Jamal Mecklai: Another Valentine's Day massacre?

MARKET MANIAC

The original "Valentine's Day massacre" was in 1929, when notorious mobster Al Capone tried to eliminate the opposition by wiping out members of a rival [Bugs Moran] gang. This event was widely seen as the turning point in the gang wars of Chicago, and led to the cleaning up, to the extent that such things ever get cleaned up, of organised crime in the US.

The "Saturday night massacre" was the name given to a series of firings and resignations from Richard Nixon's administration on October 20, 1973, which resulted in an uproar in public opinion that finally resulted in Mr Nixon's resignation as President of the United States. I was in the US at the time, a relatively fresh-off-the-boat graduate student and I vividly remember marching in anti-war (Vietnam) protests at Times Square and the angry enthusiasm on campus as the nightly news unfolded the Watergate scandal.

From the outside, the situation in the US today appears to bear an uncanny resemblance to that time. Opposition to the Iraq war is growing by the day; senior administration officers, including the once-and-future-kingmaker Karl Rove, are under suspicion for a cover-up, with the vice-president's chief of staff already under indictment, and the President's approval ratings have fallen to all-time lows (around 35 per cent). Bush continues to attract comedians and satirists, just as Nixon did. It feels just like the mid-1970s all over again""all that's missing is a petulant Mr Bush wringing his hands pacing the Oval Office muttering, "I am not a crook."

The appalling level of global discontent with US "leadership" further queers the pitch; the anti-Bush protests at the recent Summit of the Americas in Argentina simply adding one more nail to the coffin.

And, then, of course, there is the robust but hugely indebted US economy (complete with moral hazard issues of a few large""read Asian government""holders of US government debt), a US current account deficit at an all-time high of 5+%, sky-high oil prices, inflation showing signs of life after almost a decade, and a new chairman taking over the US Federal Reserve (on February 1, 2006) after 18 years of "heroic" stewardship by Alan Greenspan.

All the makings of an econo-political potboiler.

Here's one way it could unfold.

With the US economy turning out to be surprisingly strong (3Q growth came in at 3.8%) and wage pressures beginning to build up (the average hourly earnings rose by 0.5% in October, the highest rise since February 2003), the market is quite sanguine that US interest rates are going to continue to rise steadily""in fact, Fed fund futures for February are at 4.48%, signalling that the market believes that Mr Greenspan will hike rates at both of his last remaining meetings (Dec 13 and Jan 31). Now, clearly, Mr Greenspan is going to be a tough act to follow, and Mr Bernanke is going to have to work hard and swift to convince markets that he is in control.

One of the jobs of financial markets is to test policy makers. Mr George Soros took advantage of this in 1972, when the Bank of England's resolve (not to raise interest rates) became uncertain""it pushed the sterling lower and lower, till the Bank had to relent. Mr Greenspan himself was tested months after he took office in 1987, when Wall Street crumbled; he acquitted himself admirably (at the time) by pouring money into the system. Closer home, Mr Bimal Jalan was tested, weeks after he took office in 1997, when the Asian crisis threatened to blow the rupee out of the water; he acquitted himself well by slamming down the shutters on capital flows.

Putting all this together, it is possible that Mr Bernanke will be tested soon after his arrival at the Fed""say, on February 14, 2006.

Mr Greenspan will just have concluded his reign after presiding over the 14th Fed funds hike (to 4.5%), the US economy will continue to confound with 4th quarter growth coming in (say) at 3.5%, oil prices will continue to rule in the (say) $60-70 range (abetted, say, by a severe winter in the West), and the equity markets""in a response, say, to the now-fully-blown political crisis, threatening a Bush resignation""will collapse. The Dow, which will by then have spent 18 months in the 10,000 to 11,000 range, will slump, falling substantively below the critical 10,000 mark. (Let's not forget that on Black Monday in 1987 the market fell by 22.6% in a single day. Could this be repeated? Certainly, there are few technical supports left below 9,000.)

What will Bernanke do? Will he, a la Greenspan, announce that "liquidity support will be made available" and call out his helicopters? If he were to try to support the market with liquidity, would his attempt to create credibility be dashed? Would the bond market get spooked and, finally, push long-term rates up, up, up""above, say, 6 or even 7 per cent? Would this bring the US housing market crashing down?

Would this, finally, in a poetic echo of historic timing, begin the clean-up""to the extent, of course, that such things can ever get cleaned up""of US economic (and foreign) policy that is long overdue?

I don't know. Wait for Valentine's Day 2006 to find out.