VEON FINANCIAL SERVICES, INC.  Registered Investment Advisor Joan M. Veon, CFP - Editor

June 2001 VFSI P. O. Box 77 Middletown, MD 21769 301/432-7511

IS THE GLASS HALF FULL OR HALF EMPTY?

An Analysis of the U.S. Economic Picture Through May 30, Includes 2001 BIS Report

The over-riding question which all investors have in the back of their mind is "How can I recoup the paper losses in my portfolio?" In light of the actions of the Federal Reserve to increase interest rates which had an adverse affect on the technology industry is, "Should I wait for technology to recover or should I take my losses and reinvest elsewhere?" A follow up question which most investors have is, "Are we in a recession or headed towards a recession?" Whether or not we are in a recession will determine if you can recoup your losses, minimize your losses or position yourself for the forthcoming storm.

In this regard, I have just returned from the 2001 Bank for International Settlements-BIS annual meeting. This letter was written before I left. In this regard, I think it is fair to say that the "Big Boys" who literally run the world's monetary system are gravely concerned. The 2001 Annual Report, over and over again, made references to "how sudden and fast the U.S. economy fell." Furthermore, as this letter points out, it is the American consumer who is responsible for the growth and demand in the world's economy. The question which I asked several times is, "What happens if Americans stop spending?"

In order for you to understand where we are economically, let us take a look at some behind the scenes information. On the last several pages which have been inserted, you will find a some excerpts from the Annual Report as well as a number of questions asked during the press briefing. While there is a fair amount of information, I believe your response at the end will be one of concern.

BEHIND THE SCENES

In order to try and determine what we should do and how to position for either boom or bust, we must analyze the economy overall. Usually when something of a catastrophic nature happens, it is not possible to understand it in total when it occurs as it usually takes some time to look back, to review related factors and to perhaps, come up with a better understanding. In reviewing where we are and if we are going to make it is the glass half full or half empty, we much consider additional factors.

The stock market high was not just a product of technology, but something else: The agreement made between Bill Clinton and Federal Reserve Chairman Alan Greenspan when Clinton was elected.

In the book Maestro, author Bob Woodward, writes that when Clinton became president Greenspan made a deal with him that if he reduced the federal deficits, he would lower and keep interest rates low. In Clinton's first State of the Union address on February 17 1993, he announced a $140B deficit reduction package. Within a week, long term interest rates fell to a 16 year low with the yield on 30 year Treasury bonds dropping below 7%. When Clinton was elected the Dow as at 3168. By March 2000, the Dow reached 11,452, almost TRIPLING in 7.3 years! Why hasn't anyone said the Dow was too high? How come it is only the NASDAQ?

I could never understand what was meant when the term "bubble" was used to describe the NASDAQ highs. I never saw the bubble. What I saw, and what I think is still relevant today, is innovation and competition. When we understand that a technology bubble was created as a result of seven years of easy money and low interest, then we can see that it created the perfect circumstances for many hands to take from the honey jar without being caught individually.

Market manipulation

Last year at the Bank for International Settlements Annual Meeting, I interviewed Svein Andresson, Director General of the Financial Stability Forum secretariat. He explained to me the reason for the increased volatility in the stock market, "There is a whole lot of new stocks being traded which unlike the new stocks traded in the Old Economy days, do not have a sound or accepted valuation methodology to them. For a company to be listed in the old days, a company had to demonstrate that they had a quality of earnings, they had a whole year of disclosed profits and you were not permitted to be traded until you had met the criteria. With tech stocks there was a desire to facilitate these companies to give them access to capital and listing requirements in various stock markets came down. That by itself creates the basis for much more volatility."

At the 2001 annual meeting of the World Economic Forum in Davos this past January, they held a workshop on market volatility. Two of the panel members were Thomas A. Russo, Vice-Chairman, Lehman Brothers and Abby Joseph Cohen, Managing Director and Chair, Investment Policy Committee, Goldman Sachs Group. As they deflected any responsibility for the volatility of the stock market, I was able to ask the second to last question of the workshop, "I would like to revisit the crash of the dot.coms. Exactly who is responsible for the dot.coms going public? Does not some of the risk inherent in the internet go back to the underwriting firms and investment bankers bringing them public? Exactly where does the accountability lieperhaps we need standards for Wall Street and some accountability." The whole room gasped. I knew I struck a chord when Abby Joseph Cohen, who is always so under control with her brilliance and rosy investment predictions, said through very visible clenched jaws, "If someone wants to buy stock, it's there for them to buy" while investment banker Thomas Russo put on a happy face and went in circles with his answer.

Initial Public Offerings and the Honey Jar

When an investment bank brings a stock public, they must find a market for all of the shares which they commit to sell. USA Today revealed that the IPO market may have been artificially manipulated by the Wall Street investment banks that managed those stock offerings. The regulatory branch, the National Association of Securities Dealers is focusing on whether the investment bank's demanded kickbacks in the form of higher commissions in exchange for IPO shares. Investigators are weighing evidence that the banks fueled the Internet bubble by pressuring some large investors who got IPO shares to buy more at higher prices after the stock began trading. Banks under investigation include Credit Suisse First Boston, Goldman Sachs, JP: Morgan, Morgan Stanley, Lehman Brothers and Bear Sterns.

In interviews with USA Today, several current and former Credit Suisse First Boston employees, securities regulators and professional money managers provided details of what they characterized as IPO manipulation. One said, "It was rape and pillage." Said another, "The Internet bubble completed the prostitution of Wall Street analysts." When choosing an investment bank for an IPO, an internet company would prefer an investment bank with an analyst who was upbeat about the internet company or industry. Analysts with "buy" recommendations were well positioned to earn investment-banking bonuses. Congress has scheduled hearings for June (USA Today, 5/25/01, B1).

I think it is very apparent that there was a TREMENDOUS amount of money to be made by Wall Streetnot only in bringing stocks public, but in buying and selling the stock as they created the hype for how good the market was. Furthermore, now that I put together the comments from Mr. Andresson, I can see that it was a time of "rape, rob and pillage" in which the investment banks made a heap of commissions by bringing the stock of a lot of very fledgling companies public which basically should not have been brought public to begin with. They used techniques to jack up the price which contributed to the frenzy by giving it great reviews and when the insiders got out before the drop since they were driving the market to begin with.

a. The stock market

The strength of the stock market is dependent on many variables: consumer sentiment, productivity, Fed easing of money and interest rates.

Consumer Sentiment

It is true, no one wanted to miss out on the incredible gains to be made in the technology sector. My goodness, a "normal" investment return of 15 to 20% was made to look like nothing in comparison to a 100% or 130% gain in technology. In looking at the "turn over of money," known as "velocity," it was creating a situation in which people were anxious to get in on some of the incredible gains which others had made. There were many investors who did not use basic investment common sense by allocating a percentage of investment monies but instead invested pretty heavily.

High expectations fueled extremely high consumer sentiment. Based on market valuation, people were feeling "rich" and spent freely, production was up and overall the economy was stable. While you and I thought it was stable, the Federal Reserve viewed it as being inflationary which meant they felt they had to increase interest rates in order to "cool it off."

Divergent Stock Market Trends

In studying the change in share prices of internet stocks and of defense stocks. I found that the percentage of drop in internet stocks was the percentage which defense stocks gained. For example, from April 14 2000 until May 22 2001, Boeing gained 85.649% while General Dynamics gained 57.137%. Energy stocks not all, like Conoco, for the same period, had a gain of 37.63%. If you compare this to the fall of Nasdaq stocks, Akamai had a loss of (87.614%), Cisco Systems (77.4333%), Conexant (62.558%), eTrade (80.97%), and eToys with (80.975).

b. The Economy

In order to understand what kind of strength or durability the economy has, we must review some of the economic highlights from the 1990s:

1990: Kuwait War, banking system in worst shape since the 1930s; 1991: 45 credit unions close and BCCI fails; 1992: Clinton elected and the dollar bailed out by 13 central banks; 1993: foreigners bought $45.3B in U.S. Treasuries to hold up our economy and Clinton passed the largest tax hike in the history of America; 1994: as a result of a dollar crisis, the US was bailed out by 15 central banks; 1995: Barings Bank went under and foreigners bought $134B in US Treasuries; 1993: The Nasdaq dropped 15%; 1997: The Asian Crisis with $100B IMF bailout; 1998: the Dow dropped 1800 points or 19.26% only to recover after Greenspan reduced interest rates; 1999 in preparation for Y2K, the Fed made $50B available, the European Union and euro were birthed and the Nasdaq rose 86%; in 2000 the Fed begins to withdraw the $50B liquidity from 1999. In addition, the Federal Reserve raises interest rates 1.75% causing the NASDAQ drop 36%, closing at 2557.

What has been made very clear throughout this crash is the fact that it is the U.S. consumer who is responsible for the economic strength of the world. It is the power our economy which has allowed the world to go around. We Americans have been made fun of and criticized for being "consumers," but without us and the abundance which our economy has produced, the economies of the world would stop.

Given our consumerism, there is one major flaw which has every possibility of being our "achillea's heel". Our success and our power is not built on a sure foundation of "black dirt" but it is built on the plastic of credit and debt. Just like the effects of over-eating, smoking or drinking on the body, too much debt in the economy will catch up to us. For the countries of the world which have invested in U.S. stocks, bonds, and real estate, like any investor, they are here because we have been able to manage our debt. Depending on how the Federal Reserve handles our economy and whether or not American's can continue to spend will determine whether or not we remain competitive in the world arena. Given the NASDAQ crash, and the Fed's reversal of their 2000 policy, the world is looking to see if and how we will recover or WHEN the sins of our past come due.

ARE WE IN A RECESSION OR HEADED TOWARDS A RECESSION?

First we need to start with some definitions:

(1) INFLATION - an act of inflation; the state of being inflated; Inflation IS NOT RISING PRICES, it is an increase in the money supply which CAUSES rising prices. As the number of dollars increases, the value of each dollar falls and prices rise

(2) DEFLATION - An economy experiences inflation when its price level is falling. A STATE OF BEING DEFLATED: Reduction in the volume of available money or credit resulting in a decline of the general price level. A decrease in the amount of money, which causes a decrease in prices. If the supply of dollars falls, the value of each individual dollar rises and prices fall. That's deflation.

Inflation or deflation can occur even under conditions of full employment if the expectations of workers and firms about future monetary policy lead to an upward or downward wage- price spiral.

(3) RECESSION - Classic definition is two quarters of negative economic growth.

Role of Federal Reserve

Because the Federal Reserve-Fed has the power to create economic booms or busts, we need to again re-visit them. The Fed is a private corporation which has been given by Congress the right to manage the monetary system of the United States of America. In this regard, the United States borrows money from the Federal Reserve for which they are charged interest. Since the American people are not indebted to the Treasury of the United States but to the Federal Reserve, it is for this reason that we cannot "forgive" ourselves the interest on the debt we owebecause we owe it to a private for-profit corporation.

Let me inject here that the Federal Reserve meets at the Bank for International Settlements on a monthly or bi- monthly basis to review and consider the state of the world economy. Dr. Carroll Quigley said of the BIS, "The apex of the system [financial capitalism] was to be the Bank for International Settlements in Basle Switzerland, a private bank owned and controlled by the world's central banks which were themselves private corporations" (Tragedy and Hope, p.324).

The Federal Reserve controls the amount of money in the financial system. As such, when it decides on an "easy" monetary policy, it creates or prints more money which reduces interest rates which stimulates the economy and increases the possibility of investment and consumer purchases. If the consumer feels positive, they will invest that money into the economy. If the Federal Reserve feels "inflation" is kicking upas they have said in the past, then they will reduce the amount of money available in the system. This automatically makes people compete for the available dollars which are in the marketplace, pushing up interest rates and the price of money, leading to an economic slowdown.

Since the entire health and welfare of the American business cycle is dependent on the opinion and wisdom of the Federal Reserve, it is the Federal Reserve ALONE which has the power to CREATE THE BOOM OR THE BUST. Recently in a moment of transparency Greenspan said, "Do we have the capability to eliminate booms and busts? The answer in my judgment is no, because there is no tool to change human nature or to predict human behavior with great confidence." (Financial Times-FT, 5/26-27/01,1) (emphasis added).

With every Federal Reserve intervention, the economy is affected in a number of ways. First, the science of knowing when to add or subtract money to and from the monetary system is not an art, it is an unknown. Every time the Federal Reserve injects money, while they may stop a recessionwhich is their intent, they are interrupting not only the natural flow of the market, but the amount of injection of money is sort of like the heroine a drug addict needs to attain his next high-- they need more to reach the next high. According to Richard Mayberry in his book, The Money Mystery, in 1950, the Fed injected $10B to stop the recession, in 1983, they injected $100B, in 1993, they injected $350 billion. Currently the Federal Reserve has increased $600B into the monetary system in the last 12 months. They are expanding money at a rate of 25%! So the question which needs to be asked is, "How serious is the U.S. economy?, "What repercussions does it have on the next need for money to be injected?", and "If we go from bubble to bubble, what happens when it eventually breaks?"

To be honest with you, I don't have the expertise to examine all of the Fed's actions in the last thirty to fifty years and provide you with a technical answer as there possibly could be numerous correct answers, but I think it is important to note that the amount of money in the monetary system affects: the value of the dollar, the strength of the stock market, the strength of businesses, and how high or low interest rates are as mentioned below:

1. Value of the Dollar

This is key. How others perceive how strong our financial situation to be determines whether they feel secure in investing in the dollar. If they buy dollars, the dollar will be strong due to demand which means they feel confident about our country. If they sell dollars, they are signaling their belief that something is terribly wrong as they turn to other currencies, commodities, real estate, Jaguars, or diamonds as a better and safer place to invest. The amount of money in our financial system is a key indicator as to whether or not the world views the actions of the Fed as being reasonable and prudent. Should the Fed come under criticismas it has in the pastthen both foreigners and American investors will sell dollars and go elsewhere. Please see #16. Note: We are one world financiallythere are no financial borders for money which flows at the speed of light and now is referred to as "hot money."

2. Strength of Stock Market

The stock market is usually a key indicator of how much money is in the system and the confidence which investors have in the economy. If there is a large amount of money available, it will work its way through most of the economyif investor sentiment is positive, the stock market will rise, if not, gold/silver, real estate and other tangibles will rise in value.

Richard Mayberry has likened the reaction of the amount of money available in the system to a cone. Money changes hands at a certain speed or velocity. In cones where the velocity is low, the fluid is thick and flows slowly. Prices do not rise much. In cones where the velocity is high, the fluid is thin and flows quickly. Each dollar changes hands more often, participating in many transactions, driving the prices up very quicklyas we saw in the price of technology stocks and mutual funds.

3. Strength of Businesses

When there is a lot of money made available by the Federal Reserve, it creates the availability and ease for start up businesses and for business expansion. This demand for products creates confidence and is seen in higher earnings reports. When money is tight and interest rates rise, people become cautious in how they spend money. Increased layoffs begin to hamper confidence and inventory buildups begin to occur which, can lead to recession if not checked by changing monetary policy.

4. Interest Rates

When there is a great deal of money in the system or easy moneyinterest rates drop which causes people to refinance their debt and depending on the amount of their personal debt, perhaps buy up or trade up to the bigger house or the luxury caror diamond (in the case of us ladies!). However, when the Federal Reserve starts to withdraw money from the system, borrowers are now competing for the available money and interest rates start to rise, straining the business cycle and demand for products, squeezing the ability of many small and medium businesses out of the credit market. (Note: This is what occurred when the Fed started raising rates in 1999 and continued in 2000.)

Basically, the role of the Federal Reserve is the same as the heart in the body which pumps blood throughout the system. It should be noted that all of the above is determined not only by the health and stability of the U.S. economy but what is or is not happening in other countries. Using the above, let us examine these same variables in light of current Fed policy:

1. Value of the Dollar - The dollar is at a high and has continued to be strong against the yen and euro. The reason for a strong dollar is as a result of a number of factors.

Japan

The dollar is strong against the Japanese yen because of the severe debt problems which they face with their banks and real estate valuation. They are accused of not fixing the problem by transferring all of the bad assets off of government books by creating an entity similar to the Resolution Trust Corporation which we created when we had our banking crisis. As a result, many economists around the world are suggesting they take a bank holiday during the summer while everyone is on vacation to fix their economy. Japan has been warned by both Alan Greenspan and U.S. Treasury Paul O'Neil. Because of Japan's low or no interest rates over the past number of years, U.S. Treasury Bills have been the happy investment vehicle of choice for not only the Japanese, but recently, the Europeans as well.

Lastly it should be noted that many economists wonder if the fate of the United States will mirror the fate of Japan since both have very high debt.

Euro

Last year at the Bank for International Settlements meeting, it was announced in no uncertain terms that "It was Europe's time to grow." It appeared for a while that this is what was going to happen. International papers touted the strength of Europe and the sins of the United States. Last year there was the euro crisis when the newly birthed euro dropped to $.82 on the dollar. It strengthened to $.94 and now is back to $.86. Just recently both France and Germany which account for nearly 50% of the growth in the euro region have reported a drop in economic activity.

The strong dollar has and is creating policy problems and exacerbating imbalances around the world. A strong dollar makes the US un-competitive and increases our trade deficits which could lead to a fall in business confidence. On the other hand, it allows the "poorer" countries of the world to benefit at our expense.

2. Strength of the Stock Market -In 2001, the NASDAQ stocks continued to fall based on poor earnings reports. The strength of business, the stock market and Fed monetary policy are all inter-related. Obviously the stock market is reflecting a weakness in technology stocks. If you were building a business and the bank called in your loans, wouldn't you have a problem with staying in business?

After another quarter of bad earnings reports, the Dow and NASDAQ have had a positive run as the NASDAQ has recovered from a low of 1639 to its current June 3 high of 2229. This activity is as a result of the Federal Reserve reducing interest rates for a fifth time bringing the Federal Funds rate to 4 and the discount rate to 3.5%, the lowest since April 1994.

3. Strength of Businesses The blue chips or brick and mortar appear to have much greater holding value, strength, and stability. However, they have had their days in the tank. The NASDAQ stock market crash wiped out $4 TRILLION. This has lobbed a serious blow to our economic strength and to investors as it has also created disillusionment in the minds of creative individuals and entrepreneurs whose dreams have been shattered by the technology bust. This loss will take time to be absorbed. If we can avert recession, then this imbalance will be muted. If we cannot, then this imbalance will accentuate the severity of the economy.

Trade Deficit

The amount of business which the United States does is measured by our trade surplus or deficit. A deficit means that America imports more than it exports.

Today our trade deficit equals on a monthly basis what used to take a whole year to accumulate in the 1970. If it was unbearable then, it is even more so now. What do trade deficits indicate? It tells us that Americans are importing more goods than they are exporting. There are a number of reasons for this: (1) over the last 40 years, America has transferred it manufacturing needs to Japan and China. We no longer manufacture the steel, plastic items, tools, slippers, clothing, shoes, toys, and Christmas decorationsChina does. Our corporations have opted to use slave labor in order to increase their bottom line, depriving Americas of the well paying jobs they once had. (2) the value of the dollar.

As a result, we are severely chastised. Barron's put it this way, "The US is now absorbing roughly 70% of the world's available capital. If foreign capital stopped flowing into the US and started flowing to Japan or Europe, the economy would be in huge trouble" (Barrons' 11/27/00). British economics reporter Martin Wolf pointed out in an article in The Financial Times "In 1999 the US current account deficit of $339B was financed by $228B in net foreign private sector purchases of US non- governmental securities and $130B in net inflows of foreign direct investments (FT, 12/6/00, 14).

It is interesting to note, once again, that this trade imbalance has been described as a noose around our neck, YET, I repeat, without Americans importing available capital, the world economy would stop.

Global Slowdown

Reporter Clay Chandler recently reported that "Throughout Asia, the U.S. economic slump is taking a heavy toll battering exports, dragging down growth and threatening to derail recovery from the financial crisis that began sweeping this region in 1997. Asia's export dynamos have stumbled badly in recent months and analysts are nearly unanimous in blaming sluggish demand in the world's most important market as the primary reason for the abrupt reversal in fortunate. Many feel the worst is yet to come. The abrupt turnabout in Asia's fortunes highlights the degree to which the U.S. economy remains the dominant engine of growth for the rest of the world. For producers in this region, no other export market comes close to matching the importance of the U.S. Asia's exports as of April are down: 11.3% in Taiwan, 10% in Thailand, 9.9% in Korea and 2.4% in Hong Kong. Japanese auto exports are down 23% to day. Spending by U.S. firms on information technology products soared 25% last year. Today it is flat to slightly negative. With the squeeze on profits, many Japanese companies are going to China for cheap labor. China's growth rate in the first quarter was 7.5%" (WP, 5/30/01, E1).

4. Interest Rates - As a result of the Fed increasing interest rates 1.75% in 2000, the NASDAQ which reached a historic high of 5047 in March, dropped 36% to close out the year at 2557. Interestingly enough, the Fed, in response to what appears to be the WRONG MOVE (some economists believe it was the right thing to do. However look at what we lost. How much would we have lost if they had not taken this drastic action? We will never know) is now trying to pump as much liquidity back into the economy as fast as they can. This is evident by the five « point decreases in the last five months as well as the amount of money being pumped into the economy which is at a 25% rate (JV Note: Have you ever stamped on a bug and then lifted your foot to see if it was dead? Well, that is what the Fed did and now they are trying to resuscitate the bug.).

IS THE GLASS HALF EMPTY OR HALF FULL?

When God created man and woman he gave them armpits. It has been said that opinions are like armpitseveryone has them. In this day of information, the number of opinions, economists and experts have multiplied unmercifully. We are on information overload. Add to that the Internet and the ability to poll literally the whole world. What I have tried to do is provide information which is extremely important for anyone wishing to (1) stay their current investment course (2) completely change it or (3) hold with the option of changing.

In light of the above, let us summarize the information in light of the glass: Is it half full (boom) or half empty (bust)?

1. FULL: It is the Federal Reserve which creates both boom and bust. They created boom back in 1993 when they made a deal with Bill Clinton to reduce the deficit in exchange for low interest rates and easy money. It is this bubble which birthed the initial public offering mania's in which investment banks and their analysts made a bundle of money, bringing to market small companies which should have never seen the light of day. (Please see BIS Transcript.)

2. EMPTY: It is the Fed which orchestrated the bust when they began to increase interest rates. Who cares what their reason was. The bottom line is $4T has vanished and a lot of savers/investors have lost 50-80% of their savings.

3. FULL: The Fed has now gone back to a policy of easy (boom) money by pumping it in over the last twelve months at a rate of 25%. This is in addition to an unprecedented monthly interest rate drop of « of 1% in the first five months of the year. Their hopes is that it will increase consumer confidence. For some it willthose who have money, they will go out and buy the new and bigger house, luxury car and all the do-dads they want. For those who lost a significant amount of savings and who have maxed out on their credits cards, it will take a long time before they can do anything. (Please see BIS transcript below.)

4. UNKNOWN: It is extremely apparent that the WHOLE WORLD economy is dependent on the U.S. consumer. We are the "ugly American" when we spend and when we don't spend! The world economy is experiencing a slowdown which could be extremely detrimental to all of our economies. Yet, the fate of the world economies lies in the back pockets and purses of Joe and Jane Average American since Joe-Six Pack is up to his eye-balls in debt. Consumer spending accounts for 2/3's of all U.S. economic activity and has been a main pillar propping up the sluggish economy. (Please see BIS Transcript on pp. 8 and 9.)

5. EMPTY: Both brick and mortar as well as technology companies are laying off as a result of economic slowdowns. This is as a result of lack of demand for products and for services. Layoffs could drop consumers' income down to a point where he cannot spend.

6. EMPTY: Those that still have jobs, should they decide not to spend, could start to save. According to economist John Makin of American Enterprise Institute, if consumers "save $350B, this could cut economic growth by 3.5%. When combined with plunging business investment spending and falling exports, that retrenchment in spending could cause a 'nasty recession'" (WT, 4/30/01, 1). After all the hype about Americans not saving, should they start now, it would or could exacerbate "recovery."

7. EMPTY: America has built its economic strength based on debt or "shifting sand". What happened to Asia when investors decided to bailout could happen here in America. Everything depends on how the Federal Reserve and the consumer react.

8. FULL: "From early April until May 22, the tech laden Nasdaq composite index soared 41%. The Dow rose 21% from its spring high and the Standard and Poor 500 rose 19%. Money that poured out of mutual funds during February and march suddenly reversed. "'We're finally looking at the glass being half full rather than half empty', said Ned Riley Chief Investment Strategist at State Street Global Advisors which has $1.8B in active management. According to the bulls, this Scenario Makes it All but Certain That Stock Prices Will Rise 10% to 20% by the End of the Year" (WP, 5/27/01,E1).

9. FULL: There is a great deal of money waiting to be invested in the stock market. By the end of March there was a record $2B parked in money market mutual funds. Pension funds report at 14% of their assets are in cash. Adding to this are the billions of dollars that continue to flow into the US each day from European investors who think they can still earn better returns here than at home. The Europeans are converting euros into dollars at 86 cents, the lowest in six months (WP, 5/27/01, E1).

10. EMPTY: In order to understand how much one has to make up given technology losses, "Pro-funds Ultra OTC fell 94.7% between March 2000 and April 4, 2001, the Nasdaq low. Since then the fund has risen by 95.6% but at that point it will take a 1900% gain to return to one's original stake after a 95% tumble" (Bill Bonner Internet newsletter, 5/22/01, "Will the Fed Succeed?").

11. TEMPORARILY EMPTY: Recently it was reported that US economic growth hardly picked up at all in the first three months (before rate increases 4 and 5).

12. FULL: As a result of the interest rate drops, housing is still the backup industry which hopefully will keep America going. One out of every five jobs is tied to the housing market. In addition, Americans are re- financing their debt.

13. TEMPORARILY FULL: The jobless rate is 4.5% which is the highest in years. The Fed has pulled out all the stops, inflating the money supply. During the past 12 months they have added $600B to the money supply. They are trying to prevent not only a depression but a recession. This is the biggest threat to the dollar. As the number of dollars increase, the value of each individual falls, both in relation to goods and services made in the United States and to other currencies (Richard Mayberry June 2001 newsletter) (emphasis added).

14. EMPTY: Giles Keating, Chief Economist at Credit Suisse First Boston argues that the unexpected strength of the dollar is helping Europe and Asia by making their companies more internationally competitive. "All other countries are using the weakness of their currencies against the dollar to insulate them from the worst effects in the US downturn. The downfall of the dollar has been predicted many times in the last few years and it has not happened yet. When it falls, it will both reinforce the slowdown in Europe and Asia and add to the inflationary pressures in the U.S. (FT, 4/20/01,5).

15. EMPTY: "The downturn on top of the rising trade deficit has prompted mass layoffs and production cuts. But the industry has kept mum about a principal cause of its woes: the U.S. dollar. A Strong greenback has been jacking up the cost of US exportsparticularly in Europe and Canada while making imports cheap. The National Association of Manufacturers will soon begin pressing the Bush Administration to weaken the dollar. Our dollar's trade-weighted value is up 27% since 1997" (BusinessWeek, 5/21/01, 14).

16. EMPTY: "On Tuesday (5/17) the Fed cut interest rates by 50 basis points for the 5^th time in as many months, expressing concern about the health of the US corporate sector. Trade figures show the deficit increasing about $1B a day. Apparently Wall Street sees the increase in the trade deficit as good news because it shows that the cuts in interest rates are stimulating consumer demand. The Bank of England said in its inflation report, "The rise in the dollar since February has been puzzling as it has been associated with falls in US growth forecasts." The IMF cannot explain the dollars rise either. If you are running a big trade deficit the price of your currency will fall; if you are running a trade surplus, it will rise. The IMF has concluded that the possible explanation for the strength of the dollar against the euro is as a result of hot money flowing out of Europe into the US" (The Guardian, 5/21/01, Internet).

The Europeans and central banks are still trying to figure out why all this money, which has contributed to the drop in the euro, is flowing to the U.S. Should foreigners begin to think American is having its own financial problems, their money will flow out as fast as it came in.

17. EMPTY: "The Fed's monetary policy is based on prosperity without recessions. Until the 1990s the Fed operated on the assumption that depressions could be averted but an occasional recession was inevitable. Now their heavy expansion of money supply in the face of 4.5% unemployment means we have entered a new era of hyper-Keynesianism. Keynesianism is the philosophy [John Maynard Keynes British economist who Roosevelt relied on for thirty years] that says the government should inflate the money supply however much is needed to avoid high unemployment, no matter how much this damages the value of the dollar. Keynesianism is what led to the severe inflation of the 1970s and 1980s when the CPI was rising at more than 10% a year. The April 18 rate cut moved the Fed from Keynesianism to Hyper-Keynesianism to avoid not only a depression but a recession" (Richard Mayberry "Early Warning Report", June 2001).

18. FULL: Saddam Hussein is building a "Jerusalem Army", Syria is preparing for war and Egypt said recently, "We will side with Syria against Israel." Arafat is on the run with the PLO virtually finished. They are reaching out to Syria, Jordan, Egypt and Saddam Hussein is funding them all. Bush and Blair vowed to remove Saddam Hussein (from friends who follow the Middle East). Recently Saudi Crown Prince Abdullah told the German magazine Der Spiegel that "the region is 'sitting on a powder key' that could 'explode at any time''.

BOTTOM LINE

19. Using debt, it has been the American consumer who has kept world economies moving. At some point, our economic foundation is going to crumble. When it unravels, the US will take a very hard and serious hit as never before in our financial history. Should the Fed make a wrong move and savvy foreign investors perceive it is the wrong move, a lot of money will flow out of the U.S. at electronic-wire speed, prompting the Fed to reverse its course of easy money by jacking up interest rates to compensate for the risk of staying, thereby throwing our economy into a tailspin. What could save it? A war. War is above all, an economic stimulus. Instead of a regional war, it might be something larger because now the world economy would come to a stand-still. Could it be that this idea is not so far from the truth when you consider the massive debt load of not only the United States, but every country of the world? (Please see the transcript of the 2001 BIS Press Briefing on pp. 8 and 9.

20. It is interesting to note that when the technology stocks were dropping, defense stocks were just starting to move up!

BANK FOR INTERNATIONAL SETTLEMENTS:

SOME ABSTRACTS FROM THE ANNUAL REPORT

TRANSCRIPTION OF THE 2001 ANNUAL PRESS BRIEFING

BIS 2001 ANNUAL REPORT - ABSTRACTS

The most significant development during the period under review was the sharp slowing of the US economy beginning in the second half of the last year. Although a slowdown had long been expected and even desired, its suddenness was remarkable for a variety of reasons. It seemed to market the ending of, or at very least a significant pause in, the decade-long global expansion in which the US economy had play a disproportionate but welcome role. 3

Another recent feature of ongoing globalization has been the ease with which large divergences in national savings rates have been dealt with through international capital flows. In the U.S. the net private savings rate fell below (6%) of GDP last year (a decline of 12% since 1992), whereas in Japan, net private savings rose to almost 9%. 4

The capital flows into the U.S. as well as other recipient countries were driven in part by the quest for diversification and perceived opportunities to earn above average investment returns. As a by-product, they provided strong support for the US dollar which in turn helped to tame inflationary pressures. A COMPLEMENTARY EXPLANATION COULD BE THAT THE SAFE HAVEN ASPECT OF THE RESERVE CURRENCY RECEIVED INCREASED EMPHASIS AS UNCERTAINTIES MOUNTED ABOUT GLOBAL ECONOMIC PROSPECTS. 5

Nowhere were economic developments more dramatic than in the United States where GDP growth accelerated to almost 6% in the first half of 2000 under the influence of strong consumer spending and a further large increase in business fixed investment. 5

Yet, as the year progressed, signs began to emerge that risks were accumulating. The Nasdaq fell and kept falling as did other indices to lesser degrees. As a consequence, nominal household wealth in the U.S. actually declined in 2000 for the first time in the postwar period. Conversely, personal disposable income rose to near record levels while the personal savings rate fell still further below zero. While corporate debt levels were in aggregate further from historical highs, the circumstances of smaller enterprises became more problematic. Banks imposed much stricter lending standards, bond market financing for non-investment grade borrowers became almost unobtainable for a time, and vendor financing by technology equipment also tightened. Moreover, consumer spending held up surprisingly well given announcements of job losses and further recorded declines in consumer confidence 6 NOR DID ECONOMIC ACTIVITY IN THE EURO AREA SPEED UP AS HOPED. Europe seemed for a time insulated from developments elsewhere. 7

As in previous years, US demand growth was mainly driven by consumption, supported by strong income growth arising from favorable labor market conditions a well as sizeable wealth gains. Household spending, supported by employment gains, was the fastest-growing demand component. 12

TRANSCRIPT OF 2001 BIS ANNUAL PRESS BRIEFING

Transcript by Joan M. Veon

June 11, 2001 - Basel, Switzerland

Andrew Crockett, Managing Director - BIS; William White, Economic Advisor and head of BIS Economic Department

Veon Questions: Mr. Crockett you said last year that "no country goes indefinitely with a large current account deficit", has the U.S. seen their hard landing, is it yet to come a as result of their large current account deficit and strong dollar, will their hard landing come when Americans no longer consume and spend, what does America need to do to turn around?

Mr. White: I noticed more uncertainty in your economic conclusionsis the world get more complex or the debt level of the world much higher?

Crockett: I think as far as what we said on the US current deficit, we stick with the view that a large current account deficit is not sustainable indefinitely. This is not a controversial proposition as it has been said by U.S. policy makers. This does not mean that a hard landing is inevitable. It is possible to correct a large current account deficit over time. It will require a combination of shifts in absorption in the U.S. relative to the rest of the world. It will probably, in our judgment, involve in the course of, time a decrease in the U.S. dollar relative to other currencies but there is no reason why this should happen suddenly or disruptive manner. It will over time almost certainly happen. The task facing policy makers is to make it happen in a manner that is gradual and positive rather than sudden and disruptive. Clearly, the best way this could be resolved is an acceleration in growth in the rest of the world. This would provide the context in which the slowdown in U.S. domestic demand could be accompanied by an increase in the rate of U.S. exports. That would be the ideal way and probably would be accompanied by a strengthening of other currencies as their economies strengthen relative to the dollar. If those things do not happen then the risk remains of mor disruption and that is something we have frequently warned about.

White: About the issue of the world becoming more uncertain. I think we have always been modest in this institution in our forecasting abilities. We do recognize that there is a lot of stuff that is difficult to understand and to predict. It is true that the world has become more of an uncertain place in recent decades and it has to do with the growing importance of financial markets and changes in wealth valuation. All of these things, of course, are very hard to predict but they do have real side implications and in that case, yes the world has become more uncertain than it used to be.

Question; How great is the risk that the Fed is blowing up a new bubble in the equity markets?

Crockett: The Fed is very aware of these potential dangers and has reached the judgment that given the level of inflationary pressures of the moment and their expectations as to productivity growth in the future that it is will within the prospects of

the U.S. economy to achieve faster growth and therefore a reduction in interest rates will not generate an unsustainable increase in asset prices but will be desirable as necessary to renew the growth rate potential.

Question: Having seen a number of annual reports over years, the main message in this one is that there is the fact that there is a savings rate and rates of investment capital. Capital flows attracted from some other source not savings are driving investment. The U.S. is attracting money from Europe and you are coming across with a strong conclusion that you are coming through with is the need for more and more international cooperation. Is that the central message and how do we achieve it?

Crockett: It's an important message. It used to be a puzzling one that levels of savings were more closely related with investment that was in individual countries than in global capital markets this is the work by Feldstein and Marioka(?). It seems in the last ten years that this bias is diminishing and therefore the level of investment is becoming less closely associated with the level of savings within a country. That means that the capital flows can be greater. Capital flows cannot continue indefinitely. Savers are accumulating claims on other countries because they want to utilize them at some time (all boldface replies denote emphasis added). The fact that the short term discrepancy between domestic savings, investment and balance of payment deficit can be greater without necessarily changing long-term constraint that balances must subside back to a sustainable level means that is more scope for disruptive adjustments as well as more scope for productive use of capital. There is a need for careful monitoring of this process to make sure that first of all imbalances don't grow to be too large and that when they correct that they are corrected in a smooth gradual way rather than in a sudden, disruptive way.

Follow-up Question: The ultimate conclusion therefore is that monetary authorities should certainly be more cooperative. Crockett: I don't think it is fair to say that there isn't cooperation. I would draw a distinction between formal coordination and cooperation. It is true that central banks do not formally coordinate their policy responses but have an intense dialogue about they model they feel affects their economies, how that relates to the model of transmission in other countries and how they would react in different circumstances and I would say that the international cooperation in the monetary sphere is alive and well.

Question: One message of your report, if I got it right is that the risk of recession is not over until now and that we have to wait several more months to get a clearer picture?

Crockett: I think that is true. I think it is true that we are going through a U shaped cycle. There would be a period of importance which will transpire before there is a convincing upturn. What is particularly important is that during that period effects operating through the financial system do not exacerbate the downward tendencies of the real economy. If we can avoid that then I think we are reasonably confident that after a few quarters we will see a normal economy.

Veon Question: What if the American consumer decides they have too much debtwhat will this do to your expectations for recovery on a global basis?

Crockett: This is one of the uncertainties and why we are pursuing a narrow course. If Americans consumers stop spending then you will see a SUBSTANTIAL downturn in demand and that would seep through to other areas and the result would be a MUCH LONGER, DEEPER PERIOD OF SLOW GROWTH LEADING TO RECESSION. That is why it is very important that the confidence of the consumer and businessman is maintained. There is clear evidence that the monetary authorities are alert to the need to preserve this confidence.