January 7, 2003                                                          Volume XXVI, No. 1

THE BIG PICTURE:

Reflation Brings Opportunities

THE U.S. ECONOMY: REFLATION!

This may be the important change in the investment and economic environment since March 2000.  Read this issue carefully.

On November 6,2002 the Federal Reserve Open Market Committee (FOMC) confirmed its decision to fight the strong deflationary forces with all means at its disposal, by producing the largest interest rate cut, on a percentage basis, in memory.  It may be the largest ever.  It was 50 basis points, reducing the Fed Funds Rate from 1.75% to 1.25%.  That was a clear signal. 

Yes, they do ring a bell on Wall Street.  And this one will go down in history as the one that changed the investment markets for many years to come.

The key word for the next several years will be "REFLATION."  Whereas the Federal Reserve had fought inflation for the past 22 years, even over the past 2 years when they should've been putting their inflation fighting in the freezer, they are now in a war against dangerous deflation.  They do not want to repeat the experience of Japan.

One of the most important signals from the Federal Reserve in decades was a speech by Fed Governor Ben Bernanke on November 21^st before the National Economics Club.  He addressed the topic of deflation and what the Fed could do about it.  While dismissing the probability of  having a deflationary episode such as Japan, he did list how a number of ways the Federal Reserve would combat such a dangerous trend.  In a statement that should be of utmost importance to investors, he said: "The U.S. government has a technology, called a printing press . . . that allows it to produce as many U.S. dollars as it wishes."

At the same time, Europe has just woken up to the fact that they may have a huge deflationary problem as well.  The European Central Bank has been extremely stubborn, even raising interest rates last year although their economies were stagnating.  I have criticized the European political and central bank leaders for many years.  They're too old and too stubborn.  They don't know they word "flexibility."  They take pride in not doing what the U.S. is doing, even when the U.S. might be doing the right thing.

The prestigious Bank Credit Analyst, an economic publication I highly respect, described it: "the Euro zone economies are trapped in a nightmare environment of structural rigidities and extraordinary complacency on the part of policy makers. The European Central Bank (ECB) seems to take pride in its hardnosed approach to policy especially in contrast to what it regards as an irresponsible U.S. monetary stance."

With Germany's economy, the largest in Europe, on the verge of recession, the government is imposing huge tax increases ahead.  The deflationary forces in Europe will accelerate.  As a result, the Central Bank will be cutting interest rates in a hurried fashion as they suddenly wake up to reality from their long slumber.  European government bonds should do very well.

In Japan, another major industrial center of the world, they're finally taking steps which will enable the government to nationalize large, failing banks and other corporations, and thus clean up the roadblocks to recovery.  I believe that Japan will vigorously start reducing the value of the yen by reflating its economy.  Reflation will be the keyword everywhere in 2003.

Reflation will be the important, long-term trend worldwide over the next several years.  This is an extremely important trend change, which investors must recognize.

The long strike in Venezuela has changed that country to an oil importer from being the fifth largest oil exporter in the world. Oil supplies in the U.S. are at the lowest level in 25 years.  At the same time, a war against Iraq, another major oil producer, appears ahead.  Those oil supplies would dry up as well, at least for a while.  The result: much higher oil and gasoline prices if there is a war.  In my view, that is still a big "if."

Central Banks would have to accommodate this drain on consumer purchasing power by producing even more printing press money.

Additionally, a war against Iraq would by itself dampen economic growth, which will have to be counteracted by Central Bank monetary policy.

  For 22 years, a lid has been kept on inflation by stringent Central Bank monetary policies, even in the late 1990s when some economists say the Federal Reserve was too loose in its monetary stance.  The facts show that the Fed was not overly stimulative in its policy. (Look at the "Monetary Base.")

But suddenly, after 22 years, the lid is lifted.  Now the burner underneath the kettle is turned to "high" in order to generate steam.  As deflationary forces are very powerful now, it will take a while to heat up the kettle.  But the fuel for the steam is already being supplied.

 Recent economic statistics are actually quite positive.  On a year to date basis, industrial production rose 2.5% over the past 12 months.  The prior year, it had actually declined at a 6% annual rate.  Additionally, the index of Leading Economic Indicators rose 0.7% in November, which was the largest increase since December 2001.  I think that's significant, as December 2001 was part of the vigorous economic rebound after the terrorist attack.  The gains in economic statistics were very strong.

 In December, we also had a big, unexpected jump in the ISM Manufacturing Index, which measures the strength in manufacturing.  The "new orders" component of the index surged over 20%.  That was probably a fluke, but it does reflect strength, even if it wasn't as big as advertised.

 Unemployment numbers may stay high for a number of months, but that's normal in the earlier stages of an economic recovery.

 Of course, investors should not make the mistake in thinking that just because the economy is recovering, that the stock market will do as well.  In fact, in 2002 the stock market had one of the strongest declines, while the economy did relatively well.  Instead of blindly following economists, chart analysis should once again give us the right signal as it did in 2002. 

 I'm not thrilled by the new Bush appointees for Treasury Secretary and Chief Economic Advisor.  They do not have a passion for tax cuts, and in fact are more on the side of those who feel that tax cuts are not important.

 Well, economic history of the last 100 years tells us that tax cuts are the only thing that can get a country out of a deflationary spiral.  Fed Chairman Greenspan is aware of this.  Hopefully, he can convince Snow and Friedman, the new appointees, that deflation could be a humongous problem if not handled in the early phases.

 In regard to Bush's new appointments, a recent Barron's article concluded: "As a low level member of the Nixon and Ford administration's Transportation and Highway Traffic Safety

divisions, Snow (Treasury Secretary) learned his way around Washington, while Friedman (Chief Economic Advisor) has enormous credibility on Wall Street.”

 Well, I would consider both of these so-called qualifications negative.  I don't think we need "low-level" Washington administrators to determine economic policy, which not only affects 270 million Americans, but the entire world.  And in view of the scandals on Wall Street, I don't think that "credibility on Wall Street" is a positive.

 THE TAX CUT DEBATE

 The opponents of tax cuts say that the last Bush tax cut did not fuel economic growth.  What they don't mention is that a vast portion of these tax cuts have not even taken effect yet.  At the time, I criticized the Bush package for deferring the effective date of such tax cuts.  History has shown that tax cuts, once voted in, should be implemented immediately.  Otherwise, there's even a negative, anti-growth effect as businesses and individuals defer profits into the years when taxes on those profits will be lower.  But what do all the lawyers on Capital Hill, our representatives, know about that?

 Too many of the politicians say that we must have a tax cut which would go to low-income individuals, as these are the people that would immediately spend that money.  Economic illiteracy is a terrible thing.  President Bush gave everybody a tax rebate, as that was money to be spent immediately.  But as we saw, there was only a brief effect, almost immeasurable, lasting maybe a month or two.  Once the money was spent, the economy went back to its trend-line growth. 

Meaningful tax cuts are those which take effect immediately, are permanent, and encourage entrepreneurs and businesses to take more risk, expand, hire more people, which creates low term growth.  The little booster shots that so many uneducated lawyers in Washington favor are nothing more than a shot of heroin.  Once it wears off, the patient feels worse than before.

 Too many economic writers only know the Keynesian economics taught at virtually all universities today.  The deficiencies of this theory are known, but it is still taught, because the professors don't know anything else.  Most economic professors aren't even aware of the “free-market school of economics”, also known as the Austrian School, which basically holds that most governmental efforts to manipulate the supply/demand equation in the economy do nothing more than produce even worse distortions.

 One current, popular proposal, is a so-called "payroll tax holiday" for all or part of 2003.  In other words, people would have more money left in their paycheck for a short period of time.  And presumably, that money would be spent, boosting the economy.

 Of course, I'm in favor of any tax cut because it is better than no tax cut at all.  But it is so simple-minded, I can't believe that intelligent people can really consider that this is a cure for the economic malaise.  What do they think happens when the temporary tax cut ends, and people find big short falls in their paychecks, money that they had learned to depend on for the past 6-12 months?  Consumer spending will stop in its tracks.

 It's obvious that investors and business people this year will wait until the Bush tax cut is passed.  That won't be until the second half of this year.  Therefore, economic activity could actually be depressed as everyone waits to see what they do in Washington. 

 The Democrats talk about budget deficits being too high to allow significant tax cuts.  If they don't like budget deficits, which in my opinion are not really important at this time, then they should stop spending.  From 1998 to the year 2002, Congress has increased its spending by 8.5% per year, much more than the rate of inflation.  In effect, they were spending the huge, expected inflow of tax revenues produced by big capital gains of investors.   

Now, there are no capital gains, only capital losses by investors.  Therefore, the tax revenue bubble has burst along with the stock market bubble.  But Congress' spending habits have not changed.

 GOLD CONFIRMS A MAJOR TREND CHANGE

 The "message of the markets" is what we must listen to.  The major trend change, from upward to downward, in the U.S. dollar is telling us that reflation will be the theme for the longer term.  The gold price, which has been in the bear market for 21 years, has changed to what could be a new bull market.  Major downtrend lines have been penetrated to the upside.  This could be one of the most important investment areas for investors for several years.

 There are other factors supporting gold……..

             (excerpted out of fairness to subscribers)

 CONCLUSION:

 As long-term readers know, since March of 2000, when I warned that the Federal Reserve policy would lead to a stock market crash, I had warned that the Fed's inability to recognize that their monetary policy was too tight would lead to dangerous, long-term deflationary trends.  That has happened.

 Even when the Federal Reserve started reducing interest rates in 2001 and 2002, I continuously warned that their actions were too little and too late.  They were always behind the curve.

 The September 11^th terrorist attack finally caused the Fed to wake up and try to get ahead of the curve.  If you look at the charts of economic statistics, that terrorist attack actually marked the bottom.  This allowed the economy to start on a recovery process. But once again, they were very slow.

 However, the recent statements of Federal Reserve officials about potential deflation, and the significant interest rate cut on November 6, 2002, make me much more positive for the future. 

It will provide excellent investment opportunities for alert investors, or those who have good advice.  These opportunities should last several years.  They will offer much higher returns than those offered on money market funds.

 I believe that subscribers to our services will be positioned correctly to benefit from these trends.  Those who follow the old, biased Wall Street advice will probably continue to suffer.

 The way to make big profits in the investment markets is always to go where the majority is not.  The majority of investors still seem to be looking for new bull markets in overpriced technology sector.  They all want to buy the old glamour stocks of three and four years ago.  But that's not where the big, long-term opportunities will be.

 Contrarian opinion is the one way to achieve superior profits, but you have to know how to use it.  The majority of investors are usually correct during a major trend, but they are wrong at the turning points.  They will always deny that a certain trend has ended, or expect the end much too early.

 On the other hand, the contrarian will recognize that a trend is ending, or has come to an end, and will act accordingly.  That's when the real contrarian makes his fortune.  Timing is everything. 

 WHAT TO DO

    (excerpted out of consideration for paying subscribers)

 POTPOURRI

 WALL STREET SETTLES WITH THE REGULATORS

 Depending on what figures are used, the brokerage industry will pay about $1.4 billion to settle charges by local and federal regulators regarding deceptive and illegal practices.  However, $500 million would go to buy independent research.  It’s not a penalty. 

 For the big brokerage firms, this is a bargain.  The City Group alone made over $3 billion in underwriting fees on Telecom stocks.  To some people this settlement is equivalent to a bank robber who steals $1 million from a bank, and then is forced to return $50,000 of that when he is caught.  

The star Telecom analyst, Jack Grubman from Salomon Smith Barney, settled for a penalty of $15 million and a lifetime ban from the brokerage industry.  Over just the last few years, his compensation was over $100 million.

 You see, crime pays.

 Maybe the real penalty will be administered by the market place, when many investors flatly refuse to believe any of the Wall Street recommendations, and even start abandoning these firms for their trades.  Maybe investors will become smart enough to realize that it's more productive to go to a discount broker, who does not provide advice, and then separately pay for independent research, such as ours, with the savings in brokerage commissions.  Of course, there will always be investors who like the "hand holding" of an account executive, or being invited to lunch once a year.  That’s an expensive lunch. 

 It's really unfortunate because Wall Street does have some very good analysts.  It's even worse that most of the bears got fired from their jobs over the past several years, as Wall Street prefers bullish analysts.  And when finally one of the bearish Wall Street analysts is invited on national TV, he's extremely careful not to be too bearish.  After all, his job depends on it.

 SHOULD YOU GET A SMALLPOX VACCINATION?

 Recently, I wrote about the smallpox vaccine, which the government will force upon all military personnel, including health care workers who might have exposure to smallpox in an emergency.

 I've pointed out that the U.S. vaccine is very "dirty," which causes many adverse side effects, including encephalitis and death.  Oddly, we don't hear much about how dangerous this vaccine is, and usually an article just talks about "side effects."  Well, when the side effect is death, it's time to pay attention.

 I had my own episode with this vaccine as a teenager.  I was in a virtual coma for three days.

 Therefore, its almost unbelievable that a safe vaccine exists, but is not used.  Since 1980, a safe Japanese smallpox vaccine has been available.  It is very pure.  It does not have any side effects, even in tests covering 50,000 people.  It is not allowed in the United States, probably to protect the business of the domestic manufacturer of the impure vaccine.

 Now a U.S. company, Vaxgen, has made an agreement with the Japanese manufacturer in order to produce this vaccine in the U.S.  Hopefully it will get approval within a year.  In the meantime, anyone who's vaccinated for smallpox stands a high risk of so-called "side effects," including death.  The recent "Homeland Security Act" protects the manufacturers from lawsuits.  Isn't that wonderful.

 A reader just sent me an article of the subject from another publication.  Here are parts of that article:

           John Rappoport, in an article dated December 19^th titled "Smallpox Vaccine Results Are In" had this to say: "Before our eyes, the mass smallpox-plan is going into the toilet.  NBC is reporting: health officials strongly discourage this [getting the vaccine] and said once people become aware of the risks, they expect few to press for the vaccine."

          "Translation: the whole thing is a bust.  The medical cartel couldn't keep its story straight.  Doctors and medical bureaucrats scurried away             from the scene yelling: don't blame me if a lot of people die."

  More from NBC: the Federal government is not recommending vaccination … of the general public" said Health and Human Services Secretary Tommy Thompson.

And then we have this . . . story at AP: "Health and Human Services Secretary Tommy Thompson said Sunday he does NOT plan to be inoculated with the smallpox vaccine and recommends that other cabinet members not request the inoculation either."

Another article sent to me by this subscriber went on:

 Many medical and public health officials have serious doubts about the expected benefits versus known health risks.  A scientific consensus voted against this plan last summer, Dr. Horowitz explained.  Forcing military and emergency personnel to receive a 50 year old mixture of cow pus, mercury, and fetal calf serum to adequately protect against modern strains of smallpox, including those weaponized for mass destruction, grossly violates common sense and medical ethics." 

Well, there you have it from someone else. If we want to have mass inoculations, let's at least use a proven, safe vaccine, such as that made in Japan.

 THE TAX-CUT DEBATE…SIMPLIFIED!  by Anonymous

 Let's put tax cuts in terms everyone can understand.
 
 Suppose that every day, ten men go out for dinner.  The bill for all ten comes to $100.  If they paid their bill the way we pay our taxes, it would go something like this.
 
 The first four men -- the poorest -- would pay nothing; The fifth would pay $1:  The sixth would pay $3; The seventh $7; The eighth $12. The ninth $18.  The tenth man -- the richest -- would pay $59.
 
 That's what they decided to do.  The ten men ate dinner in the restaurant every day and seemed quite happy with the arrangement -- until one day, the owner threw them a curve.
 
 "Since you are all such good customers," he said, "I'm going to reduce the cost of your daily meal by $20."
 
 So now dinner for the ten only cost $80. The group still wanted to pay their bill the way we pay our taxes.
 
 So the first four men were unaffected. They would still eat for free.  But what about the other six -- the paying customers?  How could they divvy up the $20 windfall so that everyone would get his "fair share?"

The six men realized that $20 divided by six is $3.33.  But if they subtracted that from everybody's share, then the fifth man and the sixth man would end up being *paid* to eat their meal.
 
 So the restaurant owner suggested that it would be fair to reduce each man's bill by roughly the same amount, and he proceeded to work out the amounts each should pay.
 
 And so the fifth man paid nothing, the sixth pitched in $2, the seventh paid $5, the eighth paid $9, the ninth paid $12, leaving the tenth man with a bill of $52 instead of his earlier $59.
 
 Each of the six was better off than before. And the first four continued to eat for free.
 
 But once outside the restaurant, the men began to compare their  savings.
 
 "I only got a dollar out of the $20," declared the sixth man.  He pointed to the tenth. "But he got $7!"
 
 "Yeah, that's right," exclaimed the fifth man. "I only saved a dollar, too. It's unfair that he got seven times more than me!"  "That's true!" shouted the seventh man.  "Why should he get $7 back when I got only $2?  The wealthy get all the breaks!"
 
 "Wait a minute," yelled the first four men in unison. "We didn't get anything at all.  The system exploits the poor!"

 The nine men surrounded the tenth and beat him up.  The next night he didn't show up for dinner, so the nine sat down and ate without him.
 
 But when it came time to pay the bill, they discovered something important.  They were $52 short!
 
 And that, boys and girls, journalists and college instructors, is how the tax system works.
 
 The people who pay the highest taxes get the most benefit from a tax reduction.  Tax them too much, attack them for being wealthy, and they just may not show up at the table anymore.
 Author unknown.

 Best Regards,

Bert Dohmen

 P.S. LATE NEWS: THE PRESIDENT'S PLAN

 President Bush today announced is proposal for a tax cut and economic growth package. I was pleasantly surprised that he went this far. A total elimination of tax on dividends received is terrific, especially for retired people who are trying to live on meager 3%-4% bond yields…It’s great for small businesses as they would be able to expense three times the amount of capital expenditures…There are a number of other benefits in this plan, such as accelerating future tax cuts into this year, making temporary tax cuts such as the estate tax permanent, etc. I like it.

 Of course, this is only a proposal. Some of the Dems are already howling. Senator Dashle, who hasn’t been seen since he caused the virtual destruction of his party last November with his blatantly deceptive speeches, put his two cents in today. (His objections are certainly not worth more.) Dashle and Pelosi make a wonderful couple. They will cause the “Golden Age” of the Republican party by causing the demise of their own.

 Jim Cramer, CNBC show host and a Democrat, today said something to the effect that you have to be poor to be a Democrat now a days. He is very disappointed with the leaders of his party. 

I don’t belong to either party. I just like going to them. Significant tax cuts are absolutely necessary. Bush’s people must emphasize that this plan is not just a shot in the arm for a short term boost. This is a long-term economic growth package which will help people reduce their own deficits, instead of always just focusing on the governmental deficit at the expense of the citizen. The government can always borrow all it wants. The individual cannot and must file bankruptcy.

 Dashle in effect says it’s ok to tax the same money twice. In fact, he would probably like to tax it

three and four times. The more he can get, the more he likes it. According to him, that’s “fair.”

 We can help to get this package through by writing our Representatives. I think we have a chance of the market responding very favorably. Now even companies with huge cash hordes, such as Microsoft, which has over $40 billion in cash, may start paying dividends.

 Over the past 80 years or so, 44% of the return on investment for stock holders was through dividends. Yes, dividends are important. And it’s not only for the rich, but for anyone who has a fund or a stock. That’s the majority of Americans.