I believe there are some interesting and substantial changes coming relating to the “macro economic cycle.” Before I get started on this topic, you may want to know where I get my information and who I speak with concerning these topics. Well, it comes from anywhere and everywhere - both sides of the aisle and both sides of the world. I personally love economics and I’m a bit of a geek in that I enjoy feeding my brain with business stats vs. sports scores (don’t get me wrong - love sports). Some of my favorite media outlets are CNBC, The Economist, Harvard Business Review, Bloomberg, Forbes, etc. I listen and read like crazy. I try to keep up with what the Fed is saying, other central banks - and it’s fun to have economic debates with various brilliant business people and economist in my direct sphere of influence. The opinions and possibilities that I have shared (and how they relate to our industry) did not actually come from any specific source, but more a personal breakdown and employed common sense as I see and read the data. Not many have actually listened to my predictions over the last year - but some of what I have been looking out for is now showing up in various media outlets.

You have two main topics of discussion, very closely related, but two topics nonetheless that I find extremely interesting and “Global Shifters” as I like to call them. I want to attack the “savings vs. spending” issue first - then move on to the Stagflation concept (and possibility).

Think of it like this: Try to visualize money flowing between the two spheres of our planet on a big highway - coming and going. Now, think of a highway during rush-hour - in most cities one side of the highway is packed and the other side cars zooming to their destination. This is pretty much how the “money highway” looks today that stretches between the US (major economic power) and Europe & Asia, et al. The “traffic” is on the inbound to the US side of the highway. Why is this? Simple - Europeans and Asians are “savers” and Americans are “spenders.” As Americans maintain a healthy appetite for spending - Europeans and Asians are happy to aid the US in financing such habits. Again, visualize the money highway - Europe and Asia money flowing inbound to the US - but very little money is flowing back due to Americans borrowing and spending it - which is what has sustained our economy for the last few decades - and predominantly the last 15 years of growth.

Now, you may ask: Why does Europe and Asia save instead of spend? Well, there are a few answers to this question and it is not only private consumers, but also private and public businesses that have followed a healthy regime of savings vs. spending. In both Asia and Europe it can be argued that they are simply more conservative than the average US citizen. In addition to this, without going into a two hour dissertation, these massive economies had suffered big booms and big crashes in the past that set a “new tone” for financial behavior - both “people” and “corporations.” When there is a great deal of dollars, or liquidity, flowing into the market it spills over into other countries that need to borrow it - thus the “pump was primed.” If the US is the proverbial pump then Europe and Asia is the proverbial well.

Now - here’s the big question: What if one of two things or both happen?

1. What if Americans change their spending habits and start to save?

2. What if Europe and Asia start to spend?

3. Or both, what if the pump stops needing water and the well runs dry and needs water?

The answer is simple-the traffic on the money highway flips the other way - the traffic jam would be headed into Europe and Asia and traffic heading into the US would be drastically less congested.

There is one idea if, but more when, this happens. The US Bond Market is a simple mechanism of “supply and demand.” In addition, the price of the bond runs opposite to the yield, rate or coupon on the bond. Simple enough right? - If there is less demand for US Bonds (due to other countries not participating in the purchase of US bonds to the extent that they have in the past), the price will need to be reduced enough for demand to come back into play. As the price reduces then the opposite will happen to the yield or rate - it will go up.

Ok - now the question is - how far could rates go up due to this global shift in money flow? That my friend is the 64 Trillion Dollar, Euro and Yen question! Who blinks first - right? If the timing is perfect and it plays out that Europe/Asia start to spend at the very same time that the US starts to save (which we are starting to already see evidence of) - you can argue that the demand on bonds created by US citizens and US corporations could possibly fill the demand - or void (approximately 30% to 35% of our bonds are lent to countries beyond the US). That is a lot of demand to fill. If there is an imbalance to the flow of money weighted too far to one side or another - this could spell trouble. However, back when Alan Greenspan was the Fed Chairman he stated in a speech, “The US can and will buy its own bonds all the way up the yield curve to preserve the balance in demand.” That’s nice - and I hope the Fed can actually accommodate the market to such an extent - especially if the bill comes in the mail to pay for all of the failed Nation Building that the US has been meddling in over the last five years. That, in itself, is a hefty price tag that was financed with US bonds that will need to be paid off. When these “war finance bonds” are paid off they will inevitably be shoved back into the supply chain - again, lots of bonds to sell with only so many buyers - price is forced down (or way down) and yield goes up.

We are about to segue into how I see this issue tying into Stagflation (simply defined as an economy of high unemployment and high inflation - look back to the years when Jimmy Carter was in office - perfect example), which is a second topic that is related to the overall macro changes I have been keeping an eye on over the last 18 months. Before we move into that aspect of the discussion I would like to shed just a little light on why societies / economies make the transition from “saving” to “spending” - or visa versa. Let’s take Europe and Asia for example. These societies are feeling very confident and comfortable with their current economic state - times are good. In addition, younger generations are being influenced by Western influence, which has sparked new beliefs that obtaining and adopting a materialistic mentality is becoming more popular - regardless of financial state. As long as there is an institution willing to lend them the money - why not buy? In addition to this, European and Asian corporations are feeling their oats as well, but there’s another factor on the commerce side of the equation that I believe is extremely relevant in this argument - and that is the fact that European and Asian businesses spent a lot of money over a decade ago (even 15 to 20 years ago) to drastically ramp their productivity technology infrastructure. We are now starting to witness a great number of these companies that are utilizing close to 100% of this now outdated technology and they are looking to re-build their technological platforms for the next decade (one reason why I like a lot of sectors in Tech). This, in turn, creates a spending / borrowing attitude rather than a saving / retaining attitude. The “well” is turning into the “pump.”

I think anyone can figure out for themselves the countless reasons why the US will “wake up and smell the debt burden.” The wake up call is not a soft whisper in your ear as you wake up slowly to a hot cup of coffee on a sunny day with breakfast served in bed. No my friend - it comes first with a ice cold bucket of water thrown on you as you are in deep REM, followed by a hard slap across the face and it’s sleeting outside and you forgot to close the sunroof on your 911. Not a fun process - and when this occurs it is natural to rapidly move into a conservative state/attitude. I think the “bucket of water” has already been thrown for the most part - the overall credit crisis that we have all witnessed as of late. What comes next? It’s not too hard to contemplate that - just talk to a large enough group of Americans and they will share a laundry list of fears and issues that are plaguing our nation that no one is doing much about! Ok - let me jump off my soap box and reel this back in. Let’s move forward and talk for a minute about Stagflation.

Stagflation is the worst of the worst of any economic cycle - if I dare call it that. It’s happened before - why would it not happen again? Now, any economist will tell you that high interest rates (as I have laid out a possible blueprint of above) is a direct deterrent to inflation - which is the second major ingredient to stagflation - high unemployment coupled with high inflation. Ok fine, but stagflation is a forced issue that all central banks and social economies try to avoid at all costs. With that in mind, stagflation happens regardless of many economic standards. The two issues, unemployment or inflation, may or may not be related. In addition, why do we always look to traditional forms of inflation when determining stagflation? If there are forces causing unemployment and at the same time your housing expense has increased due to higher interest rates (that cannot be reduced by the Fed - just too tall of an order) how does this not reduce a person’s discretionary spending? How can we not argue that the higher interest rate is not an inflationary ingredient? This can only be done if the higher rates slow the economy “just enough” to entice commerce to “lower prices.” But what’s next? What if the economy continues to slow and commerce can no longer reduce prices? At some point commerce is forced to say “uncle” and head the other way. The cost to produce a good is “X” - then add a margin of profit and you have a business. Well, this is where stagflation comes in - a business eventually crosses a line and starts to focus only on customers that can actually afford the goods they are producing. This, in turn, reduces the volume of goods sold and the business is forced to “inflate” prices to meet profitability demands. The scary part is - this phenomenon feeds on itself. This same business is producing less so they layoff employees (higher unemployment). At the same time they are increasing the price of the final product due to the lower volumes only being sold to the few that can afford them (higher inflation). There’s not much you can do in this scenario except ride out the storm.

Ok - let’s not all jump off a cliff here! There are many features to the massive US economy that suggests that even if this did happen it would be more of a “low level stagflation period.” In addition, there are many more channels of our economy and it is much more global than it was in our last stagflation cycle in the 80’s. I also want to stress that no matter what, there are always people buying homes, cars, boats - you name it. In addition to this, the “need factor” for the typical American citizen has drastically changed over the last three decades. In years past the need for two cars, a computer, stylish jeans, certain types of foods, and the list goes on forever, was simply not a part of this equation and there is no way to determine how that factor will impact our ability to stem-off or heal from a stagflation period. Bottom-line - don’t lose any sleep over it and use the knowledge to position yourself for the inevitable opportunities that will arise in any market environment. What I have stated is a lot of “what if” and “opinion.” But the one thing I can state with certainty - things just never stay the same.