International Property Investment in Central and Eastern Europe

By Katja Huitikka & Julie Page

2006 saw direct investment into European real estate reach record levels with total transaction volumes of €242 billion – up 39% on 2005. Although the UK, Germany, and France continued to dominate market activity in 2006, accounting for 64% of total volumes, there was significant growth in Central and Eastern Europe (“CEE”) where volumes more than doubled from €5.8 billion to €13.3 billion. Poland alone was the biggest CEE market with transactions exceeding €5.0 billion.

As real estate continues to become an increasingly global asset class with new capital flowing frequently between the US, Europe and Asia, and as new options of entering into the European market are being implemented, such as the introduction of REIT structures, further tremendous growth is expected over the next five years.

The incredible growth of the CEE markets is hardly surprising. Even prior to EU accession, the CEE was viewed as a lucrative market for high-risk investors seeking good returns with yields of 10-12% for properties located in major urban areas being common.

However, following EU accession and the corresponding reduction on restrictions as to foreign ownership of real estate and the perceived reduction of risk in view of harmonized legislation and increased transparency, the attraction of the CEE markets, particularly to conservative investors, grew exponentially, although yields did correspondingly reduce.

Now viewed as safer markets and yet largely untapped, developers began to look aggressively for opportunities. Poland, for example, with a population of nearly 40 million, made it the largest single market in Central Europe and therefore a huge potential for residential development. All of the CEE countries, in view of their physical location in Europe, became extremely attractive to the logistics sector as development and expansion of transport infrastructure became a priority. Each of the markets also provided lucrative opportunities in respect to the construction of Class A office space and upscale retail centers to service Western European retailers seeking to expand their customer bases. Additionally, with the significant migration of manufacturing and R&D ventures into central Europe, the assembly of large tracts of land for industrial purposes became essential and yet another prime investment opportunity.

Although the investment opportunities in the CEE are very attractive, potential investors are strongly advised to rely upon local advisors in regards to specific legal, tax, and planning issues which, if not properly resolved prior to acquiring a property, could lead to serious delays and losses.

In regards to legal matters pertaining to a property’s title, conveyance practices and real estate due diligences are based on the civil law and generally involves the use of both attorneys and notaries in commercial transactions. As between the various jurisdictions in the CEE, the land registration systems and commonly accepted standards of title investigation vary quite dramatically, raising the potential for a number of issues to arise which could affect an investor’s end ownership in the title.

In Poland for example, there is a very solid principle called “the reliability of the perpetual books” which entitles a buyer, if they’re in good faith, to rely upon the most recent entry in the land register to transfer title to them. However, should there be odd annotations against the land register for the property, or references in earlier transfers to outstanding interests, or evidence that the property may be subject to restitution proceedings, that good faith will no longer be applicable and the buyer may be facing litigation and/or administrative proceedings challenging their registered title. Moreover, the likelihood of there being an “adverse” entry against the property is very likely. For example, if the property being bought is within the boundaries of the City of Warsaw, the property would have been nationalized under the Warsaw Decree. Accordingly, it is extremely likely that there were administrative proceedings by the expropriated owners seeking an interest in the nationalized property which, quite frequently, have never been finalized, leading in many cases to ongoing litigation.

In Romania as well, although the returns are very lucrative, restitution is a major issue. Nearly 80% of properties are affected by claims of previous owners whose lands were seized by the Communist government. And considering that Romania is only second to Russia as regards to the number of complaints to the European Court of Human Rights related to the handling of those restitution claims, one can easily imagine the potential costs an investor may sustain in having to defend his title against a restituent.

Even in the Czech Republic where it is possible to investigate titles quickly through an automated system which allows you to query back to the 1930s and earlier, title problems are common. Under the Civil and Commercial Codes, the manner in which a sale transaction is to be documented is specifically set out. Frequently, the actual conveyance documentation is defective as it may be missing necessary attachments and approvals, contains erroneous legal descriptions, and/or is based on Powers of Attorney which are not in accordance with the requirements of the company’s founding Articles – all of which can lead to the transaction being challenged by an interested party.

In response to these issues, many investors are turning to title insurance policies as a cost effective way of protecting themselves against issues identified during the due diligence phase and unknown title matters which could assert themselves after their acquisition of title.

Having recognized this need on the part of investors, Stewart Title Limited entered the CEE market in 2000 as a provider of title insurance and has since underwritten nearly €5 billion of risk in all of the CEE countries.

To discuss title insurance in foreign markets, Stewart’s team based in the company’s corporate head office in London will be happy to help you.

Katja Huitikka is Director of Underwriting for Stewart Title’s European Operations. Ms. Huitikka can be reached at +44 (0)20 7010 7820 or via email katja.huitikka@stewart.com.

Julie Page is Business Development Executive & Solicitor for Stewart Title’s UK Operations. Ms. Page can be reached at +44 (0)1392 680680.

China and America's Future

Business Leaders and Top Hedge Fund Managers discuss the latest issues facing the economies of the US and China

by Bruce Fenton

Recently I had the pleasure of attending this year’s Committee of 100 Annual Conference at the Waldorf Astoria in Manhattan. The Committee of 100 is a group of Chinese-American business and social leaders whose impressive membership list includes: Yahoo co-founder Jerry Yang, Cellist Yo-Yo Ma, and YouTube co-founder Steve Chen.

You don’t have to be a Committee of 100 member to attend the annual conference; the conference is open to the public at a very reasonable price, particularly after considering the incredible list of speakers in attendance. Individually, any of the dozens of speakers would be worth listening to for an afternoon. Featured speakers included: US Treasury Secretary Hank Paulson, New York City Mayor Michael Bloomberg, Quantum Fund co-founder Jim Rogers, Hedge Fund Legend Daniel Och, Hedge Fund Manager Richard Perry, and Yahoo’s Jerry Yang.

This year’s conference had an electric excitement with the smiling attendees extremely interested in the topic at hand. The audience members, like the speakers, were as diverse as any ‘who's who’ guide to business, but the subject was always the same: China and its growth, its economy, its change, its influence, its buying, its selling and its future.

Hearing our best and brightest speak about China can be quite whelming. The immensity of the information was so great that that during a few presentations I found myself entering a sort of "short circuit" mode and where I would then have to catch up. I began to look forward to having time to sit down after the conference and digest the magnitude of the ways in which China is changing the face of the globe.

One common complaint voiced by speakers was about China's lack of desire to both accept US investments and relinquish control to US investors. Top investment professionals, men and women who make the financial ground shake with their footsteps in New York or Chicago, have increasingly complained about getting a cold shoulder from Chinese companies. I wonder if this is a series of isolated incidents or if it is simply the fact that we in the US need China more than China needs us. Did French and English barons of previous centuries expressed the same frustrations as America became more self sufficient and less reliant on their capital?

While the conference was mainly about the big changes in China, perhaps most impressive is the "smaller" things, the little known and less quoted statistics that hammer home just how immense the growth of China has been. While many people talk about Beijing, Shanghai and Hong Kong, what might come as a surprise is the fact that China has over 100 cities with populations in excess of 4 million people each.

With such a staggering population, even the tiniest percentile of change translates into some very large numbers. One of the speakers, Wilbur L. Ross of WL Ross & Co, raised a few great points in regard to these vast numbers: if China’s automobile penetration per 1,000 citizens increases by 1% it would equal the total output of the US auto industry. Mr. Ross added that Chinese universities are now graduating seven times the number of engineers that the US: “Unless American engineers are seven times smarter”, he points out, “most future innovation will come from Chinese engineers”.

We are truly interconnected in a global economy and the US economy still influences both China and the rest of the world, but our influence is weakening relative to China's strengthening economic independence. The US Government indicates that China’s Gross Domestic Product (GDP) is roughly US$10 trillion and ours is US$12 trillion, in terms of purchasing power parity. Nominal GDP is also very close.

When asked about China’s decisions in managing the Yuan, US Treasury Secretary Henry Paulson said, “I have learned over the years not to ascribe motives. What I do is say they clearly see the principle.” He further commented, “It’s a big advantage for us if China does well economically” and “My own concern is that China has the right goal, which is stability; economic stability and growth.”

Most striking of all is a look at the Chinese trade surplus in comparison to the US’s increasing trade deficit. In terms of real dollars (when adjusted for currency value and debt), China’s surpassing of the US economy may not be in the 5 to 15 years projected by many economists, in fact it may have already occurred. Furthermore, China owns over US$380 billion in US debt, when this debt is sold it could surely harm the US economy greatly.

Given the magnitude of the discussion, it is no surprise that Committee of 100 attracts such an incredible list of members, speakers and attendees. In terms of the future of our global economy perhaps the audience should have had another million members. With the effect of China on our own future, maybe everyone in the US needs to learn more about this future leader of the global economy.

I am glad to have attended the conference; the question now is what to do about our place in the world relative to the world’s newest economic superpower? I suggest visiting the Committee of 100 website (www.Committee100.org) and attending next year’s conference. Additionally, perhaps we should pursue the often quoted advice of investor Jim Rogers: “Learn Chinese”.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

National Savings Rates

by Bruce Fenton

If you are short of something economic to worry about, try the American savings rate. The people of Europe might tell us that our economy is going down like a lead sled because we Americans are such poor savers. And, more than a few of the financial press seem to share that view.

The world is so concerned that we Americans save too little, borrow too much, and basically consume too much for our own good.

The problem is one of perception and definition. To begin, we need to be clear on the term “national savings rate.” The Bureau of Economic Analysis (BEA) defines the savings rate as the amount the U.S. population saves divided by its disposable income. Personal savings is calculated by taking personal income and subtracting from it personal contributions to social insurance, personal tax, non-tax payments, and personal expenditures.

Their measurements are totally out of touch with contemporary American wealth accumulation practices. Missing from the calculations are increases in wealth from short or long-term capital gains. Nor is wealth created from real estate by refinancing or selling counted. The numbers do not count gains from growth inside pension plans or IRAs. Neither do the numbers include valuations of business interests or growth in equity in investment real estate.

An article in Reuters® pointed out that despite the high savings rates in the growing economies of Asia, Asians need to learn to save “smarter” according to Jonathan Larsen, head of retail banking in Asia for Citibank®. He notes they tend to keep too much in cash. Traditionally this has been due to the relative immaturity of the investment markets.

As the middle classes develop in Asia, and they begin to put more of their savings to work in the markets, we can anticipate their savings rates to come down, their wealth to grow, and their consumer class to spend.

Not a bad equation for a stronger economy!

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

India and the Hunt For Oil

by Bruce Fenton

It’s oil, not gold, that developing nations realize they need to power up their economies and grow with the rest of the 21st century world. India is a prime example. Unlike the days of the British Raj, when Indian princes and their British counterparts found fame and fortune as hunters of exotic game and precious gems, today these princes are hunters of oil.

While India’s economy races ahead at growth rates in excess of 8%, year after year, its ability to keep up that pace is becoming more dependent on oil and energy resources every day. It has struggled with power shortages, blackouts and rolling brownouts which are hurting overall production and growth, according to a report on Economy.com® by Matthew Cairns.

India’s economy is not dissimilar to ours 100 years ago. Our population came out of the fields and joined the middle class as jobs were being created by new manufacturing industries. With this new found middle-class status comes the demands for perks of life … air conditioners, cars, electric appliances … all of which put even more demands on an overtaxed energy system.

According to Department of Energy figures, India’s current domestic crude oil production accounts for only 30% of its total demand. To take up the slack, India is looking to increase its nuclear power output by a factor of 10 in the next 15 years. India is also striving to increase hydroelectricity generation, which currently supplies around 20% of current power needs.

India does not have enough domestic oil resources to meet the demands for energy. As a result they are forced to import about two thirds of their daily need of 2 million barrels a day.

Part of the reason we have seen oil prices skyrocket in the past two years can be attributed not only to India’s thirst, but also to that of neighboring China, its competitor for imported oil. Between the two nations they import about 7% of world demand at 5.46 million barrels a day, according to PetrolWorld statistics.

By 2025, Indian officials project their nation could be consuming 7.4 million barrels a day … over three times what they consume today. This level of consumption bodes ill for the rest of the world competing for scarce oil resources as well as an environment which could pay the price for increased energy related pollution.

India’s success at dealing with its growing needs for energy in large part will come from its diplomatic success in dealing with old adversaries. By not directly bordering oil producing Asian countries, India needs a transit system through bordering Pakistan, or access to Myanmar, a geographically strategic Asian source of oil … both of which historically have not been “best friends” with India.

In the hunt for oil, India’s biggest competitor remains China. India’s Oil and Natural Gas Corp. (ONGC) has invested approximately $3.5 billion in overseas exploration since the beginning of 2000 … but that pales in comparison to China’s largest international oil company investments of around $40 billion.

While the two giants are competing for the same prize, they have begun to cooperate and work together on a number of other energy related projects. Last year, as reported by Glenn Levine writing for Economy.com, the two countries reached an agreement that aims to promote cooperation and collusion between Indian and Chinese companies when competing for energy resources.

Investors should keep an eye on this part of the world and its struggle to deal with energy needs. The outcome will greatly impact our oil prices and the development of these giants as traders for our economy. On the plus side, these nations are learning to compete economically rather than on the battlefields of war.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Cash Flow Is Basic

by Bruce Fenton

A basic part of family planning begins with cash flow management. In many cases it is this first step that determines the ultimate financial successes of the household. By understanding cash flow, the family can make good decisions that will enable it to avoid unnecessary debt, borrow responsibly, accumulate wealth for the future, and plan for major needs such as education expenses or retirement.

My experiences have shown me that many families and individuals do not have a sound understanding of how they spend their money. Due to the ease of purchasing with credit cards, its accompanying deferral of debt, and the proliferation of ATMs, it is not uncommon to encounter situations where the family unit has no idea how much it costs them to live.

The cash flow statement to the family unit is similar to the profit and loss statement for the business. It tracks income in and expenses out. An easy way to develop the cash flow statement is to begin by setting up a simple spreadsheet that lists sources of cash coming in and expenses going out.

Cash may come from a variety of sources including, but not necessarily limited to, employment income of the working household members, gifts, realized investment gains and losses (a subtraction), net rental income earned, interest earned and reinvestment of dividends and capital gains in non-retirement investment accounts.

I like to categorize my expenses into three main categories: fixed costs that must be paid each month, variable living expenses, and discretionary expenses.

In the book, How to Run A Business In Trouble, the author advocates breaking expenses between those you had to pay to keep the bank from shutting down the business, such as bank loans and insurance, and all others. The former you pay first and the latter you negotiate or make choices with. The smaller the former amount is in relation to income, the better. The lesson of this is simply to lower fixed costs such as mortgages, loans, and credit card payments for financial health!

Variable living expenses make up the bulk of our remaining expenses. These include the many basic expenses over which we have some choice as to how we spend. These include utilities, household upkeep and maintenance, food, transportation costs, insurance, personal care and clothing, subscriptions, and club dues.

If we take the total of these two expense categories and subtract that from our income, the remainder is money we have available for discretionary spending.

Discretionary expenses include expenses we choose to incur, although they are not essential to our basic lifestyle, including gifts to charity and gifts to others, recreation, travel, unaccounted-for-spending, hobbies, and savings in retirement and other investment accounts.

Knowing where we can make choices is the most important part of this exercise. It has been said that there are two kinds of people: Those who spend first and save what’s left and those who save first and spend what is left. Invariably, the former ended up working for the latter. Taking that to heart and knowing where you are spending money for wants vs. needs is the first step in developing a sound financial plan.

Bruce Fenton is a financial consultant, a writer, and the Managing Direcetor of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Down with Inflation

by Bruce Fenton

Despite a consensus opinion among market followers that we are in for another round of Federal Reserve interest-rate hikes, the current year’s outlook, and continuing for the next several years, is “all systems go.”

Driving this are the economic forces of continued growth of the U.S. economy at a sustained and healthy pace, coupled with strong global deflationary forces that will act to keep wholesale and retail prices down, thus curbing inflation and the Fed’s need to make dramatic rate increases.

The importance of inflation to stock market investors cannot be overstated. Profits, interest rates, and inflation are the fundamental variables in the pricing of stocks. If profits continue to grow, the future value of a business (as represented by stock ownership) grows. Therefore, investors should be willing to pay more for the stock.

But the future value of those business earnings must be related back to a present price. If inflation in the future robs the purchasing power of earnings, or profits, the stock is less valuable today. Conversely, if inflation falls and the earnings of the business buy more, the stock has a greater value today. If there is no inflation, the stock price should stay the same.

Understanding this principle, it is easy to see why some traditional investors who looked only at today’s lofty price-earnings ratios could conclude that stocks are overpriced. However, if they had factored in lower inflation, they might have been more willing to pay today’s stock prices.

The Federal Reserve’s role is to attempt to control inflation by controlling short-term interest rates. If the Reserve can cool an overheated economy by raising short-term rates, the long-term outlook for inflation (as measured by market expectations priced into falling long-term bond yields) becomes positive for the markets.

The Fed doesn’t have to shoulder the entire burden of controlling inflation. A number of other factors impact price direction. First, there is growing foreign competition, spurred on by a decade of world capitalism. This competition makes it difficult for businesses to raise prices.

Second, domestic competition has intensified as buyers have more power, thanks to the Internet, to shop for lowest prices. Lehman Brothers economist Stephen Slifer calls the impact of the Internet on pricing “the most deflationary event of our lifetime.”

With foreign competition breathing down their necks, and consumers everywhere able to shop for the lowest prices, how can the great companies of our country survive and continue to employ our workers and produce profits? In a word: “Technology.”

By becoming more efficient and growing their markets, businesses can compete in a falling price environment. Technology has increased productivity and made this possible. Businesses can exercise the same competitive strength as buyers, which their own customers use against them. For example, by using the Internet to shop for lowest-price supplies, businesses can achieve cost savings.

The need to be more efficient and competitive will give rise to an evolution of larger businesses. Small businesses will become incubators for technology and new solutions, but many will lack the resources to compete on a global scale. Their ideas and solutions will be consolidated into larger companies with the resources to compete.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Transportation and Our Economy

by Bruce Fenton

Recent attention given to the financial troubles of the airlines underscores the importance of transportation systems to our economy. Indeed, the so-called “Dow Theory” used by technical analysts to predict major market movement, uses the Dow Jones Transportation Index as an integral element for such predictions.

Charles Dow, father of the Wall Street Journal and developer of the Dow Jones Averages, theorized in his early financial reporting late in the 1880s that there was a relationship between industrial stocks and the railroads. (Keep in mind that there were only railroads at that time. It wasn’t until 1969 that the Dow Transportation average was broadened to include truckers and airlines.)

Dow was of the opinion that market movements could be categorized as three types. A primary trend takes place over the course of years. This trend can be either up (Bull) or down (Bear). Secondary trends may run counter to primary trends and are usually of much shorter duration, lasting several weeks or months. Finally, of lesser importance are the day-to-day fluctuations, which can move in either direction.

He theorized that in order for a reliable trend to signal the market’s direction, the railroad index and the industrial index should be moving in the same direction.

The relationship between the two indices was logical to Dow. In order for the industrials to get their products to market, they must use the railroads. He noted that when the industrials did well, so did the transportation companies. But, when one sector was doing much better than the other, a divergence was forming. If the other sector did not catch up, a major market reversal was coming.

During Dow’s time, railroads had a monopoly on industrial transportation. The invention of the automobile gradually diminished the strength of this monopoly.

Even though the automobile was invented in the 1880s, it was not until the 1920s that it became a factor in industrial transportation. The reason was simple—there were no roads.

In 1919, the U.S. Army put together a cavalcade of military motor vehicles and set out to drive from Washington, D.C. to San Francisco. This epic continental journey took them across and through 3,250 miles of dirt, mud, rocks and sand. They averaged just less than 5 mph along the way.

The struggles of the journey left an indelible impression on a young Army officer, Dwight Eisenhower, who, four decades later when he became president, launched the building of the interstate highway system.

Author Pete Davies chronicles this adventure in his book American Road. He notes how important the development of a reliable transportation system was to the building of commerce across the lands.

Then, with very few exceptions, there were no paved roads. Few states were willing to fund the development and paving of roads. Much of the journey in the western states took place on wagon trails left over from the western migrations of 50 years earlier.

Today, our land arguably boasts the finest transportation system in the world. But Dow’s original theorizing retains remarkable relevance.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Measuring Oil Reserves

by Bruce Fenton

The cold winter, strife in the Middle East and a contentious energy policy proposal all make fertile ground for investors looking to profit from investments in oil companies. However, as investors are finding out, a barrel of oil in the hand is not like a barrel in the ground!

Any investor looking to profit from an investment in an oil company wants to know the amount of oil available for sale. Unfortunately, that oil is in the ground, and its actual volume must be estimated and then extracted before it can be sold.

Measuring oil reserves is both a political and a practical problem. Different countries and oil companies use different methods. Politicians would like to see oil reserves grow and contribute to the wealth of the world. Regulators like the SEC are apt to take a more conservative approach. And there is the issue of the unit of measure—what constitutes a barrel of oil?

The Handbook of Chemistry and Physics lists eighteen different definitions of “barrel,” ranging from 30 to 50 U.S. gallons in volume. For example, a barrel of beer equals 43 U.S. gallons, while a barrel of oil is only 42 U.S. gallons, a measurement adopted by the Petroleum Producers Association in 1872.

In the political arena, the stated value of a nation’s oil reserves can enhance its perceived wealth, enabling it to borrow for other purposes at more advantageous rates against its oil reserves. Oil producers doing business within these nations are encouraged to use more liberal measurement techniques when measuring oil reserves. However, those who lend against reserves require a tighter definition of “reserves.”

Oil that has been discovered and remains in place is considered “reserves.” All discoveries are initially appraised for their size in terms of oil in place. Based upon complex calculations involving many variables, the probability for successful extraction is estimated. If there is a reasonable certainty that the oil can be recovered given current and projected future operating conditions, the reserves are considered to be “proven.”

The remaining reserves are assigned “probable” and “possible” designations. The former are reserves with better than a 50% chance of recovery and the latter have a less than 50% chance of being recovered.

Over time, reserves can be changed from probable or possible to proven or vice versa. For example, according to OPEC futures in 1944, a special mission estimated Persian Gulf reserves at 16 billion barrels proven and 5 billion probable. By 1975, those same fields had produced 42 billion barrels and had 74 billion remaining. In 1984, geologists estimated a 5% probability of another 199 billion barrels remaining. Within five years, they had already appeared.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Stock Market Performance

by Bruce Fenton

In case you may have failed to notice, as of March 30, the Dow has remained above 11,000 for the past 15 days, 31 days in all for the first quarter, according to WSJ numbers. We have not been treated to numbers like this since 2000 when the DJIA hit an all time high of 11,722 on Jan 14, 2000.

Despite wars, pestilences of all types, kidnappings, bombings, rising interest rates and oil prices, steadily declining numbers for the current President’s approval ratings … you name it … this economy keeps chugging.

If you find this confusing, take a look at the numbers underlying the economy. Corporate profits jumped 21.3% in 2005 to $1.35 trillion … representing the largest share of national income in 40 years, 11.6%. To stock market investors, rising profits are like rising rents for real estate investors … a nice feeling.

The Bureau of Economic Analysis (BEA) released its final report on Gross Domestic Product for the fourth quarter 2005. Real gross domestic product, calculated as the output of goods and services produced by labor and property located in the United States, increased at an annual rate of 1.7 percent in the fourth quarter 2005. In the third quarter, real GDP increased 4.1 percent annualized.

Gross domestic product is the universally accepted measure of the economic activity of the nation. It is the sum of final output measured by the equation C+I+G +(X-M) = GDP where C is consumer spending, I is private or business investment, G is government spending and X-M is the net of exports minus imports.

As the economy goes through different cycles, the changes in the components become important indicators to market watchers. For example, the I component, or business investment, contributed to the 2001 recession by decreasing -7.9% in 2001, and further shrinking by -2.6% in 2002. Yet, the economy remained afloat thanks to the consumer, whose spending increases, year over year, were +2.5% and +2.7% for the same years.

While year over year changes in consumer spending are +2.9% 2003, +3.9% 2004, and +3.5% for 2005, the real muscle for the economy is coming from the change from negative growth in business investment in 2001 and 2002, to strongly positive figure in 2004 and 2005, where year over year changes were +11.9% and +6.1% respectively.
Those worried that the government is spending the economy into a deep hole might find some comfort in the fact that the growth in government spending is decreasing from +2.8% 2003 to +1.8% in 2005.

The above figures came from the BEA’s web site, www.bea.gov.

GDP as an indicator has evolved since the 1930s. Simon Kuznets, an economist hired by the U.S. Department of Commerce in the 1930s, led the creation of a national accounting system. Up to that time, policy makers had little idea how the economy was performing, and worse, had no way of predicting with any accuracy, the impact of fiscal and monetary policy changes on the nation’s economy.

Today we take for granted the operations of the Federal Reserve Board as it attempts to control the nation’s money supply, and indirectly, inflation. With libraries of data at their fingertips, these watchdogs of our money can make relatively informed decisions as opposed to their predecessors in 1928 and 1929 that are widely criticized for their actions which many felt contributed to the crash of the stock market. Little mention is given, however, to the difficulty these Fed governors had who were “flying blind”, without any reliable data to guide their decisions and measure results.

Markets will continue to react to changes in GDP. Strong positive growth is good for the stock market, and generally a negative for bonds, as increased economic activity tends to push up prices and interest rates. The opposite is true as the rates of change decline.

Bruce Fenton is a financial consultant, a writer, and the president and founder of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Reagan Tax Cuts

by Bruce Fenton

Opponents to of tax cuts cite numerous reasons why tax cuts won’t work. Too much, benefits the rich over the poor, will lead to deficit spending, will waste the surplus… all concerns expressed by the doubters. However, they are ignoring history.

Somehow they forgot the legacy of the Reagan presidency. So, on the anniversary of his 95th birthday, it seems fitting to comment on his legacy and vision.

Described by economist Art Laffer as the last “real President,” Reagan brought to the office a strong, singular focus to build a better country and to shut down world communism. Without a doubt, he did both.

Upon assuming office, he immediately embraced the supply side economic policies advanced by his economic advisor, Laffer. The Laffer Curve theory held that if taxes were cut, the resulting money left in the hands of the people and not the government, would stimulate the economy and the resulting growth would actually generate more tax revenue.

The broad-based income tax cuts that Reagan pushed through did exactly that, setting off an entrepreneurial boom that has propelled the growth of the economy for the past 20 years. Certainly the Clinton Presidency benefited from the tax cuts, and to Clinton’s credit, he even added his own cut by reducing the capital gains tax.

Reagan added to the economic well being of the country by facing down communism, and for all intents, shutting down its socialistic economic system around the world. This has opened up vast parts of the world as a marketplace for our goods and services. Today, one form or another of capitalism propels the economic environment of the world.

Reagan’s detractors, and to be sure there are many, point to his lack of sensitivity for social issues and the legacy of his deficit spending on defense and the infrastructure throughout the land.

In the case of the latter, we can draw a corollary by comparing his spending with what all of us do with our homes. We buy homes, and when home values and/or our income goes up, we remodel. By remodeling, we add value to our homes and increase the livability, or quality of life that comes with having a nicer home. The money for this remodeling usually comes from refinancing… adding to our family debt with additional long-term mortgage borrowing.

But, we do so with the mindset that we will have the income in future years to pay off this debt. Reagan envisioned leaving money in the hands of the people rather than the government, where it could be put to more productive uses than government spending would provide. He was right—our economy grew, and government income increased, eventually providing cash flow capability to pay for the “remodeling” that his Presidency did over his eight years in office.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Remember WIN?

If your consciousness level exceeded the decibel level of your favorite rock band of the 70s, you recognize WIN as President Gerald Ford’s exhortation to all to Whip Inflation Now.

Over the last few months, current but outgoing Federal Reserve Chairman Alan Greenspan has left no doubt that he will whip inflation now as his Federal Reserve cranked up interest rates. All this while telling us the economy was in fine shape, all things considered. Thus far, the underlying rate of inflation has yet to show many signs of being pushed higher by the surge in oil prices.

Mr. Greenspan and most other Fed officials tend to view higher energy prices as a one-time event, and pay much closer attention to the “core” rate of inflation that excludes energy and food prices. Despite the rise in gasoline prices, the core rate remains tolerable.

Government economic data suggests the economy has the strength necessary to absorb rising energy prices, a hurricane or two, and the interest rate hikes. In November, the government surprised many forecasters by estimating that the economy grew at a rapid clip of 3.8 percent in the third quarter, despite the impact of Hurricane Katrina and skyrocketing fuel prices.

No doubt about it, inflation remains the big gorilla in our economic forest. But the inflation of President Ford’s era, and the inflation Greenspan is jousting are two different inflations. Ford’s battle was with “cost-push” inflation … the type that occurs when companies’ costs go up leaving no alternatives other than raising prices. Hence, costs have “pushed” prices up.

This can happen when workers have wage pricing powers, such as occurs with strong labor unions, and equally strong cost of living benefits in union contracts. If commodity prices increase, companies are forced to raise prices to recover their costs. Businesses may be forced to “price in” interest rate increases, tax increases, along with excise duties on fuel and oil, and changes in currency exchange rates. These can all cause cost-push inflation.

The second type of inflation, “demand-pull,” is the current Fed’s enemy. This inflation results from too much money chasing too few goods. A sure sign of this inflation is a rising GDP and falling unemployment.

Today our economy is primarily service based. Our wage structure remains flexible and out of union control. To better understand the dwindling power of labor, one only has to look at the difficulties organized labor is having trying to organize Wal-Mart workers.

Thirty years ago this was not the case, as organized labor exerted significant leverage to force businesses to raise wages, which in turn exacerbated the impact of rising oil prices.

The recent successful efforts of airlines to cut wages, and Delphi to cut pension benefits signifies even more evidence that we have a flexible wage economy … one where inflation is not likely to be driven by a cost-push wage spiral.

The inflation we face today is more events related (the growing world demand for energy resources) than it is a secular inflation that is likely to increase over time. Fortunately our economy is resilient and flexible enough to adjust to higher energy costs. And, we are productive enough, thanks to the productivity gains brought about by technology, and a better educated and more skilled workforce made to produce the goods and services necessary to keep up with demand.

While it is likely that we will have more rate increases even after Greenspan gives up the reigns of the Fed, I do not believe the inflation we face will be of the WIN variety. And with some attention to investing and saving strategies, our soon to retire Boomers will be able to look forward to more than flipping hamburgers in retirement.

Dawn of a New Economy

by Bruce Fenton

Mornings are a magical time. Whether it’s the first rays of light hitting the wave-tops, or the panoply of morning pinks peeking out against the waning blue of the night sky, mornings are special. Each new dawn brings with it the promise of a new day, the promise of something better yet to come.

Not that long ago, we we were treated to a special dawn of a new millennium, an event that comes once in a lifetime for only a few of those who have walked this planet. Less than a decade ago, many fretted over the calamity that this date change would bring about if computers failed, power went out, telephones stopped ringing, banks ran out of money, food disappeared from the grocery shelves, or the world came to an end.

As the years since the millennium have progressed and systems all over the world checked out, it became clear that except for a minor glitch or two, the new century arrived bringing with it a new morning of hope and prosperity instead of catastrophe.

A world of uncertainties will be replaced by a world of change, change driven by the entrepreneurial spirit, capitalism, and technology. These changes, that anthropologists might consider to be of the 500-year variety, have occurred overnight, transforming our nation and the globe into a better place to live.

The new dawn has brought to us the promise of a new economy. The underpinnings of the new economy are increased productivity, globalization of the marketplace, and the Internet.

Never before has our work force been so productive. As competition has increased, technology and training have allowed our workers to produce more at lower prices and for higher pay.

Our marketplace has become the world. Capitalism has won out over the inefficiencies of socialism, communism, and managed economies. The dominance of capitalism has given us a world market thirsty for the goods and services that only free economies can provide. As the economies of emerging nations grow, and their workers become more productive with the wants and needs that go beyond simple subsistence, they also will soon become consumer societies. The growth potential for our economy and those throughout the world has never been brighter!

Finally, the Internet, once a playground for techno-geeks, has become the backbone that makes all this possible. Its unique ability to pass information quickly and efficiently around the globe, combined with the forces of technology and globalization, are redefining trade and business. The result is a fundamental shift in economic thinking where ideas and the entrepreneurial spirit are valued at least as much as tangible goods. This promotes higher growth and lower inflation.

According to Stephen B. Schepard, editor-in-chief of Business Week, “Every second, seven people get onto the Internet somewhere in the world.” The changes brought about by the Internet have been the driving force behind our productivity improvement, the most critical part of economic growth over the past decade.

But now is not the time to be looking back. This is the time to be looking ahead to the excitement of the new economy.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

2006 New Years

by Wendell Cayton

What’s not to like about this economy … especially looking forward to next year? Considering hurricanes, soaring energy prices, higher interest rates, and a war that won’t go away, the overall performance is a testament to the willingness of both consumers and business to spend and invest. According to Moody’s Economy.com®, the economy should enjoy a real GDP growth of over 3.5% this year. By their figuring, this will translate into the creation of over 2 million jobs and a 5% unemployment rate. They note that this in not on par with the 3 million jobs created annually during the latter part of the 1990s; labor-force growth has slowed, indicative of an increasing rate of retirement from the workforce.

As a nation, we are growing stronger balance sheets, both on the business and the household
sectors. Corporate profitability is up. And helped by historically low interest rates, corporations have strengthened their balance sheets and have plenty of cash on hand.

Household net worth is growing even more quickly and will soon hit an all-time high, six years
after the previous peak. Naysayers who continue to point to increasing consumer debt as the engine fueling consumer spending are neglecting to factor in increasing household incomes, increased retirement plan account values, and higher real estate equity.

Fears of higher inflation caused by higher interest rates and increasing fuel costs are perhaps
overblown, as core consumer price inflation is only 2% and the federal funds rate target and fixed mortgage rates hover around 4.25% and 6% respectively—both low by historical standards.

Looking forward to 2006, we see more promising signs of continued economic growth, with some bumps to be avoided.

The domestic auto and airline sectors can be described as anemic at best. Bankruptcy plagues both industries, leaving investors scratching their heads, wondering if they will ever return to profitability. Personally, I believe airlines will be increasingly impacted by the proliferation of broadband Internet and the spread of inexpensive video conferencing capability.

Speaking of inexpensive video conferencing, if you haven’t been in an Apple® store recently, treat yourself to a demonstration of their capabilities. With a setup in Grandmother’s home and one in your house, you can have everything you need to stay in touch (except for the cinnamon rolls and hugs) without the hassles and expense of air travel.

The combination of increasing interest rates and higher energy prices could also put a damper on the 2006 party. A disruption in supplies, or a colder than average winter, could drive oil and gas prices to much higher levels, which in turn puts pressure on economic growth. Lest we forget, higher interest rates in the home mortgage market could continue to drive down housing affordability and cool off the hot housing market.

Aside from the “bumps,” on the plus side we have increased business productivity, as growth in labor compensation has not kept pace. Moody’s points out that businesses are generating more than enough cash to cover their projected investment needs.

With cash to spend, it is a good bet we will see increased business investment spending, which should result in expanded payrolls and more jobs, which means stronger consumer spending.

Germany and Economics

by Bruce Fenton

When the unification of the two Germanys occurred in 1990, I recall one economist calling it the worst “leveraged buy-out” in history. The only economic factors the two nations seemed to have in common was a language and a dependence on manufacturing. Germany is still struggling today, as evidenced by its economic performance.

At issue is the fact that the German economy has spent the last three years muddling along in near stagnation. Under Schroeder’s watch, Germany’s jobless total has risen above five million, and remains at more than 11%. The source of the problem stems from poor labor market performance that has weighed heavily on consumer and business confidence.

Dr. Angela Merkel’s solution proposed cuts in welfare benefits and weakened job guarantees. Some of the highest taxes on labor in Europe serve to act as a disincentive to business to create new jobs.

Trained in Communist East Germany as a physicist, Merkel chafed under the strict state controls in place at the time. With the fall of the Berlin Wall she became a political activist and held important positions in the Helmut Kohl government. When Chancellor Kohl was hit by scandal, she wrote a pivotal newspaper column that helped bring about his downfall and eventually helped elevate her to national prominence.

Germany has long been known for its strong social programs and support of organized labor. In fact, when they took on the East Germans, they inherited a huge pool of organized labor accustomed to “cradle to grave” care by the state. In today’s world of market economies this system leads to loss of productivity, loss of markets and becomes a drag on the economy.

Merkel’s platform called for Germany to reform its economic structure and become more of a market-oriented economy. She proposed deregulating the country’s labor market, simplifying the tax system, and cutting the burden on businesses for paying for the welfare state.

Conversely, Schroeder’s plan is economics as usual … extension of the state controls, taxes on high incomes, and continued high taxes on businesses to support a social welfare state whose social costs are growing faster than national productivity.

A couple of years ago, the Wall Street Journal recounted an example of a midsized family-owned business that manufactures and exports machine tools … typical of the heart of the German economy. This firm found itself unable to effectively compete for world customers when saddled by German labor laws and welfare taxes.

Their “work around” was to set up a manufacturing plant in neighboring Switzerland. Despite paying 30% higher wages, their productivity rose, and their overall cost of production dropped. If they have to lay off workers due to changing markets or demand, they can do so without having to put up with German laws on job protection and working hours.

As we witnessed in past elections, bringing social and economic reform to Old European countries is easier said than done. The uncertainties of a risk-taking, market-based economy leave too many unable to shake off the comfort blanket that comes with a strong government entitlement system.

But, there is a price for everything economic. In this case, Germans have opted for slow growth and continued high unemployment in exchange for strong social programs.

Bruce Fenton is a financial consultant, a writer, and the president and founder of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Supply Side Supreme Court

by Wendell Cayton

It’s just possible that John B. Roberts Jr. will be our first supply side member of the Supreme Court, according to Lawrence Kudlow, also well known for his outspoken, supply side views. As the hearings on Judge Roberts’ nomination to become the next Chief Justice of the nation’s highest court wound down, it was clear that his conservative views might just be the elixir business has been looking for in the court for years.

Supply side economics received a large burst of publicity in the 1980s as the Reagan economic team put the principles to work. Supply side theory contends that growth in the economy can be stimulated to a greater degree by unleashing entrepreneurial capitalists free to work, innovate, and grow businesses in a low-tax as well as a lower-regulatory environment.

According to Kudlow, “C. Boyden Gray, the key organizer of a business coalition that weighed in on the White House nominating process, told me Roberts believes that ‘government intrusion should be limited.’ In other words, in the economic area, Roberts is ‘likely to take the view that government should get out of the way and not pick the winners and losers; that government should work to level the playing field and trust markets to get the job done.”

It is ironic that just before the nomination hearings began, Jude Wanniski, journalist/economist, who coined the term “Supply Side Economics” died on August 29th. As an editorial writer at the Wall Street Journal® in the 1970s, Mr. Wanniski was part of a core group of young, revved-up conservative thinkers hired by editorial page editor Robert L. Bartley.

He was a hero of many economic/fiscal conservatives in part due to his role in publicizing Laffer Curve in mainstream media. The Laffer Curve, as promoted by Wanniski and economist Art Laffer, held that an economy would respond best and produce higher tax revenues for the government if taxes were reduced.

Frank Keating, the president of the American Council of Life Insurers and the former Oklahoma governor and federal prosecutor, told Kudlow that Judge Roberts believes that “the engine of commerce comes from individual creativity” and that Roberts “is likely to encourage enterprise through the creativity and genius of individual men and women to produce the next generation of jobs and growth.”

This would be a far cry from the liberal interpretation of the Commerce Clause that was behind many of the questions asked by the more liberal members of the Judiciary Committee during their grilling of Roberts. The Commerce Clause has long been a favorite of those advocating greater, rather than lesser, government controls on business and individuals.

Over many decades activist judges in the court system have expanded the Commerce Clause to create a regulatory state that has seized private property, taken over school systems and prisons, interceded in private-sector hiring and firing practices, ordered farm quotas and property-tax increases, and expelled God, prayer and the Ten Commandments from the public properties.

Judge Roberts responded to the incessant questioning by Democratic committee members by making it clear that he was there to interpret the law, not make the law. As he so eloquently stated in his opening address, he is there to call balls and strikes, not hit the ball.

In general I found his answers to be on point, logical and consistent with the views of those who believe judges do not make laws, rather they interpret and apply them. On the other hand, the Democrats, who will never find a Bush nominee to their liking, insist on politicizing the process, and will not recognize nor accept the role of the Chief Justice as apolitical.

Transportation and Our Economy

by Bruce Fenton

Recent attention given to the financial troubles of the airlines underscores the importance of transportation systems to our economy. Indeed, the so-called “Dow Theory” used by technical analysts to predict major market movement, uses the Dow Jones Transportation Index as an integral element for such predictions.

Charles Dow, father of the Wall Street Journal and developer of the Dow Jones Averages, theorized in his early financial reporting late in the 1880s that there was a relationship between industrial stocks and the railroads. (Keep in mind that there were only railroads at that time. It wasn’t until 1969 that the Dow Transportation average was broadened to include truckers and airlines.)

Dow was of the opinion that market movements could be categorized as three types. A primary trend takes place over the course of years. This trend can be either up (Bull) or down (Bear). Secondary trends may run counter to primary trends and are usually of much shorter duration, lasting several weeks or months. Finally, of lesser importance are the day-to-day fluctuations, which can move in either direction.

He theorized that in order for a reliable trend to signal the market’s direction, the railroad index and the industrial index should be moving in the same direction.

The relationship between the two indices was logical to Dow. In order for the industrials to get their products to market, they must use the railroads. He noted that when the industrials did well, so did the transportation companies. But, when one sector was doing much better than the other, a divergence was forming. If the other sector did not catch up, a major market reversal was coming.

During Dow’s time, railroads had a monopoly on industrial transportation. The invention of the automobile gradually diminished the strength of this monopoly.

Even though the automobile was invented in the 1880s, it was not until the 1920s that it became a factor in industrial transportation. The reason was simple—there were no roads.

In 1919, the U.S. Army put together a cavalcade of military motor vehicles and set out to drive from Washington, D.C. to San Francisco. This epic continental journey took them across and through 3,250 miles of dirt, mud, rocks and sand. They averaged just less than 5 mph along the way.

The struggles of the journey left an indelible impression on a young Army officer, Dwight Eisenhower, who, four decades later when he became president, launched the building of the interstate highway system.

Author Pete Davies chronicles this adventure in his book American Road. He notes how important the development of a reliable transportation system was to the building of commerce across the lands.

Then, with very few exceptions, there were no paved roads. Few states were willing to fund the development and paving of roads. Much of the journey in the western states took place on wagon trails left over from the western migrations of 50 years earlier.

Today, our land arguably boasts the finest transportation system in the world. But Dow’s original theorizing retains remarkable relevance.

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Inflation Headlines

by Bruce Fenton

That nasty “I” word…inflation is making headlines again and helping to kick stock prices around like a ping-pong ball. Just about the time we have grown accustomed to what economists like to call “benign” inflation, prices are inching up.

The classic definition of inflation is a persistent increase in the price of goods and services in the economy as the purchasing power of money decreases. The opposite of inflation, or deflation, is an economy where prices are falling and the purchasing power of money is increasing.

Putting this in perspective, there is a web site run by the University of Miami and Wake Forest University where you could enter a value in any year going back to 1665, and relate the purchasing power of a dollar up to year 2003. Checking a few years at random, you would find that in the year 1700 today’s dollar would buy $23.66 of goods. In 1865 the figure was $11.23. In 1900 a dollar today would buy $21.79, and by 1980 a dollar would buy $2.23 in goods and services.

Inflation has been a constant in our economic history, and except for periods of war and the 1972–1982 years, stayed under 5%. Long, continuous periods of deflation have also been a part of the picture. Historically our long-term deflation was the end result of increased efficiency as we opened the west and made incredible technological advances in the 20th century.

In today’s dollars, 1981 oil is worth about $92 a barrel…that’s about 50% higher than we are actually paying, and we are using less!

While I realize this is not on your mind when you are pumping $50 worth of gas in the family SUV, keep in mind that our household income has gone up more rapidly than inflation, giving us greater purchasing power today than we had in 1981.

Many of the current financial press discussions of inflation center on the impact of rising energy prices and the projected tightening of the job market in 2006 and beyond.

Another view on inflation has been expressed by best-selling author, Harry Dent, in his book “The Great Boom Ahead,” and his latest, “The Next Great Bubble Boom,” Dent makes a case for inflationary pressures resulting from younger workers moving into the work force. Younger workers cost more to train, are less productive, and more costly to employ. Since they make less and want more, they borrow to finance their entry into adulthood. The net result is higher prices, higher demands for money (increase in interest rates) and higher inflation.

If Dent is correct, since there are fewer young people coming into the work force, this blip up in inflationary pressures will be short-lived and not change the secular trend of inflation, which has been sloping down since 1982.

Bruce Fenton is a financial consultant, a writer, and the president and founder of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Strong Federal Reserve Leader

by Bruce Fenton

As the great American Investor class has grown in the past 20 years, so has the focus on the Federal Reserve and its current chairman Dr. Alan Greenspan. Arguably one of the most powerful men in our country…indeed the world…his words move markets. Precedent for such power comes with the position and dates back to the founding of the Federal Reserve and its first leader, Benjamin Strong.

Ironically, Strong, considered by many at the time to be an easy money advocate, was beginning to take the necessary monetary steps to put a stop to rampant stock market speculation when he died in 1928. Had he lived to continue his work, the Crash of ’29 might have been prevented.

After suffering through the short depression of 1920-21, the American economy took off on a tear. Then Treasury Secretary Andrew Mellon pushed for lower income tax rates and plowed government surpluses into paying off the national debt. Government expenditures fell, but personal income and the gross national product soared in the 1920s. Per capita income rose by a third while inflation was nonexistent.

The boom was fueled by the emerging technology of the time…the automobile. Ancillary industries sprang up…oil, rubber, glass, steel…all financed by booming Wall Street.

Wall Street soared along with the economy. From 1922 to 1929 the Dow Jones® industrial average quadrupled. Worker productivity, thanks to the use of electricity increased 40%, according to author John Gordon in The Great Game.

Credit played an important role in this expansion. Up to then, credit was a privilege reserved for the rich. General Motors®, Macy’s® and other retailers began offering credit to their customers, making the good life available to the middle class. And, it became an easy stretch to expand credit to the stock market by borrowing from a broker to buy securities on margin.

With 90% financing available, the masses flocked to the rising stock market in the quest for easy money that came from buying stocks with low down and selling at rapidly rising prices for a profit. (This practice sounds similar to real estate today in parts of the country.)

Benjamin Strong was named the first governor of the Federal Reserve Bank of New York in 1914 and dominated the Federal Reserve System during its formative years. Strong was an internationalist and saw the central bank playing a substantial international role. Strong advocated monetary policies that assisted our European Allies in rebuilding after World War I.

He wanted U.S. interest rates low to keep European capital from flowing out of Europe and into the U.S. While this may have helped our Allies, it fed the speculation that was going on at home. Low interest rates allowed lenders to earn more lending for margin borrowing…rates got as high as 20% toward the end of the summer of 1929.

Finally Strong had seen enough. He began by raising the discount rate three times in 1928 up to 5% (considered high at the time). He took steps to restrict the money supply. His goal was to avoid a crash on Wall Street while aiding, if possible, the recovery in Europe.

Unfortunately he died of tuberculosis late in 1928, leaving the Fed without a strong leader. As a result no further steps were taken by the Fed to halt the stock market speculation.

The result as the Saturday Evening Post wrote was:

“Oh, hush thee, my babe, granny’s bought some more shares,
Daddy’s gone out to play with the bulls and the bears,
Mother’s buying on tips, and she simply can’t lose,
And baby shall have some expensive new shoes!”

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.

Inflation, Deflation and the Future

by Bruce Fenton

I don’t know about you, but I’m paying more for my gasoline and medical expenses, and it seems like my neighbor’s house is selling for more than he paid for it a few years ago. What’s more, it’s no secret that interest rates will soon be going up. Add all that to increasing commodity prices around the world, and . . . well, if it looks like a duck, walks like a duck and quacks like a duck, you have to surmise that there may be something to this idea of inflation.

However, market contrarian Robert Prechtor and financial forecaster Peter Kendall cast another light on things. They see an indicator of deflation, not inflation, just around the corner.
The picture they paint is different from the runaway inflation we faced in the 1970s, when the prices of hard assets (precious metals, real estate) went opposite that of the stock and bond markets, a typical response to inflationary pressures. Today, commodity prices and financial asset prices seem to be moving together.

Prechtor and Kendall attribute this to the expansion of liquidity (easy money, or more money in circulation). They believe expanded liquidity has driven up the prices of all investment classes. When liquidity contracts, they believe the prices of all asset classes will fall together. At that point, they predict the Bull will go to its knees as psychology changes from expansive to defensive.

To buttress their theory, they cite historical examples of similar price movements that were followed by severe deflation. Going back to the 1830s, they point out a liquidity spike that preceded a subsequent depression. The Great Depression followed a soaring stock market and an expansion in credit.

Specifically, in 1837, an unexpected drop in cotton prices began a decline that took everything with it. Real estate prices fell and the stock market dropped off the table. Prechtor and Kendall claim the same scenario is set to play itself out today. If you believe them, you will be following their advice to hoard your cash along with a generous helping of U.S. Treasuries.

Several years ago, I heard Prechtor debate Harry Dent, the demographic trend-following Bull author of The Great Boom Ahead. While their debate showed some similarities (e.g., both use the Elliott Wave as a basis for long-term trend forecasting), there were many differences in their views.

One major difference is that Prechtor tends to rely only on historical data and pattern analysis for his forecasts. Dent combines a good deal more economic and fundamental analysis, taking into account demographics and consumer spending data to make his case. As a result, his analysis tends to relate more to current situations, current policies, and current events, while Prechtor is bound to and by history.

The chilling part of their debate, however, was that both agreed we are in for a wicked downturn in the financial markets, equal to what we experienced during the Great Depression. The only difference between their forecasts is that of timing. Prechtor sees this decline coming any day—and has been saying so since the early 1980s. Dent sees it coming sometime in the second decade of this century, following a strong growth in the markets.

Neither forecast is good news. Take your pick!

Bruce Fenton is a financial consultant, a writer, and the Managing Director of Atlantic Financial Inc. Bruce welcomes inquiries, comments, and questions. He can be reached by contacting The Fenton Report.