Monday, September 17, 2007


Greenspan talks from both sides of his mouth but he is probably right about long term interest rates. LONG BONDS SHOULD BE SOLD!

Some of you own long term bonds hidden inside of various mutual funds. Some of these funds automatically buy more bonds the older you get. SELL, SELL, SELL.

Look at in terms of the US Dollar versus the Euro. Back in 2000, a great time to sell stocks and to buy bonds, the US Dollar would buy the same as $1.17 Euros. Today, a dollar will buy the same as $.72 Euros. It is not time to take a vacation in Europe! The relative costs has gone up better than 60%! Of course, with the value added and carbon taxes added, it costs about 23% more to travel to Europe than it first appears. If you want to conserve wealth and energy, stay home.

I do not believe the pattern we are about to follow is like prior times when inflation was out of control and long rates went up and up and up. On the other hand, it is not wise to own long bonds while thousands of billion dollar industrial projects are underway around the world. The demand for money is real. Some of these projects are close to the time when they will reverse their current effects. For example, the cracking unit was just installed on the first of the new super refineries in Vietnam. For the next 18 months, a lot of resources will be devoted to finishing the construction. Then, when it cranks up early in 2009, it will supply two thirds of all the fuel used in the whole country. When the second unit is finished, a couple of more years out, Vietnam will be a finished oil product exporter.

Investors must always keep in mind that inflation is a result of too much money relative to the amount of goods available. In the 1970's, it was assumed that the "oil shock" had to cause inflation. As we have just experienced over the past 5 years, oil can go up and up and up without causing the overall inflation rate to go crazy. For years, the demand for oil has increased dramatically in Asia but the prices of the products flowing from Asia has gone down. Have you noticed the price of a GPS mapping device lately? Pretty soon, owning an electronic map will be affordable by almost every one in the entire world. Now don't tell me how awful the inflation rate is. The iPhone has dropped 25% in price only a few months after its introduction.

So, long bond rates are not going to go out the roof, as implied by Greenspan. However, there will be pressure on interest rates while the infrastructure is built to "catch up to the demand". My friend and former colleague at Merrill Lynch made a forecast in the early 1980's. He said that the business cycle was going to be tamed. I believe Ben Bernanke will not take the Fed Funds rates up and down the ladder as was done by Greenspan. Shortly after Greenspan was made Chairman of the FOMC, he took short rates up sharply and the crash of 1987 hit. The Dow Jones Average went down and down some more, then on October 19, it went down 23% in one day. The little 10% dip we had last month was not enough to cry over.

The problem in the short run is that the market may be initially disappointed with tomorrow's rate cut. It took a number of years after the 1995 rate cuts for the dollar to recover against the Euro. The ECB is still holding rates at 4% so Ben will not likely match that rate any time soon. We also have Congress to worry about. The leaders of congress want so badly to install a carbon tax system that will raise the level of lobbying to new all time levels. Already, billions have been spent trying to influence the outcome. Of course, those companies that have room to reduce carbon emissions would love to be subsidized for providing the service. Just like corn farmers, who would turn down the payments from the "government of the people."

As usual, good intentions have hurt us all with unintended consequences. Had the environmentalists not fought the management of the forest and had the government not paid land owners to not grow crops, many more acres of forest would exist and the world would be a cooler place. The democrats in congress have a "mandate" from the misinformed to raise taxes in order to "improve" health care and the environment and to end the war in Iraq. Bush has the upper hand except in regard to the expiration of the tax cuts passed in 2001 and 2003. Economically, raising taxes and spending inefficiently will keep the US from achieving its potential. Our country is so strong that we can take a tax hit and keep on ticking. As we are moving into the prosperity phase of the business cycle, we can afford a lot. Still, we should not waste what we have.

The ECB is under great pressure to "normalize" their interest rates, which is another way of saying that they need to bring them in line with US rates. The export growth from the US is adding to our total GDP but Euroland will suffer a huge trade deficit if they do not adjust. As is evidenced by the bank collapse this past weekend, Euroland is also suffering from the sub prime mess.

Until the adjustments are made, the dollar will fall, oil in US dollar terms will go up and gold in dollar terms will go up. Even so, inflation rates are falling so it is possible for the ECB to hold rates and for the US rates to fall more than I expect they will. Like I have said, I believe the swings are going to be less violent than in the past. Therefore, I expect Ben to make a cut but for the ECB to increase rates. Growth will slow for a quarter or two, as the consumer who has listened to the news has been frightened. Those who pay little attention to the news are as happy as can be. Their paychecks are rising, they are buying stuff they could never afford before and enjoying the good life. Their retirement accounts have risen in value year after year for 5 years in a row and the value of their homes has doubled in a relatively short period of time.