Thomas is another Maestro, the man most responsible for the marvelous shape of last year’s tax bill, but even he may not be able to maneuver through the political swamps on that kind of calendar. Remember everyone thought that the legislation would be wrapped up by April, given the escalating penalties of the World Trade Organization. They still are escalating, but obviously not enough to get the job done quickly.
The passing of President Reagan has brought back to mind his successes as a supply-sider. This may add to his legacy by coloring the political backdrop even slightly as we move toward the elections. It especially makes it a bit easier to discuss a gold-based monetary reform, the one dream the Gipper had in 1980 that eluded him. If you do not regularly check my public website, you might find two "memos on the margin" that I wrote this week of interest. The first is “The Basis of Reagan’s Greatness.” The second, “How About a Reagan Gold Coin" suggests that instead of pushing Hamilton off the $10 bill or Jackson off the $20 to honor Reagan, we wait until we get to a gold-based monetary system and stamp his image on a monetary gold coin, one fixed in value at, say, $350 per ounce, which would make all paper dollars as good as gold at that value. It’s just a thought.
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