A Weekly Outlook and Analysis of the Global Investment Climate September 18, 2000

The Point of Recognition
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US Dollar Index

Goldman Sachs Commodity Index1

This "remarkable" coexistence reveals how the dollar has been losing purchasing power even as intensifying capital inflows into the US financial system inflate its foreign exchange "rate." The process is ultimately inflationary for an economy whose money creation role is increasingly determined by a reckless financial oligopoly.

And it is coming to a head, perhaps as early as this week, seeing that the big question has been answered; which will happen first, a reversal in the dollar or a collapse in the Euro? Although the Dollar Index chart above is a trade-weighted index², its strength is mostly attributable to multi year lows in the pound and the Euro. Personally, I did not think that we would need to bring down Europe before we realized what in the heck was really going on. Perhaps I overestimate the interests. More frightening, however, is the possibility that I have underestimated their barbaric arrogance instead.

Dollar bulls ecstatically proclaim that foreigners will continue to finance the US trade deficit so long as Americans can continue to produce the kind of economic performance that they have been claiming credit for, and so long as the Clinton administration's claims - to have eliminated the budget deficit - prove creditworthy. As this political and financial deception continues to delude investors with charts like the one above on the left, the European Central Bank has begun to maneuver its defense systems into place. Three days ago they announced the intent to begin converting their dollar income profits back into Euros. A small move, but undoubtedly it was the intelligent thing to do for anyone with too many dollars.

More importantly, the consequent market reaction must have also answered any lingering doubts that Mr. Duisenberg may have had about where the investing public stands, with regard to confidence about the "external value" of the Euro.

What everybody knows is that this is the big test of the internal strengths (or weaknesses) of the Euro monetary fabric via economic arrangements made between individual members of the EMU. What no one knows is whether the structure will hold up? It is, after all only the first test, and even here there is conspicuous dissention. Noteworthy is that German politicians have loudly demonstrated their desire for a weaker Euro, while the ECB has quietly established its contrary desire to preserve soundness in the currency. What does this all mean for your money?

Artificial growth versus real growth
Say what? Customarily, the prospect for an economic slowdown concomitant with an energy crisis should produce a weaker currency, but that was in the day when Milton Friedman envisioned the free-floating exchange rate system as a self-correcting mechanism. Then again, I guess there also used to be a day when people would not believe everything they heard from the government when it came to forecasting anything, let alone lower oil prices. How can an inflating dollar exchange rate be self-correcting when it endows the already profligate consumer with ever more global purchasing power to accentuate unstable economic imbalances with, and which the free-floating exchange rate mechanism ought to correct?

Some may say that the rising exchange value of the dollar is all it takes to correct an overheated economy, but they would be those who have yet to hear about the stimulative effects to demand, of the virtuous (read virtual) circle. It has been my observation, on the other hand, that the price mechanisms of various markets have been misfiring due to inappropriate, if not unprecedented, dollar inflation. In the end, any capital inflows into the US have to be inflationary because their mere existence will encourage the creation of more money supply, without due respect for moral hazard or Fed Policy. It may not work in Japan, but it does here, and in these times. From what we can tell, European capital flows have largely been flowing into higher risk Asset Backed Commercial Paper this summer, or more precisely, finance company and general consumer debt.

I will try to explain why. The deteriorating technical condition of US stock markets, a curiously rising negative sentiment toward third quarter public earnings announcements, an escalating energy crisis, domestic political uncertainty, and even some longer term dollar uncertainty have forced the majority of these fresh funds into the short end of US money markets, in the process, normalizing the yield curve. This week will be particularly interesting as traders await US inflation data, monthly US trade data, and news from the G7 on a number of rising trade tensions as well as any potential disagreement on oil prices and exchange rate policies.

Intel Corporation

NYSE Composite Index

One wedge down, three to go. Could Intel's bearish chart resolution foretell the composite's fate?

So even though tight money policy reigns at the Fed and undoubtedly the US banking sector, through some degree of moral suasion, short duration credit issuance by finance companies continues to overwhelm eager foreign capital. In other words, the US money market isn't what it used to be. Capitalists aren't to blame. They are only reacting to the market's signals, which are telling them that their customers want to spend more dollars, which already over inflated global purchasing power is evidently on the rise again - at least for anything that doesn't contain anything real. Is this the virtuous circle? Perhaps to some, but to others it is a step in the wrong direction, a fact that may become more apparent shortly.

If an escalating oil crisis is not enough to expose the new reality (as opposed to the new economy), perhaps collapsing stock prices and a fast approaching recession might do the trick. Already, some of the old economy companies, like McDonalds that still calculate their profit in cash rather than stock, have noticed that the inflating dollar is beginning to deflate the dollar denominated value of their global assets. And as far as we know, most shares on Wall Street are still priced in dollars.

Stock Bulls Got Their Wake Up Call Last Week
Raymond James' market call last week perhaps deserves credit for deciding the point of recognition, at least for all of us who were still not quite aware of the bear market. This point theoretically arrives during the second phase of a primary bear market, and although it may come as a surprise to many, it doesn't normally include a bifurcated market. Nevertheless, stocks began to slide almost immediately after Mr. Ralph Bloc's announcement on CNBC, on rising volumes. If so, what are employers, which have become dependent on the issuance of stock options to finance labor costs, going to do from now on? How many companies are going to be able to grant higher cash remuneration if at the same time their own sources of financing are drying up, and they suddenly discover that they are not actually running a self-sufficient business entity? For many, many companies, presumably in that category, the news going into this week is not good.

More Misinformation
Persistently bullish analysts, who claim that rising oil prices will not batter the US economy, should have their license to steal taken away from them! What they mean is that oil prices can now rise to higher ground before affecting the US economy in the way that they used to. Yet even this is a dangerously unqualified conjecture. They are missing the point. Not only have we no idea at what level oil prices will finally exhaust the overextended US consumer, but we have no idea what the dollar denominated price of that oil will be in the near future.

If Wall Street refuses to believe that the dollar-biased exchange rate mechanism is misfiring on us because we have a reckless (maybe even imperialistic) monetary system, at least they ought to remember that we are on a floating exchange rate regime, not a fixed one. And as long as policy makers do not adjust to this new reality and headlines encourage consumers not to worry, nobody will take the tough medicine required, preventing an energy crisis from actually falling on our lap (tops). Indeed, the artificially strong exchange rate (external value) of the US dollar continues to obscure the reality that economic demand is way out of sync with energy supply, a fact that itself has become more evident in the Dollar price of oil. If this financial spin weaving is allowed to continue, it will engender an economic crisis like nothing we have ever seen before, in my very humble opinion.

Sincerely,

Edmond J. Bugos

1. Total Return Index; weighted by relative annual consumption of a basket of commodities.
2. Against a basket of currencies that represent major trading partners of the US.

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