-->A BULLISH MIRAGE
By Kurt Richebächer

Good news about the U.S. economy is proliferating. The
international media is littered with articles stating that
the U.S. economy is forging ahead with rapidly rising
profits. Yet neither the stock markets nor the currency
market have taken any notice. Asking traders, nobody could
offer a plausible reason. Yet there are two very simple
tentative explanations: first, the economic news is good,
but not good enough to meet the high-riding expectations;
and second, the bulls are fully invested, and short-
covering by the bears is finished.

Better-than-expected economic news, actually, is coming
from all parts of the world. Asia, accounting for 24% of
global GDP, is hitting 7.7% growth this year. Ex Japan, the
economies are firing on all cylinders, with growth rates
vastly outpacing current and expected U.S. GDP growth. The
tiger in the group is China, with expected 11.5% growth
this year. Common to all these countries are high levels of
gross national saving, including depreciations (averaging
almost 30% of GDP), and also high levels of gross
investment (averaging between 22-23% of GDP).

The U.S. economy, accounting for a quarter of the world's
GDP, is likely to finish 2003 with GDP growth of 2.9%.
Gross national saving is hitting a low of 13.5%, while
gross investments in the past few years have been hovering
around 18% of GDP.

The euro area, accounting for 18% of global GDP, will exit
the current year with barely 0.5% GDP growth. Both gross
domestic savings and gross domestic investment equal on
average between 20-21% of GDP.

While U.S. economic growth is increasingly lagging Asian
growth, the global focus remains primarily on the U.S.
economy as the world's supposed predestined locomotive, for
the apparent reason that America's consumer is the world's
greatest spender. Implicitly, the U.S. current-account
deficit of about $560 billion per year reflects what
Americans spend in excess of their current production and
income.

Yet the Asian countries, ex Japan, have a second reason to
run a surplus with the United States. It is the main source
of the high-powered money of their banking systems. As their
central banks are buying gargantuan amounts of surplus
dollars, they create liquid reserves for their banks that
foster the lending boom to their domestic producers. Vastly
excessive reserve growth is creating vastly excessive money
and credit growth, stimulating and financing an unprecedented
investment boom, similar to that in Japan in the late 1980s.

Global activity data has kept surprising on the upside for
months, and there has even developed speculation that
unexpectedly strong global economic growth may fuel
considerably higher inflation rates. Commodity prices, in
the past generally an early indicator in this respect, have
soared spectacularly. Given, moreover, years of extremely
rampant money and credit growth around the world,
accelerating inflation will be the next great surprise for
many people.

All this raises many questions. It seems quite feasible
that the Asian tigers, with their record-high savings and
investment ratios, will continue to power ahead with
runaway credit creation. Yet our fear rather is that some
of them, in particular China, may derail into Japan-style
bubble economies.

For us the greatest uncertainties are about the U.S.
economy, its financial system and its currency. The great
issue not only for America but also for the global economy
is whether the U.S. economy has definitely reached the
stage where economic growth has become self-sustaining. Or
whether it may relapse into sluggish growth next year, if
not recession. Looking at the markets, we have the
impression that many people are struggling with this
question.

On the surface, the report of real U.S. growth of 7.2% in
the third quarter, later revised to 8.2%, was most
impressive. Many commentators hailed it as the highest
growth rate since 1984.

To us, the exciting growth number raised more questions
than it answered. Yes, it was the U.S. economy's fastest
sprint in 19 years. At the time, it was actually 7.3%, but
this rate referred to GDP growth over the whole year. This
time, it was an annualized quarterly growth rate of 2%,
which is not always meaningful.

Considering that the U.S. economy's long-term growth
potential is around 3%, it should be clear that after three
years, during which annual real GDP growth has averaged
1.8%, it will still take a lot more demand and growth
acceleration to remove the output gap that has accumulated
in these years.

It is also generally agreed that a sustained and
sufficiently strong recovery of the economy is only
possible with a prompt, brisk rebound of business fixed
investment. The bullish consensus is satisfied that this is
happening.

As reported, nonresidential business investment rose in the
third quarter of 2003 by 11%, after 7.3% in the second
quarter. For sure, these are impressive numbers, but the
only thing that gives them this strength is the fact that
the actual quarterly numbers have been annualized. The true
non-annualized growth rates of 2.75% and 1.8% for the two
quarters would have caused nothing but yawns.

But there is a second big snag in the reported investment
numbers. As usual, it arises from the familiar statistical
spin concerning the measurement of business investment in
computers.

In real terms, or"chained" dollars, it increased over the
full year until the third quarter of 2003 from $297.6
billion to $390.3 billion, that is, by $92.7 billion, of
which $35.4 billion occurred in the third quarter. That is
the statistical fiction; actual business spending in
current dollars on computers increased over the same time
by just $11.5 billion, from $76.8 billion to $88.3 billion,
of which $5.9 billion was in the third quarter.
In reality, measured in current dollars, nonresidential
investment over the year increased overall by $46.2
billion. Among this total, computer investment soared by
$93.1 billion, of which $81.6 billion came from the hedonic
spin.

Each additional dollar spent on computers in the real GDP
accounts during the year translated into eight additional
"chained" dollars, accounting, by the way, for 26% of real
GDP in this time. The difference between the two measures
of business computer investments is exploding. So much for
the trumpeted investment recovery.

As we have explained many times, these particular dollars
are fictitious dollars that nobody has paid and nobody
received. Obviously, such dollars inherently add nothing to
profits.

Putting it briefly and bluntly: The trumpeted brisk rebound
in U.S. business capital investment is another bullish
mirage lacking any serious substance.

Given this reality, it seems likely that the coming year
will find the U.S."recovery" neither sufficiently robust
nor constant enough to foster true self-sustaining economic
growth in the U.S economy.


Regards,

Kurt Richebächer,