Double Dip Possibility
Jude Wanniski
June 24, 1992


The New York Times this morning reports that President Bush has delivered "by far his strongest jawboning statement this year on interest rates," practically insisting the Fed lower them to lift the economy out of the doldrums. Unhappily, the President has chosen exactly the wrong time to bash the Fed, as market demands for more liquidity that accompanied the anemic recovery of the last several months have reversed. The inching up of the price of gold in the last several days, to $344 from the mid-$330s, has less to do with easier Fed policy than with a weakening in the demand for bank reserves. After rising steadily from the beginning of the year, the dollar volume of commercial paper of non-financial companies -- a fair proxy for the economy's demand for transaction balances -- went into decline in May. It's still not a dangerous situation on its face, but when we add in political ingredients such as President Bush's heavy-duty jawboning, it becomes much more troubling.

Most of you by now understand our approach to the gold/liquidity nexus -- which has had us complaining about monetary deflation in recent months, as the gold price dipped below $350. I'll explain again for those who are still having trouble juggling the variables, as your understanding is critical to how you assess the pitfalls ahead. We start with the assumption that gold is the best commodity to reflect the market's demand for dollar liquidity. That's why a gold standard worked so beautifully for centuries. If, at the end of the day, the Bank of England, or the Bank of the United States, observed the sterling price or dollar price of gold rising, it knew the markets had delivered their judgment that the banks had supplied a few too many pounds or dollars. The banks would adjust by extinguishing pounds or dollars, keeping the supply and demand for their currencies in harmony with the supply and demand for specie, as "gold money" was termed. Tiny daily adjustments would suffice, and the sterling/gold price and dollar/gold price thus remained constant for decades, even centuries. There was no monetary inflation or deflation during this era, although prices of other commodities would fall a bit then rise a bit as harvests were better or worse. The system worked so well because everyone who used pounds or dollars participated in making the decision on needed liquidity. It was a democratic method, as opposed to the Federal Reserve's current method, whereby a tiny group of experts, who we might call monetary monarchs, make all the decisions for the rest of us. As in any monarchy, the people have to pray every day that the royal family is wise and just, and will not use its vast powers for narrow political purposes.

Now then, we have worked diligently to discover what dollar price of gold the people as a whole are happiest with in the current context. As in any voting process, some people would like a higher gold price, which means more inflation, because they would like to pay their debts with cheaper currency. Others like a lower gold price, because they are net creditors and would like to be repaid with a stronger currency. The voting of these two groups takes place every day not just at one point in the gold/dollar price, but at many points, as the dollar (which is non-interest bearing debt of the U.S. government) has both a spot value and a future value. Interest-bearing dollar debt -- notes and bonds -- tells us the market's judgment of the dollar's value over time. The price of the 30-year Treasury bond is the best single piece of information available to us (and the monetary monarchs) because it contains within it all the information thrown off by the shorter maturities. We then bring these two important pieces of information together: the dollar price of gold and the dollar price of 30-year Treasuries. We find the Treasuries are happiest these days at $350 gold.

But because the monetary monarchs at the Fed are silent on the gold price, the people who comprise the bond market have to guess where it will go from day to day, from week to week, from month to month. We thought we knew that at least one of the monetary monarchs favored $350 gold, Gov. Wayne Angell, but when gold went below $350 he changed his mind and decided it should go lower. This meant to us that the recovery, as anemic as it was, was being starved for liquidity these past several months. The recovery has died as a result. Had the gold price been maintained during the period, when there was still life in the market demand for liquidity, the recovery would have grown stronger. Long-term interest rates would be lower, with all that implies for consumer confidence. As it is, trying to force-feed liquidity into a dead recovery is a hopeless task. It would cause those with cash to buy up gold and other commodities, on the expectation that the cash was losing value and the commodities would retain value. But the bond market would react quite negatively, interest rates climbing, with all that implies for consumer confidence.

Which brings us back to President Bush and the Fed. If the economy is now weakening toward a second recessionary dip, the two questions we must contemplate are these: Will the Fed resist, as it must, the President's insistent demand for more liquidity when the market is saying it wants no more? And if the price of gold continues to inch up, climbing above $350, even $360, will the Fed at some point increase, as it must, short-term interest rates? With the President in the fight of his political life, imagine how hot the seat will be in the office of the Chairman of the Fed. If Alan Greenspan answers these two questions exactly opposite of how President Bush would answer them, openly stabilizing gold at $350, we can be confident the economy will not double-dip. If he answers them the way the President would, the price of gold will soar along with bond yields, the stock market will bust, and 1993 will start out in red numbers.

The other variables that weigh heavily on this analysis are the market's assessment of the other two presidential candidates. It gets nothing but more gloom from the Democrat. As David Goldman reports: "Governor Clinton's proposal to raise taxes in the middle of economic stagnation would impose a fourth bracket at 38.5% for taxpayers with adjusted gross income above $200,000, a millionaire's surtax, and a higher alternative minimum tax (AMT), according to his economic advisors, and burden foreign companies with prohibitive tax constraints [as Paul Craig Roberts explains in detail in today's Wall Street Journal]. This is an out-of-the-can, Keynesian patent formula, which presumes that the rich who got richer during the 1980s should give up their yachts so that the government can spend money for "productive" urban infrastructure. Because Clinton's political handlers know the voters suspect tax-and-spend economics, the Arkansas governor targets his tax increase at the fairly small number of voters with adjusted gross income above $200,000, and offers to spend the resulting pittance of revenue on the cities. Most of his spending proposals, the plan states, would have to be financed through economic growth. His advisors also insist dogmatically that marginal tax rates have no effect on individual behavior. If enacted, Clinton's plan would inflict damage on the economy out of proportion to its size. The alternative minimum tax clobbers entrepreneurs, who often find themselves unable to write off losing investments. A large number of the same entrepreneurs who would suffer from a higher AMT would also run into Clinton's fourth tax bracket."

As I have previously forecast, Ross Perot will be elected in November and sometime in the next four years the DJIA will hit 6500. The question here is: How soon will it seem so clear that Perot will win and follow dynamic growth policies that the markets will begin reflecting this positive information? It will be a while. First, Perot will have to withstand the hurricane of abuse he is getting from the Establishment. Every agency of the Government that ever had anything to do with Perot is now feeding raw data to the Establishment media. This morning's Times carries a report from Robert Pear on every nickel-and-dime complaint that any businessman who does work for the government accepts as part of the price. If Cap Weinberger can be indicted by our corrupt political Establishment because he refused to lie about President Reagan, we must assume that anything goes with Perot as well. He'll survive these Satanic blasts, I'm confident, and by the end of August we will see more of the outlines of his direction, particularly a running mate, but also some policy principles.

We have at least a few months to weather. Jack Kemp's enterprise zone legislation has now been stripped of its capital gains provision, the only provision that matters. There's not a peep from the President so far. There are a few dollars for summer jobs in the inner cities, meager funds that will arrive with the first snowflakes. As the temperatures rise, we'll sit back and watch the Democrats in New York City and the GOP in Houston. Not a pretty picture, I grant you.