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Will the balance of trade deficit serve as a detonator?


Templeton Trepidations,

Buffett Battle Stations


By Bill Fox

(Last updated October 29, 2003)


According to Gary Moore, who serves as a media spokesman for Sir John Templeton, the legendary investor “…Surprised even me [a few weeks ago] by suggesting that we avoid [U.S.] stocks altogether as the money that was in tech has moved to cheaper stocks around the world…John primarily suggested sovereign debt from Canada, Australia and New Zealand. He’s been there the past three years, principally in Canadian zero coupon treasuries.” When a reporter who wrote the article “"Templeton Feeling Bearish,." (Sarasota Herald Tribune, Oct 14, 2003) asked about the prediction that the dollar would slide 40% in a special Economist report, Gary Moore assured the Herald Tribune reporter that he had the feeling that Sir John wouldn’t waste much time arguing with that prediction. However, it is more Sir John’s style to say, “The odds are better than even…” rather than give a specific number. (Please note Gary Moore’s letter in the Appendix of this article for more complete background on Sir John Templeton’s views.)

The dollar index has already lost about 24% of its value since Jan 2002. John Templeton’s continued dollar bearishness implies that the unhedged gold stock index (HUI), which is already up over 400% from its low in late 2000, could run further. Precious metals have a strong historical inverse correlation with the strength of the dollar.

Billionaire investor Warren Buffett said in his Oct 27, 2003 Barron’s interview that he sold $9 billion in long term U.S. Treasuries earlier this year and feels it is unwise to buy into the stock market at current levels. He has $24 billion in cash on the sidelines. There is no evidence that he has sold the 129.7 million ounces of silver that he accumulated in 1997.

In regard to currencies, Warren Buffett wrote the article: “America’s Growing Trade Deficit Is Selling the Nation Out From Under Us” (Fortune Online Edition: Sunday, Oct 26, 2003). He stated: “I am crying wolf again [about the impact of mounting trade deficits, having first started his warnings in 1987] and this time backing it with Berkshire Hathaway's money. Through the spring of 2002, I had lived nearly 72 years without purchasing a foreign currency. Since then Berkshire has made significant investments in—and today holds—several currencies. I won't give you particulars; in fact, it is largely irrelevant which currencies they are. What does matter is the underlying point: To hold other currencies is to believe that the dollar will decline.”

America’s Achilles Heel lies in the growing glut of dollars held by foreigners as America’s balance of trade deficits grow worse. Foreigners have bought 45% of America’s deficits, typically buying US government bonds with their trade surplus dollars rather than dumping them on the currency markets and driving the dollar lower. They have allowed America’s trade deficits to grow to 6% of GDP without forcing a currency crisis. Deficits over 5% of GDP historically enter high-risk territory.

The U.S. Government and Fed response has generally been cosmetic at best. From 1995 to 2000 U.S. Secretary of the Treasury Robert Rubin used currency interventions to artificially strengthen the dollar. The more recent funds rate cuts by the Fed down to 1% serve to artificially stimulate consumption and support asset bubbles amidst over 6% unemployment.

Deep structural problems make it unlikely that a declining dollar will completely eliminate the trade deficits soon. Many Asian countries inflate their currencies in line with dollar declines and have vast pools of peasant labor always willing to work for less. Many American business leaders focus on short-term profits and neglect the reinvestment required to competitively advance quality and innovation at home. Many American consumers are addicted to buying more foreign goods with more debt.

A trap is about to close on foreign investors. Inflationary money and credit supply growth and the government requirement to attract investors to buy debt issues related to growing deficits will inevitably cause interest rates to rise. A scenario of rising interest rates, which hurts bond market values, will encourage bond investors to sell in advance, which will in turn help to drive interest rates higher. A falling dollar, related to money supply growth, will encourage foreign bond investors to sell in advance before they incur currency exchange-related losses on their dollar-denominated holdings. Selling US bonds and transferring into other currencies will help drive the dollar even lower, feeding a vicious circle.

Pressure is building to avoid being the last out the exit door. Arab states are talking about selling their oil in euros rather than dollars; in fact, Saddam Hussein was the first to switch to euros before he was deposed. In addition, Russian President Vladimir Putin touched on the euro issue in his Oct 9, 2003 meeting with German Chancellor Gerhard Schroeder in Yekaterinburg.

If foreigners stop sopping up excess dollars as a global reserve currency and wash them back at the U.S, this will add to inflation and higher interest rates in America. According to the IMF, dollars currently account for 68% of global reserves vs. 13% for the euro.

The Fed may have to dramatically hike interest rates to lure foreign investors back, and create even more money to cover continually growing federal deficits where it cannot find enough lenders. The dollar may continually decline to new lows in a pattern characteristic of many Third World countries.

Considerable evidence backs up Templeton’s preference for the Australian dollar as a refuge, even though it has rebounded over 40% from a very depressed base vs. the US dollar since Jan 2002.

According to the “The Big Mac Index” (The Economist, April 24, 2003), “Among rich economies, the most undervalued currency is the Australian dollar. The Aussie dollar [was back in April] still 31% below PPP (Purchase Power Parity) against its American counterpart.”

The Australian Governments debt is only 18% of GDP, a better credit risk compared to “official” US government debt of over 68% (not counting horrendous “off balance sheet” obligations such as Social Security). Australian trade deficits are smaller and more manageable.

Last but not least, the Australian dollar has historically correlated strongly with global commodity prices. 65% of Australian exports involve commodities. Chinese economic growth actually helps Australia by putting upward pressure on commodity prices.

According to Gary Moore, “[Sir John Templeton has] also been interested in another hedge fund…that invests in companies producing natural resources... it's not hard to see that he thinks the development of China and India is going to put upward pressure on the natural resources produced by Canada, etc., an idea that he and others have expressed for years. Add in the strip mall [one of his real estate ideas] and foreign bonds and you get a falling dollar, which has been John's primary theme the past few years.”

The Fed has increased the money supply over 10% a year over the last five years, and other central banks have followed suit. According to global investment guru Dr. Marc Faber, we are now experiencing a global “reflation” trend similar to the stagflationary 1970s, in which excess liquidity flows away from over-inflated stocks, bonds, real estate, and other “paper” assets and into “things” such as commodities.

According to Dr. Faber, money supply and credit-related inflation will ultimately win out over concerns about “deflation” related to asset price bubbles, Asian imports, and politicized low-ball government inflation statistics.

Precious metals expert David Morgan advises riding the precious metals and commodity bull market for however long it takes until the Fed decisively arrests rapid monetary expansion. The commodities trend of the 1970’s lasted over eight years until tightening by Fed Chairman Paul Volcker pushed three month T-bills to a high of 16.3% in 1981 and finally caused a trend reversal.

Financial commentator James Puplava believes that we are only in the first phase of a multiphase commodities bull market, and that the establishment remains in denial. Wall Street insists that the old 1995-2000 bull market has been reignited and will keep going. Bush administration neoconservatives promote more open-ended military projects while Bush himself has advocated a $400 billion drug prescription program on the home front.

In view of the underlying economic dangers, perhaps the Financial Times had it right in a May 2003 editorial that declared, “The lunatics are now in charge of the asylum.”



The following is an e-mail sent to me by Gary Moore on October 29th to clarify the October 14, 2003 Sarasota Herald Tribune story "Templeton Feeling Bearish"::

Bill: as there's been some confusion over this article and its unexpectedly been picked up around the country, let me do my best to clarify.

First, who I am? I am indeed an investment advisor, but I've also written four books about Sir John and/or his ideas and serve on the board of advisors of his foundation. My most recent book, Faithful Finances 101, and my previous book, Spiritual Iinvestments, were published by John's foundation press. Over the years, I've often served as an intermediary with the media, see past articles about John in Money, etc. but John is now past ninety and only wants to talk about spirituality and religion, which have always been his primary interest in life. Still, I feel his financial views are quite important and John has allowed me to keep people up to date on them. (Only yesterday I emailed him to see if he now wants even me to stick to spiritual matters.)

You may know that in late 99, John grew quite bearish on U.S. stocks, and even shorted tech. Forbes reported that he made over $100mm shorting internet [stocks] alone. Still, he suggested we own some stocks around the globe, such as U.S. REITs and inexpensive stocks in the developing markets. But when I took his cousin to see him a few weeks ago (who wanted to know where to put some money should he sell his business), John quoted that the Nasdaq has again risen until it is 92 times earnings, which I knew.

But he then surprised even me by suggesting that we avoid stocks altogether as the money that was in tech has moved to cheaper stocks around the world and they're no longer cheap (your readers should clearly understand that John's Calvinistic morality does not encourage him to buy even fairly priced stocks in the hopes that they'll become expensive stocks to be sold to the naive. During his long career he has only purchased cheap stocks at points of "maximum pessimism" to later sell at fair prices.)

When I suggested there are still a very few cheap stocks in the developing markets, John basically indicated not enough to fill a mutual fund, his preferred mode of investing even today (which he has mandated that future trustees of his foundation to follow.) Still, John does invest in a hedge fund run by a mutual friend named Dr. Jane Siebels of Green Cay Asset Management in Nassau. It is always "market neutral" by owning relatively inexpensive stocks around the world while shorting relatively expensive stocks.

John's bearishness on residential real estate has been well documented in other publications. However, when prompted by his cousin, John did say that his cousin might invest some money into conservatively structured strip malls anchored by defensive grocery stores and drug stores. To me, that again indicates he expects at least some inflation.

Yet John primarily suggested sovereign debt from Canada, Australia and New Zealand. He's been there the past three years, principally in Canadian zero coupon treasuries. Yet he's also been interested in another hedge fund run by Jane that invests in companies producing natural resources. Add those two together and it's not hard to see that he thinks the development of China and India is going to put upward pressure on the natural resources produced by Canada, etc., an idea that he and others have expressed for years. Add in the strip mall and foreign bonds and you get a falling dollar, which has been John's primary theme the past few years.

Still, John did not predict a 40% decline in the dollar. Even when predicting a rising stock market during the eighties and nineties, John was always careful to say, "The odds are better than even..." the only real mistake our reporter friend made was to take that prediction from a special Economist report that I faxed to him and attribute it to John. Still, I assured the reporter than I had the feeling John wouldn't waste much time arguing with that prediction. The reporter would have clarified that small point had John and I been able to talk to him but we were at Harvard for our foundation board meeting and couldn't get back to him immediately. We didn't know that he had already requested space for the story, sensing its importance.

The primary point is still valid: some of us who have been very close to John for many years know that John is indeed getting older but we still respect his views so highly that we've been seriously reducing or liquidating the stocks we still own and moving the money to foreign government bonds, hedge funds and conservative REITs. As always, we know that John might be wrong this time. but we too have learned to play the odds. Your younger readers who do not remember Sir John well might be interested in those lessons.

In 1982, I wrote an article for the New York Times Group about why Sir John and I thought the odds were good the market would triple to the 3000 level during that decade. I wrote a book in 1990 about why we thought it would multiply again during that decade. when Forbes wrote its cover story in 1992 about "Templeton falls off the mountain," I wrote a letter to the editor, which he published, in which I said, "Bet against Sir John if you want; not this guy." John had his best year ever in 1993.

Simply put, with our current account deficits and China and India coming on, I again agree that the odds favor foreign bonds, a couple of conservative REITs and a hedge fund than stocks at this point in history.

Gary Moore



Bill Fox is VP/Investment Strategist and private client money manager, America First Trust. Bill welcomes phone calls and responses to this article. His web site: www.amfir.com. Address: VP, America First Trust, Reg. Rep., Sammons Securities Co., LLC P.O. Box 820669, Vancouver, WA 98682, telephone: 360-882-5369, toll free: 866-945-5369 (866-WILL FOX), email: wfox@sammonsrep.com. Securities offered through Sammons Securities Co LLC, member NASD and SIPC.




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© William Fox. Sometimes William Fox offers viewpoints that are not necessarily his own to provide additional perspectives.