We will post a monthly commentary on the U.S. and Latin America around the 15th of each month. We will also post comments on latest economic developments, as they arise.

                      StratInfo - Strategic Information Analysis Inc.   
                                        Miami, Florida, U.S.A.
                                            March 16, 2001

                                                U.S. Economy

• Mr. Greenspan’s second testimony in the month of February (House Committee on Financial Services), which occurred on February 28, was similar in content to the one delivered to the Senate on February 13. However, we were very surprised to see no mention of inflation or the U.S. dollar in his testimony. His only statement on inflation was that the rise in energy prices has had no broad effect on inflation. Nevertheless, as we mentioned in last month’s StratAlert, the Fed intends to lower the Fed Funds rate by another 50 basis points, probably at the March 20 FOMC meeting, and this move is already considered a "done deal" by financial market analysts.

• We hold a very different view from the Fed regarding growth and inflation. The day after the highly unusual interest rate cut of January 3, the Fed announced that the economy had stalled in the fourth quarter of last year. As it turned out, the preliminary estimate for GDP showed a 1.1 percent expansion. Curiously, at his February 13 testimony, Mr. Greenspan projected GDP growth this year of 2.25 percent, a far cry from recession. We expect a lower rate of 1.5 percent, which is still a comfortable rate of growth.

• We think inflationary pressures are building. Part of the reason why markets are paying so little attention to inflation has been the popular use of the so-called "core" inflation rate. As we have amply discussed in the past, this index is misleading, since it reveals inflation only after it has gathered substantial momentum. We use a moving average of the inflation rate, which stood at 3.5 percent this January, up from 2.3 percent in January 2000. Unfortunately, the Fed’s aggressive interest rate cuts may be contributing to further inflationary pressures in the second half of this year. Energy prices do matter, and so do food prices, and unit labor costs have been gathering steam since the third quarter of last year, just as productivity growth is slackening. With the Fed’s further opening of the spigot on the money supply, more inflation should be on the way. Slower economic growth, combined with higher inflation thus spell "stagflation." This condition may then be followed by recession.

• Another potential source of inflationary pressures is the planned tax cut. As we explained in the February 15 StratAlert, the timing of the current tax cut is not opportune. The economy is still hot from more than ten years of strong expansion, the unemployment rate is at a historical low. Under these conditions, further spending stimulus could ignite inflationary pressures. On the other hand, we strongly support a tax cut, since the goal of the government is to balance the budget, not to create surpluses or deficits. We also think that taxpayers’ time value of money is higher than the Treasury bond rate of 5.50 percent, thus it would not make sense to pay down debt. For example, taxpayers can invest their tax cut in the equity market for a historical return of about 13.5 percent, since we do not think they will spend the full amount of the tax cut. Some might actually use the tax cut to pay down credit card debt, which charges as much as 25 percent per annum.

• In his testimony, Mr. Greenspan gives a very clear view of the Fed’s perspective on economic trends. In their view, the slowdown is basically an inventory adjustment cycle. A surge in business investment, responding to extraordinary innovations in technology, eventually led to a glut of goods, and thus to unwanted inventory build up. This explains the slower GDP growth. Since technology has enabled businesses to respond at lightning speeds to changes in market conditions, the Fed felt that it would have to also act aggressively in lowering rates. The Fed seems to be more concerned about the speed of adjustment by businesses, than the underlying factors that led these businesses to change their views about the market.

• We are very concerned about the logic behind the Fed’s interest rate strategy. First, the key issue for policy makers should be to find out how businesses form their expectations and the underlying factors they use in determining their earnings outlook. Simply trying to beat them in terms of their response time to changing expectations, as the Fed wants to do, fails to address the underlying economic problems. Second, Mr. Greenspan mentioned that a significant number of firms were caught by surprise in terms of inventory build up; yet this is not consistent with his view that these companies are supposed to have highly sophisticated information technology at their fingertips that enables them to gauge even the slightest change in demand for their products. This is why it is better to proceed with caution in lowering interest rates, to put more emphasis on how businesses form their expectations and how these can change unexpectedly, rather than exacerbating the problems of market volatility by aggressively lowering interest rates. This policy could also lead to aggressive increases in interest rates, if businesses move in the other direction.

• With respect to consumer sentiment, Mr. Greenspan’s testimony refers to an abrupt break in confidence that is driven by fear, and thus is irrational. Why is it irrational for consumers to lower their level of confidence in response to uncertainty, while it is considered rational for businesses to dramatically cut production whenever inventories show an increase, or to discount future earnings at a sharply higher rate? Several years ago the financial markets were charged with exhibiting irrational exuberance. Perhaps the Fed’s recent actions can also be considered irrational.

• On the other hand, the University of Michigan’s index of consumer sentiment (developed in part by one of the pioneers of consumer psychology, George Katona), shows a decrease from 98.4 last December to 87.8 in February. The financial press classified this as a "plunge" in sentiment. We think a drop to a level in the "60's" would be more like a plunge, and which also happens to coincide with the level of the index in previous recessions. If consumers are depressed because the equity markets are adjusting to more normal rates of growth, they will recover. After all, a good part of the equity investments by small investors are really for their pension or 401-K type retirement programs, which are long-term investments. For that reason, consumers are not likely to lose much appetite for current consumption based on current equity market fluctuations, which only affect their retirement income.

• The economic data for January and February continue to show a slowdown, but not a sharp drop in output. Housing starts were up 5.3 percent in January, helped by lower mortgage rates. Manufacturing output is not as weak as originally expected. The National Association of Purchasing Managers index was up marginally in February. The unemployment rate remains at an a very low 4.2 percent. Finally, the trade deficit narrowed moderately in December, although it remains too high, and we think it will contribute to further weakening of the U.S. dollar, and thus further complicate the management of monetary policy.

                                         Latin American Economies

• A new economic team, headed by former Minister of Defense Ricardo Lopez Murphy, has been placed at the helm in Argentina, after the resignation of Jose Luis Machinea as Minister of Finance. Lopez Murphy is a highly regarded economist who used to be director of the economic research firm FIEL. The resignation of Machinea was not surprising, considering the persistent economic stagnation and mounting pressures on the government to engineer a recovery.

• Mr. Lopez Murphy has been a proponent of applying austerity measures in order to balance the budget. According to his early pronouncements, the new economic adjustment package will include additional government spending cuts and no tax relief. Mr. Lopez Murphy has indicated that economic reactivation must precede any consideration of a tax cut. However, we do not think it is possible to achieve a reactivation of the economy by applying additional austerity measures.

• Our often expressed concerns about Argentina’s debt burden is now shared by major financial       institutions, which are startled by the celerity with which Argentina is tapping the financial package  only recently put together as a safety net. The U.S. government is urging multilateral agencies and financial institutions to postpone Argentina’s debt service payment on $7.0 billion until 2002, in order to alleviate this year’s heavy debt service burden. Perhaps now financial markets will begin to understand our long-standing view that the fixed exchange rate regime is not sustainable, and that a devaluation is needed, perhaps this year.

• Discontent grows in Bolivia for the slow pace of economic activity. The agricultural sector has been in recession, due to the eradication of highly profitable coca crops and is now sustaining heavy losses, because of bad weather.

• The Brazilian authorities passed on the opportunity to cut interest rates recently, out of concern that it could trigger an acceleration of inflation, due to higher domestic demand and an increase in oil related prices. The Central Bank also aims to prop up the currency, against the adverse impact of events in Argentina.

• Although the Chilean economy is growing at a healthy pace, rumblings are getting louder about the slower than expected rate of economic growth. In view of the concerns about the financial health of small and medium sized companies, the government has announced programs to benefit them. Those programs include provisions for debt rescheduling and facilities for the payment of overdue taxes. However, the size eligibility parameters, imposed by the government, actually exclude most medium sized companies. Since other recent measures, directed at capital markets, favor large firms, the medium sized companies feel squeezed out Possibly, additional measures will be announced in the near future. The Central Bank cut interest rates from 4.5 percent to 4.0 percent, in an attempt to prod economic activity.

• Colombian president Andrés Pastrana is now negotiating with the other major guerrilla group, the Ejercito de Liberacion Nacional (ELN). His proposal to create another demilitarized zone for the ELN has met with stiff popular resistance.

• Regardless of Intel’s performance , the Costa Rican economy is expected to grow this year, thanks to investment in tourism, a better performance of construction and higher consumer spending.

• President Hipolito Mejia, of the Dominican Republic, is committed to further reductions of the fiscal deficit. Multilateral agencies have expressed their willingness to help improve the management of public funds.

• The indigenous population has become a force to reckon with in Ecuador. A new indigenous political leader could become a major candidate in the next presidential elections.

• The Central American nations have obtained Spain’s support in their quest to elicit a change in the European Union’s banana import policies. The current system favors African and Eastern Caribbean producers. A new system could be in effect by 2006, which will basically eliminate most entry barriers.

• The U.S. government has temporarily suspended the repatriation of Salvadorean citizens, in an effort to help the reconstruction effort. We expect economic growth to resume in the second half, spearheaded by construction.

• The major political parties in Nicaragua have already nominated their candidates for the presidential elections slated for November this year. The governing Liberal Party picked Enrique Bolanos, the Sandinistas will go again with Daniel Ortega and the Conservative Party elected Noel Vidaurre. All parties are now in the process of forging alliances to bolster their chances. For that reason, the Sandinistas and Conservatives did not pick a vice-presidential candidate. That position will be offered to an eventual coalition partner.

•  In Peru, Alejandro Toledo continues to lead in the polls with an advantage of eleven points over second place candidate Lourdes Flores. A very high 32 percent of voters are not yet decided.

                          
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