December 12, 2000
A Weekly Outlook and Analysis of the
Global Investment Climate

On the Utility of Fedspeak
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The more I think about the physical portion of Schrödinger's theory, the more repulsive I find it...What Schrödinger writes about the visualizability of his theory 'is probably not quite right,' in other words it's crap. --Heizenberg, writing to Pauli, 1926

One year later, Werner Heizenberg proved the "Heizenberg Principle," which guaranteed him the Nobel Prize in physics, in 1932, for his role in the creation of Quantum Mechanics.

In this issue of the Global Investment Climate:

US Equities Is it a sucker's bottom… or just another selling opportunity? Same thing
Commodities The boyz really hammered oil prices, but boy… was it the wrong move
Dollar Forex markets take a breather as Dollar teases to break down
Gold The implications of Gold Gate for your full faith and credit
Interest Rates Greenspan hints at "recession," but markets rally on interest rates
Economic Focus Your focus continues to be directed toward aggregate demand, by a wily group of bankers confused by the function of their own FedSpeak

The Object of FedSpeak is not Transparency
In 1999 Lawrence Lindsey (an ex-governor of the Federal Reserve Board) published a book called the Economic Puppetmasters, in which he explores the thinking of four individuals, Alan Greenspan, Dr. Yen (Sakakibara), Helmut Kohl (former Chancellor of Germany), and George Soros. In the book he describes Greenspan as the "contrarian" central banker, often having to enact 'out of favor' policies in order to neutralize potential economic imbalances.

As I read the account, it became enlightening to then observe the Fed Chairman speak and enact policy in the real world. I had begun to understand why so much ambiguity poured from the lips of Alan Greenspan and the various Fed governors over the years. More importantly, why it had to. Because the object of FedSpeak (a slang term used to label the general public opinions, speeches, and comments made by members of the Federal Reserve Board) is not transparency; indeed the prime directive of any public statement must be to minimize Heizenberg's principle.

In other words, and perhaps in its most appropriate role, it (FedSpeak) exists primarily to neutralize participants' expectation sets in order to prevent (or minimize) the uncertain influence of the observational bias - a slight twist on the original idea. Extrapolating this hypothesis, it becomes apparent that pretending that there really is no stock bubble, or an inflation problem or vice versa, is not really a bad thing… especially if your words can affect an unpredictable outcome.

There are many ways to maintain an organizational transparency, without having all of your directors give ambiguous daily speeches, which almost any analyst will tell you give us less insight into the organization by way of the constant contradiction. Thus, the process is born of scientific (read political) necessity. For, the truth may be that our monetary leaders are running an economic experiment in which they are trying to anchor our expectations. If you are unfamiliar with the concept of Heizenberg's principle, please review the two unrelated analogies below:

In politics, as much as in physics, Heizenberg's principle that the measurer cannot help but affect what he measures is true. These national polls, moreover, do not actually measure anything of much relevance (a candidate could easily have a substantial lead in a single national ballot and yet lose the electoral vote if his support is divided across small states,) and so the polls only affect the election and do not truly measure it. (Yuval Levin,

Moderator Larry Grossman, the columnist, author and former president of NBC News, noted that the problem of impartiality begins with the Heizenberg Principle, the theory that the act of observation itself alters the event. This increasingly is a problem for a press corps that the public sees as not its surrogate, but a player in the game (

More scientifically called the "principle of indeterminacy," it was named after Werner Heizenberg, who received the 1932 Nobel Prize in Physics after a spirited fight in 1926 against the leader of an opposing faction of academic thought. His opponent, Schrödinger, felt that the two theories yielded the exact same mathematical result, but that his own (Wave Mechanics - where light is made up of waves) was easier to calculate and understand. Hence, he all but concluded that the existence of Heizenberg's theory (Matrix Mechanics - where light is made up of particles) was redundant and not necessary. Heizenberg proved, however, that the simpler calculations over looked the "principle of indeterminacy," and soon after a walk in a park under a starlit sky, we are told, he had the epiphany that light was not only wave, but also atomic particle.

In the same year, he wrote a 14-page letter to Wolfgang Pauli, where he defined the mechanics of the uncertainty "premium," which occurs while trying to measure an experiment, and which results from either error in the theoretical interpretative framework for the observation, or simply, in the act of the observation itself.

The principle is especially relevant in the social sciences, for very much like the processes that go on within the atom, here to, Newton's laws of gravity need not apply. Nonetheless, if this is indeed the object of FedSpeak and is intended to replace the role of anchored policy, it is fallible because creating the inflation expectation set is perhaps the best weapon that the Fed actually has, at its disposal.

The reason we feel that way is that it is unfeasible to neutralize the expectation set of prospective receivers of dollars outside of the Fed's immediate communications, or like, domain. Thus, the enforcement of legal tender outside of US borders is and always has been determined not by US pressure, but by how the principles of monetary economics interact with foreign interests, and thus the international monetary arrangement (order). In order for a particular fiat currency to sustain a stable economic unit of purchasing power throughout the world, homogeneously and over a consequential period of time, the nation enforcing the fiat would ultimately have to take over the entire world or it would sooner or later have to holdfast to the discipline of the economic principles, which govern money supply and demand.

Anyhow, our point is not that this government and monetary authority believe that they can manipulate the economy simply by "sterilizing" our psychology, but that in order to stop the inflation, the Fed will have to do more than neutralize an increasingly global set of participants' expectations… it will have to focus its policy on the monetary principles of supply and demand, for dollars. Greenspan & company will have to actually act, which means that he will have to raise interest rates and perhaps enact 'out of favor' policies at a time when we really do not want him to, like when stock prices are reeling or when the economy is contracting faster and faster, and all the while, prices continue to rise.

If he were to do that while simultaneously telling people that there is no inflation (a possible prognosis), conceivably his credibility would be shot and then his mandate would be constrained by the general public confusion, or at least by an angry mob or two. Perhaps the best weapon in the Fed's arsenal is to come clean (why does that seem so taboo these days?), tell people that there is a problem, present a solution that they can have confidence in, and proceed to cross their fingers in the hope that the public will not invent their own solution.

We are not trying to invent new policies here, but rather we are trying to point out that the policies of the FOMC continue to err on the side of inflation. For as it becomes increasingly difficult to manage the uncertainty principle with respect to dollar policy (psychology) on foreign markets, where there is less communications influence, inflation expectations are indeed on the rise. Thus the deterioration of the purchasing power of the US dollar in international markets has already begun, and we have already shown this to be the case in recent commentary. And if this is true, then it is also true that the Fed is behind the curve on interest rates. Finally, if that is true, then one of the two prognoses (in the preceding paragraph) ought to follow.

Santa will rally off of lower levels
Notwithstanding, Mr. Greenspan apparently feels that inflation expectations have been getting a little out of hand on Wall Street as of late, which explains last week's "FedSpeak." Our peers have done a good enough job at criticizing the speech, so I do not need to. But it is perhaps of significance to report that while he hinted at recession, conceivably to neutralize the growing inflation expectation set, capital markets naturally interpreted his statements bullishly to mean that he will be lowering interest rates next week. I cannot help but wonder if this is an unintended outcome resulting from the application of the Heizenberg on a misinformed audience? Oh, the irony.

Anyhow, our guess is that if it (the stock market rally) continues, it should prompt another sterilizing non-action from the FOMC next week. Having said that, it is also our guess that it will not continue, which may in fact prompt the Fed into action. So our Fed model assumes that the Fed will react to psychological imbalances with psychological counterweights, and that it will react to economic imbalances with policy action. Of course, the model already falls short of perfection as the evidence suggests that the Fed only reacts with discretion and after much deliberation, and only to imbalances that it perceives as fear inducing. Nothing wrong with that, I suppose, if you're an eternal optimist.

However, in a bear market, all news is bad news!
Isn't it the truth? Ironically, in this case it means that even lower interest rates might come as bad news, especially if they come without being precipitated by a stock market debacle. There are two reasons. The first is that the move may imperially confirm the already weakening confidence in our economic prospects to our foreign interests, and the second is that they just might not work.

We have already shown our readers reasonable evidence that dollar owners and/or acquirers have progressively more preferred to exchange those dollars for oil, natural gas, palladium, platinum, and other commodities than they have preferred to exchange them for more equity. The evidence came in the form of two charts, which compared the rate of return on dollar denominated assets to the rate of return on the dollar price of important commodities over the past two years. Guess who won.

Chart the US Dollar Index and Crude

Ignore the relative slopes as the arithmetic chart scale conceals the out performance of crude prices. Thus it is not surprising to us that this loud yet oddly silent battle still dominates the general stock market current.

Major Global Stock Market Averages
Weekly % change
Nasdaq 100
Hong Kong's Hang Seng Index
S&P 500 Large Cap Index
Dow Transports
NYSE Composite
Dow Industrials
German DAX
FTSE London Stock Index
Tokyo Nikkei
Dow Utilities
French CAC

And it is therefore not surprising to us that the main theme in a bear market rally over this past week has been a nostalgic reversion to the goldilocks dream. This is evident in the strong relative performance of the technology and transportation issues over the utilities and oil sector stocks last week.

But what does it mean?
We think it doesn't mean a heck of a lot. In light of the fact that Mr. Greenspan's Tuesday speech ID's him as the conspicuous leader of the ticker tap parade, it is appropriate to wonder whether he was indeed sent out to encourage this theme, or at least rally the troops, by teeing up the Greenspan Put for next week. Yet despite that, the Nasdaq indices still only put in an inside week - technical jargon meaning that they closed the week off by registering a high below the previous week's high and a low above the previous week's low.

Consequently, technicians ought to point out that while encouraging, there was no real significance to last week's Miss Goldilocks pageant, other than fresh evidence that some horses were still willing to go to the trough on command. That being said, a decisive move through 3000 (on the Nasdaq), might summon enough momentum to challenge the 200 day moving average, which is quickly approaching the 3500 mark. Beyond that, however, conditions are not yet right for a meaningful general market bottom to have already occurred. There is still a lot of work to do. On the two-year weekly charts below, the last bar on the right in each case depicts last week's market action:

Chart the Nasdaq 100 Stock Index and the NYSE Composite Stock Index

The SP500 ended the week by consolidating near (but underneath) its 50 day moving average and well underneath the 200 day. I will admit that the bulls have done a decent job at bending some of the charts back in their favor. The Dow Industrials and the NYSE composite index were both rallied above their respective moving averages just in the nick of time, since the bearish crossover divergence in the NYSE composite occurred on only Wednesday of last week. In doing so, wounded bullish forces were able to contain prices in what appears to be a symmetrical consolidation of lower highs and higher lows, a neutral chart pattern, over the past 10 weeks. I do have to say that it is amazing to watch these narrow averages way up here, still near all time highs, while the rest of the market has been literally falling apart.

The main reason, I think, is that the "Point of Recognition," while perhaps having occurred, has been somewhat obscured, by the psychologically manipulative tactics of the Fed, and of course, some Wall Street types.

And so while this still might come as a surprise to the bull's militia, the primary market debate does not revolve around the next President, but instead, inflation. Specifically, whether or not we are at the breaking point of a run away inflation in commodity prices, as the result of a misguided US Dollar policy… whether or not all the charts of all commodities will soon look like this…

Consider some visual aids…

Commodity Research Bureau, Goldman Sachs Commodity Index, Natural Gas, and Palladium

All of the above are two-year weekly charts, depicting a trend that has been evolving for nearly two full years now. Not that one would know by reading anything that the Fed, administration, or the average curb monitor has to say about the market. Please observe two important points; first, that a growing proportion of commodity prices are rising not falling, despite a quickly slowing economy. Second, that a 20% retracement in oil prices (over the past 14 sessions) has had hardly a negligible effect on either the CRB or the energy weighted Goldman Sachs Commodity Total Return Index.

How is that for some truth serum? So while Greenspan is telling you that the Fed is working hard to slow "aggregate" economic demand, he is probably hoping that the reason for rising prices is in fact an overheated economy. For then, an economic slowdown should cool the inflation, right? Yet even as the US/European manufacturing sectors continue to crumble, as corporate credit markets get squished (sorry, trying a new word), global stock markets are pummeled, and the heavily indebted consumer struggles to find a way to shorten his or her Christmas list, prices continue to generally rise against the dollar. And arguably, even as the evidence of global recession mounts, prices continue to generally rise. Think about that next Tuesday when the FOMC meets to decide on whether or not to shower the market economy with more, cheap fiat currency. Think about whether the FOMC ought to consider the theory of aggregate economic supply and demand over the theory of money supply and demand, in setting interest rate policy.

Of course they shouldn't.

But OPEC, for one, would certainly love it if they did!
Iraq may soon be flowing oil onto international markets provided that the UN follows through on whatever concessions it apparently made in order to keep Saddam on side, including accepting Iraq's new price formulae, which we are told included partial payment in Euros. This took me a little by surprise, as I didn't think that the UN would cave to the extortion, but I miscalculated the apparently diverging interests within the United Nations. I also did not anticipate the logical call, in hindsight, on the IEA for its support in manipulating oil prices… two factors, which are directly behind the collapse in oil prices so far in December.

Undoubtedly, both the IEA (International Energy Agency) and the USA have already been selling oil into the market since the IEA announcement on December 1, apparently in order to avert an economic disaster. Though, we feel that the move is a bad one, and will probably precipitate an economic disaster. If the driving force behind a reversion to objective values (refer link to dollar utility article) for the dollar is the relative scarcity of certain commodities with respect to the relative abundance of currency, then will not creating a larger shortage in the reserve accounts of major oil dependent nations ultimately fuel the inflation? Perhaps not if US economic authorities are correct about the "temporary nature" of the oil price spike.

Actually, the importance for US authorities to be correct on this supposed temporary nature of the oil price spike cannot be understated. For if the economy continues to slow and oil prices continue to grow (the rhyme is unintentional), rather than decline as they should, on a slowing in "aggregate" demand, the market will have broken the Fed and its psychological game.

Furthermore, we think that they are wrong
These temporary shocks should dissipate quickly if our argument on dollar inflation is indeed correct. In fact, they may have already done so. The amount of influence that any price taker has, in setting oil prices (especially in a market that consumes 80 million barrels of oil each day), is minimal. As they say in Forex markets, intervention only works to smooth and aid a trend, rather than to determine one. So in this case, here you have the organization, which represents the world's oil importing collective, selling its strategic oil reserve into a market that is on fire with dollar inflation, believing that it is only a temporary shock? Yeah, Mr. Greenspan better be right, that the spike in oil prices is temporary.

Wall Street Gets Behind The Transportation Sectors
Could it be that speculators have determined that airlines have more pricing power than might appear? Have profits or customer traffic in the transportation business suffered over the past year as the industry pushes fuel surcharges in a bid to pass on the higher fuel costs?

On October 6th 2000, Paul Kangas interviewed Julius Maldutis, managing director at CIBC World Markets on the Nightly Business Report. Maldutis said,

"The airlines have started to hedge oil very significantly. And second, airlines put through three fair increases and a fuel surcharge. So, in effect, they've neutralized the corrosive impact of oil prices."

That answered my curiosity about the recent leg in the Dow transports. While there is certainly a relative undervaluation in the transportation issues compared with the overall market, the bulls (consistent species that they are) also perceive that there is a relative over pessimism with regard to the traditional relationship between the financial performance in the airlines and the rising cost of oil, even though it is their second largest cost category after labor. Maldutis also revealed that the airlines have been working really hard, using the Internet, to improve on the filling of typical excess seating capacity, which traditionally results in lost revenues. Furthermore, their Internet initiative has been putting the squeeze on the likes of PriceLine and other travel agents, by providing you with direct access to ticket purchases. This way, the overall price of travel does not rise to the consumer, yet the overall share of the profit pie in the travel industry grows in favor of the airline stocks. Do you see what the bulls see?

So, if the government can keep pressure on oil prices just until the end of the month, there is a good chance that the aforesaid broad hedging activity in this sector will show some off balance sheet windfall profits in the next reporting season (January?), provided that the gains are realized. So you see, the market debate is about inflation, and if the boyz are wrong about what they are telling us, then this hedging activity will ultimately result in "extraordinary" losses for some of the new puppies in the game. Do you see then, that represented by the stock market leadership last week, the tape is positioning itself around expectations for lower oil prices?

Another Great Selling Opportunity
Without a doubt, if you ask us. We're not buying Greenspan's line. Besides, one of our most consistently reliable indicators is flashing a short term pink again:

Chart 2 year put/call against 2 year S&P 500

Forex markets have been quiet over the last few sessions, after the Dollar index broke through minor trend line support and what some might call the neckline on a small double top. This might in fact be the quiet before the storm. Note the concurrent up tick through a similar trend line in gold prices below. If this were to continue, we see not less than a few catalysts ahead for gold prices. But what is the catalyst for the dollar? The point of recognition in the inflation argument and a resumption of the bear market in equities ought to do the trick.

US Dollar (fiat) Index, Gold Prices, Euro Currency

GATA supporters put their money where their mouths are
When Bill Murphy (Chairman of GATA) told me that Reg Howe had just filed a complaint against the BIS, Greenspan, Summers, JP Morgan, Chase, Goldman Sachs, etc., my first thought was holy tulips, someone is gonna have a bird! Anyhow, the BIS (Bank for International Settlements, created in 1930) shareholder issue is a strong hand for GATA because the central banks have been underhandedly maneuvering to privatize the Bank… another initiative for more market transparency (sarcasm intentional).

The move is clearly controversial because no one thinks that these guys have any proof. But the timing is extraordinary, as one smoking gun after another is discovered in one market after another. With a little help from the market forces already in motion, this could turn out to be an explosive story. As I write this, the BIS already responded on its own, suggesting that the claims have no merit. Is that all they got?

Edmond J. Bugos

The GoldenBar Global Investment Climate is not a registered advisory service and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. Of course, we recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you toconfirm the facts on your own before making important investment commitments.