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Good Morning, Chairman Bernanke


Debt issues continue when we look towards the government.

I would like to take this opportunity to discuss what Mr. Bernanke inherited from Elmer. First of all, he inherited a yield curve that is flat as a pancake, a rather sticky situation generally in itself. The carry trade has been eliminated for the time being.

What else did he inherit from Greenspan? In simple terms, an economy that, while on the outside looks OK, has a little problem I like to call the 'debt bubble.' When Greenspan took office, the national savings rate was approximately 7%. It is now around zero, after dipping to -2% a couple of months ago. Of course, there is much disagreement about what makes up savings. Some include capital gains on homes and financial assets savings. I find this concept preposterous, personally. Savings to me is what you make less what you spend. From a debt perspective, it is hard to know where to start. When Elmer took office, according to Ned Davis Research, total credit market debt to GDP was around 200%. That figure as of September 30, 2005 stood at 308%. What about household debt as a percentage of GDP? In 1986 it was approximately 50%. We are now gaining on household debt being 100% of GDP.

Debt issues continue when we look towards the government. The trade deficit and current account deficit are now roughly a combined 12% of GDP, a new record. Congratulations! This has resulted in a plummeting dollar and as a result, foreigners now control more than 50% of our national debt. This fact, coupled with the fact that emerging nations like China have a need for hard assets has resulted in 20 year highs in gold and record highs in oil. Lastly, as I have mentioned previously, from 1984-1994, M3 grew at approximately 3.5% and from 1995-2005, closer to 8%.

What the new Fed Chairman will do to right the ship is anyone's guess. In 2003, he already has said he would 'drop money from helicopters' to avoid recession or deflation. This would likely further pressure the dollar and one has to wonder just how much pain the foreign holders of our securities will be able to stomach before demanding higher rates under that scenario.

The last couple of incoming Fed Chairmen were greeted with a financial shock. Volker faced double digit inflation and Greenspan faced the stock market crash of 1987. Whether Bernanke will receive a similar gift is difficult to predict. The second year of a Presidential term is usually tough for stocks, particularly after April, usually resulting in an October low. Housing could become a problem if rates stay at these levels or go a bit higher. Since there is so much floating rate debt (even though many ARM's are being refinanced into fixed rate mortgages now), a rise that exceeds 5% in short-term rates or a move to 5% in the 10 year note, or approximately 7% for 30 year loans could make unaffordable housing even less affordable and wipe out many a condo speculator. This could be a problem for banks, but I am just guessing here.

At any rate, I would like to say one thing to the New Chairman. Best of luck and enjoy the pancakes!
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