LITTLE RED RIDING HOOD ECONOMY...

Craig R. Smith, CEO, SATC

Feb 12, 2004

Wall Street may be shaking off the dire predictions of budget deficits, but the list of voices warning Americans that the so-called "Goldilocks economy" scenario could instead become a Fox-Eats-Little-Red-Riding-Hood" scenario reads like a who's who of world finance.

Sure you can ignore my warning ... or my brokers, but you are walking down the garden path to destruction at your own risk if you choose to ignore the many voices calling for a major correction based on unsustainable U.S. debt levels.

DAVID WALKER - U.S. COMPTROLLER.

"The GAO was unable to express an opinion as to whether the U.S. Government's consolidated financial statements were fairly stated for a sixth consecutive year. And I can assure you that the US Government will not receive an opinion on its financial statements from the GAO until it earns one"

"In the case of the Social Security and Medicare trust funds, the federal government took in taxpayer money, spent it on other items and replaced it with an IOU. Given this fact, why aren't the amounts attributed to such activities shown as "Liability of the U.S. Government?"

"At present time they are not. These additional amounts total tens of trillions of dollars… They are likely to exceed $100,000 in additional burden for every man, woman and child in America today, and these amounts are growing everyday." The alternatives to a budget disaster are "INFEASIBLE." [FULL STORY: "Top fiscal watchdog's stinging attack on deficit" -Post 1-23-04.]

These solutions include ... Raising taxes to levels far in excess of what the American people have supported before… ... cutting total federal spending by unthinkable amounts, or ... Further mortgaging the future of our children and grand children to an extent that our economy, our competitive posture and the quality of life for Americans would seriously threatened.

ROBERT RUBIN - FORMER TREASURY SECRETARY:

"US Budget deficits threaten US Stock, treasury and Bond markets" He along with Allen Sinai (Economic Adviser to Reagan) Peter Orzag (Senior Fellow Brookings Institute) issued a landmark report titled "Sustained Budget Deficits: Longer - Run US Economic Performance and the Risk of Financial and Fiscal Disarray.

Their Warnings about DEBT:

· 5 Trillion in more red ink.
· A threat to all US markets.
Deficit "may severely and adversely affect expectations and confidence"
· Investors abandoning U.S. investments.
"The loss of investor and creditor confidence, both at home and abroad, may cause investors and creditors to reallocate funds away from polar based investments, causing a depreciation of the exchange rate, and to demand sharply higher interest rates on the U.S. Government debt."
· Death spiral to economy and markets.
"Increased interest rates and diminished economic activity may further worsen the fiscal imbalance, which can then cause a further loss of confidence and potentially spark another round of negative feedback effects"
· Decline worse and faster the people expect.
"The adverse consequences of sustained large budget deficits may well be far larger and occur more suddenly than traditional analysis suggest"

THE IMF REPORT:

The US budget deficits are a threat not only to America, but to the world. Deficits are "As far as the eye can see" "There is little time to address these programs (Social Security) underlying insolvency before government deficits and debt begin to increase unsustainable."

On the value of the dollar "The possible global risks of a disorderly ( dollar decline) especially to financial markets cannot be ignored" IMF says this issue should NOT be ignored.

Can you afford to ignore them?

So, unless you see serious leadership focus on deficit reduction and soon we will see the deficits become a real threat to the current calm we see in the markets.

IF DEFICITS ARE LEFT UNCHECKED WE CAN EXPECT:

· The dollar continuing to plunge.
G-7 just met in Boca Raton and the language in communique was a repeat of language from the last meeting in Dubai. "More flexible exchange rates" are needed to address the massive trade imbalances. Last time we heard this the dollar dropped 12% expect at least another 10-15% drop in the dollar.

· Higher interest rates on the way.
Look at 1950 through 1970's. Federal deficit remained under 3% and real rates remained relatively low, they never exceeded 4%. Then early Reagan years. The deficit surged and so did interest rates reaching highest level in modern history to 22%. Then late 80's. Deficits relative size dropped helping to bring down interest rates. Then the 90's. The "official" deficit shrunk but interest rates did not decline as sharply, as the government continued to finance hidden "off budget" deficits.

Bottom line we are at Reagan deficit levels and you can expect rates to increase with a bang.

Somewhere out there in our future there is a big stocks market turn down.

Slowly the Fed is abandoning its promise of lower interest rate. Speeches went from "Rates staying low in the foreseeable fortune." To "rate may stay low." The language has been subtle enough not abort the recovery, but Fed watchers have been listening and they don't like what they hear.

With all the uncertainty in the financial world, my big concern would be the potential loss of confidence from foreign investors. They hold $1.5 Trillion in U.S. Treasury Securities, $1.6 Trillion in Corp Bonds, $1.17 Trillion in U.S. stocks. If they sell even a small amount the rest of the world will take notice.

WHAT TO DO IMMEDIATELY:

1. Reduce debt - only maintain debt that has an attached asset. Real estate, Margin account, etc.

2. Start to reduce positions in speculative stocks (with P/E over 20:1)

3. Increase tangible holdings, preferably early American $20 Gold Pieces and U.S. Gold Commemorative coins.

4. Vote for the presidential candidate who will commit to lowering spending and deficit.

This may be the most important election we have ever had. -CRS

P.S. Request my FREE "What Do I Do Now" Information Kit to understand why gold is the color of hope and red ink is the color of hopelessness.