NOT THIS WAY BUT THAT WAY

Ben Bernanke, the leader of the US Central Bank, suddenly finds himself running in the opposite direction of his team mate, Jean-Claude Trichet, leader of the European Central Bank. Perhaps the blame is Bernanke's for getting to the 5.25% level too quickly or perhaps it is Trichet's for taking forever to get to the 4% level, but the large spread is pounding on the currency markets. Three months ago, the ECB had made it clear that short rates would be increased last month above 4%. When the sub prime mess hit, the ECB held rates at 4% only to spew out hawkish statements since that time. In other words, the ECB is ready to raise its interest rates.

This is a good thing as the dollar has fallen to all time lows against the EURO. TV pundits often talk upside down about the strength of the dollar. A discussion about the relative strength of a currency can be and often is just as complicated as you want to make it. The pundits tend to focus on the attraction created by high relative interest rates. This focus fails to accept that currencies are much like stocks in that the price is based on potential real growth. A country that keeps its tax burden low and that constantly works to improve its productivity will enjoy a rising currency. With 4% rates, Euroland businesses currently have a cost advantage over US businesses. US businesses must currently fight off base rates of 5.25% which is a significant burden over and above the 4% rate. As a result, the US economy is weaker than much of Euroland.

What if Trichet were to follow though on his talk and raise rates to 4.25% and what if the FOMC gradually lowered to 4%? Can you see what a relative boost that would be for US businesses and consumers?

China just reported the highest inflation rates in 10 years. The Yuan is closely pegged to the US dollar. When the dollar falls, the Yuan falls relative to other currencies. As a result, the cost of imported goods goes up. Now that the turn is upon us, the dollar will appreciate, the Yuan will appreciate, inflation rates will fall in the US and in China and the second half boom will be under way.


WHEN, WHEN, WHEN?

The $64,000 question is when? Unfortunately, the exact timing is never clear. Will it take two cuts by the FOMC or two increases by the ECB to turn the tide?

STAGE 1 AND STAGE 2

In stage one of a perfect cycle, bonds soar in value while stocks and commodities suffer. The real price of industrial commodities peaked several months ago, so even though oil and gold are hitting new highs, I believe we are well into stage one. In stage two, stocks climb on board with bonds. After all, the way stocks are priced is to capitalize earnings at the discount rate that is available in the bond market. The lower the current yield of bonds, the more attractive stocks become.

Since August 16, stocks have been in a hurky jurky uptrend. Bonds have soared in value. A cut in the Fed Funds Rate and an increase in the ECB rate should both serve to support the dollar (I know, John Brown and many other TV pundits disagree, but the evidence is clear). Strength in the dollar will cause low inflation rates to fall out of bed. By the time all of this happens, the selected stocks will be off and running.

DO THE MID CYCLE TURN STRETCH AND DEPOSIT ALL THE EXTRA CASH YOU CAN SPARE. BIG MONEY WILL BE MADE OVER THE NEXT THREE YEARS!