JANUARY 10, 2005

Today we almost got a modest oversold bounce in the equitiy markets.Unfortunately, we gave up all the gains at the end of the day, once again. This pattern of late day weakness is most auspicious. The FX and bond markets were quiet today also. The dollar fell 28 pts against the Euro after a five day rally. That helped Gold and gold stocks bounce modestly after their recent selloff. Seems like everyone"s waiting for some earnings announcements to get things moving. The day traders must be having a tough time. A lot of one day wonders with no followthrough.

Since there is nothing real exciting today, let's talk about the big picture. Anyone reading the finacial press has come across the debate over our budget and current a/c deficits and what they mean for our economic future. First of all, the reason we're talking about them is they are the biggest they've ever been. Of course opinion varies widely about them. Some look at them as portending an economic armageddon and others like Dick Cheney say deficits don"t matter and Art Laffer says the current account deficits just shows we are a magnet for capital. As an aside , in another life, a group I used to be part of , used to have him come in on a regular basis to share his views. If nothing else, he is the most unconventional thinker I have ever come across.

Either this can go on or it can't. The budget deficit can surely get a little larger, if it couldn"t we would have trouble attracting bids at our autions and rates would be going up at a much faster rate. Our trade deficit can surely get bigger and probably will because of oil,after all we are 'THE' reserve currency. Some people proclaim what's wrong with them sending us all this good stuff and us sending them T-Bonds, its a virtous circle. For those chicken littles who are afraid that one day the buyers won't show up because the dollar is falling and they are taking a beating on their holdings, I say, they were taking a beating in the 70's when Japanese Yen were 360 to the dollar when the German mark was worth 25 cents. The dollar has been declining for decades. The central banks of G-10 don't manage their reserves for profit. Can you imagine the havoc they could reek if they did.The same cannot be said for smaller central banks. The U.S. has been the largest holder of gold in the world, when it was $35 and ounce $850 and back to $250. The Bank of China will manage its reserves to achieve the greatest amount of economic growth and jobs and security for its country. They will revalue by 2007 per their agreement, but they will be accumulating dollars for many years to come, as long as they continue to sell us stuff. Hopefully, not as much and hopefully they buy a lot more from us. A weak dollar is part of the solution to this problem.

As far as the budget deficit goes, even President Bush says he doesn't want to increase it further, and has a plan to cut it in half in four years. Good enough, lets say for the sake of argument, that problem has been licked. Although another terrorist attack or armed conflict somewhere else in the world would throw that up for grabs. That leaves the current account. If they will take more dollars and we will take more stuff, where will this end? I see two possibilities, either the world runs out of money to lend us or we run out money to buy. What I mean by the former is we are consuming 80% of the world's savings currently and there is an upward boundary there somewhere, or they may need more of their savings domestically, or they may stop saving so much and consume more. Regarding the latter, our ability to buy, well our savings rate is down to almost zero, our debt is at record highs, our ability to get more is impaired in a rising rate environment because the refi window is closed, our income growth is menial, as is our job growth. When our consumption hits a wall, as it must, the current a/c will shrink as it has in the past.

Next time lets look at the ramifications of the above on the markets.