The Sluggish Bull
Jude Wanniski
September 17, 1998


How unusual to see Wall Street sell off following Fed Chairman Alan Greenspan’s testimony to House Banking yesterday, and then rally back to a solid, broad-based gain later in the afternoon --  only to tank with the rest of the world markets last night and today. There are so many things going on at once that it takes considerable effort in our analytical framework to sort it all out. In addition to the heightened uncertainty over Fed policy, there is also the increasing likelihood that President Clinton will have to resign. There is a possibility of a tax cut, which may have helped the market yesterday afternoon. And there are grave anxieties regarding Japan and Russia. My surmise was that there was understandable disappointment in Greenspan’s carefully hedged comments, which increased the risk that he would not lead the Fed’s open-market committee to an interest-rate cut when it meets September 29th. There’s little doubt in my mind that the global market reacted more adversely to the increased risk that the Fed will remain neutral when it meets and this reaction has fed back to Wall Street today. It is, after all, the rest of the world that is now primarily carrying the burden of the U.S. monetary deflation.

Greenspan’s comments that there is no coordinated interest-rate cut in the works could not have had much to do with the sell-off, because the idea, which came out of Treasury, was always a non-starter. Germany was not about to join such an effort and Japan’s interest rates are too low, reflecting the severe monetary AND fiscal deflation its policies produced. The world problem has nothing to do with the cost of new capital. It has to do with old credits, with debtors who have collateralized their incomes as commodity producers unable to pay their creditors. One way or another, they must sell their production or inventories at distressed prices and competitors who are not in distress also must cut prices, and profits, to hold market share. Forget new business initiatives until the universe of all prices adjusts to the new lower level implied by $290 gold. Greenspan indicated the global deflation now is eating into our manufacturing sector at the edges, but he continues to pretend that the Fed’s policies had nothing to do with the deflation. The one acknowledgment he made is that if the world were on a gold standard, the banking disequilibria that characterizes the Asian deflation would not have occurred.

Rep. Barney Frank [D-MA] had the best question of the day, but Greenspan refused to answer it. Frank: “Beyond just interest rates, do we have a need for more liquidity in the world? Is there a deflationary problem?...I’ve asked you this before, Mr. Greenspan. Jack Kemp and some others have pointed out you’ve always put a lot of the gold price. The gold price is now at a very low level, it would seem. Is that an indication, along with other problems, dropping commodity prices, that in addition to the technical problems...that we are in a deflationary period that requires some attention beyond some of the things we’ve talked about?” To which Greenspan answered: “I would certainly say that in East Asia, and increasingly in the rest of the world, deflationary forces are continuing to emerge. There’s no evidence, of which I am aware, which suggests that the process which began somewhat over a year ago has stabilized. And indeed, I think that has been moving in our direction. And indeed...I just think it is not credible to perceive that we can remain the oasis of prosperity that we have been, or for that matter, Europe, with the rest of the world under increasing stress. So I think there’s very little question that those processes are continuing.” As Frank saw Greenspan was avoiding his question, he jumped in again: “Could I just -- I appreciate -- I just wondered, quickly, the policy implications of that. Does that mean that there ought to be some effort to increase liquidity here and elsewhere? What are the policy implications of that, of the fact that this is spreading?” Greenspan stonewalled: “I think the policy implications are that, as the [Treasury] Secretary said, that it is important to stabilize the system, because unless and until it gets stabilized, the erosion will doubtless continue.” Greenspan gibberish.

In fact, I’d called Frank before the hearing and told him I worried that even if there were a cut in the funds rate, it might not produce an increase in liquidity -- which is how Japan has gotten into its current fix. A lower interest rate is not the objective. As Kemp and Steve Forbes have made clear, it is a higher gold price that must be the objective, with liquidity added until the objective is reached. As I’ve been discussing deflation with Frank for almost a year, he now understands the problem better than other members of Congress, but was still unable to nudge the Fed chairman into an answer that would be constructive in world markets. A simple cut in fed funds simply may increase the demand for liquidity here, with gold remaining unfazed. Gold has to rise to at least $325 in the blatant goal of making gold more attractive than the dollar. All commodities would follow in train, debts would be paid, and the world financial system would be humming again. I pointed out to Frank that the world’s most important bank, Citicorp, had sold as high as $182, had dropped to $83 when gold bottomed at $272. It climbed back over $100 as gold recovered to $290 and it would be flying high again if the central banker ended the deflation. As it is, almost every bad debt in the world causes dominoes to fall onto Citicorp’s bottom line. “Stabilization” can’t be the goal at $290 gold, or it will eventually force the average worker to accept a 20% pay cut, causing personal bankruptcies to skyrocket even higher than they are.

Treasury Secretary Bob Rubin, who sat at Greenspan’s side, does not understand any of this. At Rubin’s side was his deputy, Larry Summers, a 40-something Ph.D. economist, who knows nothing about monetary deflation because it was not taught at any school that he attended. It also is clear from Greenspan’s recent speeches and testimony that he never was taught monetary deflation either, because he confuses deflation -- a monetary event -- with contraction, a fiscal or regulatory event. The Asian and Latin markets suffer because they owe dollar debts they thought they could pay with commodities they could sell for dollar prices a third higher than they are. Ordinary people, of course, are having the purchasing power of their wages, savings and pensions wiped out by the inflation of their domestic currencies.

It is especially hard to assess the impact President Clinton’s problems are having on either Wall Street or the world markets. Although on the surface it seems the President’s job approval ratings are keeping him safe from impeachment and removal, beneath the surface it seems more and more as if he may be forced by his own party to resign -- knowing he would surely lose in a Senate trial. I still think he might win in a Senate impeachment vote under the most favorable circumstances, but the drift of events and his own behavior point toward a President Gore. The jockeying has already begun on who will be Gore’s vice president.