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The current account deficit we have reflects how much investment opportunities there are in the US. America is an attractive place for foreigners to invest.

- John Taylor Undersecretary Treasury.

The Markets

Before we begin, we’d like to apologise for disappearing for a few weeks but hope that you will excuse us for that. I’m still trying to carve a personal life for myself and the results don’t look too promising.


TARGETS FOR THE WEEK 11TH OCT – 15TH OCT 2004

TARGET RATE PREVIOUS CLOSE PREVIOUS TARGET

EURO 1.2525 1.2410 1.2400

GBP 1.8200 1.7945 1.8600

YEN 108.50 109.50 109.25

GOLD 427 422.30 405



Ok before we go any further, did you see the second debate between President Bush and Mr. Kerry? Mr. Bush called Mr. Kerry ‘Senator Kennedy’. This guy has a habit of goofs but this was the best one.

In our last update we had mentioned that we expect the US Dollar index to ‘decline and maybe even break through the 80 level in the next 3 months’ and we are sticking to our views that we will see Gold trading at $480-500, Euro $1.30 and Sterling $1.90 by year end.

Gold was back in action this week and the reality on ground is that the US Dollar is in a final down move that should pickup speed later in the year. A combination of high oil prices and weak global growth today raises the possibility of some kind of slowdown beginning in December 2004-January 2005. How severe this slowdown will be is anyone’ guess but the way things are it doesn’t look too good.

168 B School professors including Mr. Robert Merton and Mr. William Sharpe sent an open letter to President Bush critizing him on the economic policies. So now people who always used to stay neutral taken a stand however this doesn’t mean that they support Mr. Kerry’ policies.

We have no comments on Mr. Taylor’s views which he expressed when we disappeared. The deficit problem is clearly out of control, what could be the implications of this record deficit. For one it could lead to changes in the sovereign debt ratings and the other being that either taxes go up or the world is flooded with US Dollars.

In a $10trln economy, the annual deficit is running at 34% and the government’ total indebtedness is running at $334% of GDP. The debt to gdp ratio is worse than that of a third world country.

The ‘baby bubble’ is driven mainly by the record low interest rates and innovations in the derivatives markets. The baby bubble has become a Frankenstein now.

The Insanity

Non Farm Payrolls rose by 96,000 in September far lower than the market expectations and the unemployment rate held at 5.4%. The August number was down graded to 128,000. There has been a significant decline in the number of jobs created in Q3. This weakness in the jobs market comes as a stumbling point for Mr. Bush and this time unlike Mr. Bush Snr he can’t blame the Fed for not acting fast enough.

109,000 jobs were created in the services sector, private sector employment rose by 59,000, Retail and transport lost jobs. Manufacturing lost 18,000 jobs the nation has now lost 2.1mln manufacturing jobs since January 2001. That’s 2.1 million votes in favour of Mr. Kerry. The recent Challenger, Gray and Christmas report showed that there were 107,000 lay off announcements in September the highest in 8months.

Crude oil continued its rally and is expected to be on a strong footing for sometime to come. There is a view that there is a $10 terror premium in the crude oil prices but it looks more of something else is at work. With record oil prices and a weak jobs market, the economy is clearly not out of the woods in fact it looks like it’s getting into the darker parts.

There is a view in the popular media that the current high oil prices are nothing but a one off event mainly due to hurricane Ivan. We totally disagree with this view. The current oil prices are a result of increased demand. This not a supply shock, it’s a demand shock. Oil production peaked in 2003 and going forward all we are going to see is higher oil prices. We might see short term pullbacks to $40-45 levels but in the long run oil has a one way ticket.

The difference between the oil shocks of the 1970s and today is that the 1970s oil shock was driven by production cuts. At the same time there was vast amount of productive capacity sitting idle during the 1970s. Today the oil market is demand driven and OPEC is running at capacity trying to match demand and supply.

The economic boom in China and India has increased the demand for oil and it doesn’t look like its going to slowdown a bit in the coming months and years. There are a 1.5bln Chinese and a billion Indians and in between them lets say a billion are just reaping the fruits of economic development. Now if these billion require half a barrel of oil a day that makes it an increase of 0.5bln barrels.

The economy has faced a recession after every oil crisis whether it was the 1970s oil embargo, 1980 after the Iran hostage crisis, the 1990 Gulf war 1 or in 2000. This time it’s going to be no different. The question we want to ask all those who are on TV telling us that in ‘inflation adjusted terms oil prices are not high’. Was oil high in inflation adjusted terms in 1990 or 2000? Whenever I drive into a gas station I don’t think in inflation adjusted terms, to me the headline number means fewer dollars or pounds in my pocket to spend.

The fooling game continues in the markets with OPEC saying that the group will pump an extra 1.3mbpd to help bring down oil prices. But back in June wasn’t this same organization saying that they only had 900,000 bpd spare capacity?

In the past few weeks things have really moved on, bond yields dropped to close to 4% proving us wrong. Not long ago we had expected bond yields to rise to 5%. Is the bond market telling us something about the state the economy is in or is it just being propped up by the inflows from Asian central banks. To us it looks like the world’ most efficient market is telling us that something isn’t right.

One thing that keeps coming back to us like the monsters in sleep is in case of a slowdown in some of the fast growing countries of Asia i.e. China. Will the PBOC resort to printing more money to revive the economy or will it prefer to liquidate its foreign holding and repatriate the funds back home. And under such a scenario what will be the impact on the US asset markets.

Today when I was travelling in the tube I glanced over into a paper the girl next to me was reading and what caught my attention was the advertisement in there ‘be a millionaire in 3-5 years buy a house today’. Alright that advert tells me something is not right it tells me that the housing market here in the UK has peaked.

If we see the housing market slowdown in the coming months, it will result in a decline in consumer spending. A decline in consumer spending means we don’t require the extra and in Wal Marts and hence unemployment will go up. This rise in unemployment will result in a greater decline in consumer spending and mortgage defaults. Mortgage defaults will put further increase on prices and lead to trouble in the mortgage and banking industry which will see a new cycle of lay offs.

Rising unemployment, housing bubble, derivatives, record levels of deficits, high interest rates, trade protection and the even continuing threats of terror attacks and an oil shock underway doesn’t instil confidence in anyone. Under normal circumstance when the economy is faced with these risks individually policy tools can take care of them. But when all of them are at work as they are today, there is little policy makers can do about it.

Assistant Treasury Secretary Mr. Quarles went on record saying that the ‘large and growing US current account deficit isn’t an asteroid heading for the planet’. That’s true it isn’t an asteroid, it’s a black hole that sucks in nearly $1.6bln everyday to keep it going. The Q2 flow of funds data showed that the total debt has risen to 298% of GDP it’s too large to ignore and too big to handle.

The choice today is not how to avoid pain when the economy rebalances itself. The question is what will be the least painful path to follow. Will households increase their savings and cut up the cards into pieces. Will governments finally blow the whistle and say that we have to control the fiscal mess or will the US dependent global economy pull the plug.

There is nothing that is going to work in this situation and we are nothing but sitting ducks waiting for circumstances to take control. The economic fears that we’ve had for a long time in our hearts are slowly coming to the fro. When I left home, I left it with the hope that when the next big economic crisis happens I’ll see it happen and learn how to tackle it. Today I’m scared.

There is a view mainly broadcast by the beautiful Maria CNBC that if we don’t talk about it, it’s not going to happen. Denial is the thing, I meet with businessmen, recruitment agents, estate agents, flower importers and home refurbishes and Maria has been very successful.

China continued with its lip service towards the RMB-US Dollar peg, the recent noise in the system that China will move towards a flexible exchange rate system is nothing but noise in its purest form. The risks for China is far greater than most realize a revaluation of the RMB will result in lower exports and the government has been avoiding that quiet successfully till date.

Iraq is a country in civil war and I won’t be surprised if the country disintegrates under the influence of old enemy Iran and the strong hands of Mr. Al Sadr. The war in the Sunni triangle and Sadr city isn’t just one off events.

With the recent acceptance by both Mr. Bush and Mr. Blair that Sadam wasn’t in bed with Bin Laden nor did he have WMD’s. The only conclusion that can be drawn from the Iraqi invasion is that it was a move to secure the world’s second largest oil reserves and this further adds to the suspicion that things aren’t as stable in Saudi Arabia as most media make it out to be. In fact there is a news blackout on the current state of affairs in the kingdom.

Imagine Saudi royal family being overthrown in a bloody coup or the control of oil fields falling into the hands of fundamentalist. Will they continue to supply us oil or will they shut the spigot.

John Kerry if he’ smart than should make sure that he loses the elections. The winner of the presidential elections is going to be faced how to design an exit strategy out of Iraq, weakening economy, terror attack threats and the continued US Dollar problems. The triple deficits are likely to worsen the situation in the months ahead. Faced with a weakening economy the new president might even follow protectionist policies. The sad part of the whole story is that in the in the last two debates Mr. Kerry came out as a winner and is likely to win the elections by a landslide.


The Economy





On Tuesday, Gov. Kohn speaks on monetary policy.

On Thursday, Ben ‘Printing Press’ Bernanke speaks on monetary policy. Export prices are expected to rise 0.5% versus the previous 0.4%. Import prices are expected to rise 0.7% versus the previous 0.4%. Trade Balance for August is expected at ($52bln) versus the previous ($50.1bln).


On Friday, Fed Chairman Alan Greenspan talks about Oil. Business Inventories for August are expected at 0.8% versus the previous 0.9%. PPI for September is expected at 0.1% versus the previous (0.1%). Core PPI is expected at 0.3% versus the previous 0.2%. NY Empire State Index for October is expected at 20 versus the previous 28.3. Retail Sales for September is expected at (0.1%) versus the previous (0.3). Retail Sales ex Autos is expected at 0.1% versus the previous 0.2%. Industrial Production for September is expected at 0.2% versus the previous 0.1% and Capacity Utilization is expected at 77% versus the previous 77.3%.