Economics: What Next?
New York: April 06, 2004
By John R. Stephenson

What a last few weeks! A blockbuster jobs report out of the US along with gold futures taking a tumble and that wonky dollar. Yet the markets continue to mystify and there seems to be no end in sight of the confusion out there in investment land. So what's an investor to do?

Well, for starters, run for cover. We still anticipate that the US dollar will fall further even if the Euro doesn't rise all that much. The reason? Asia is coming on like gangbusters. With the Japanese economy looking a whole lot better these days and the Yen's rise likely to drive other Asian currencies higher - the likely loser is the dollar. The fall in the dollar could be significant and could be as much as 10%.

But could interest rates inch higher to support the dollar? Unlikely. For starters, employment growth in the US has remained tepid and there still appears to be an excess ability worldwide to produce goods and services. One reason for the excess world supply of goods is the massive human resources potential in both India and China which helps to keep prices and hence inflation down.

Perhaps the solution is to grow demand? Well, let's see. There really are only three levers that government can use to boost demand - exchange rate, government spending (fiscal policy) and monetary policy. With the government deficit spiraling ever upward, a loose monetary policy solidly in place and an unstated lower dollar policy, the fire has been well stoked to try and reflate the US economy. But the response so far has been slow and the Fed will continue to do the wise thing and remain on the sidelines - at least for the time being. Without doubt there is a reluctance on the part of the Fed to raise interest rates even if the reflation effort starts to take hold because it would prick the over inflated asset bubbles ? particularly in real estate. The household sector is most at risk because of the record amounts of debt with servicing costs (even with these low interest rates) at an all-time high. Nope, the risk of the Fed adopting anti-inflationary policies is just too great ? because it would cause the US consumer to hibernate for the foreseeable future.

If you look at the geopolitical situation these days, there is little room for comfort. The war on terror rages on with little end in sight. With the world as unstable as it is, there are two likely outcomes from future terrorist events ? sharply higher gold prices and a weaker US dollar. It is a matter of historical record that throughout times of war, governments have preferred to print money rather than tax their citizens. If this occurs, look for gold to move higher and the US dollar to drop.

So how does an investor play these strange and somewhat troubling times? Commodities might be the answer. Commodity prices are sharply higher this year, partly because of reflation and partly the result of strong demand from China. Not only are commodity prices higher but the recent pullback in the price of gold could present a window of opportunity for buyers. As well, investors would be wise to try and reduce indebtedness. The less you owe in uncertain times, the better off you will be.