3 August 2005

Linear Projections of the Congressional Budget Office in a Nonlinear World

To understand Mr. Greenspan's logic and approach to interest rates, it is
important to appreciate the implications of the Congressional Budget
Office's GDP projections for the fiscal out-years for the United States. At
a compounded real GDP growth rate of 3.7 percent the real GDP grows about 20
percent every five years. That 3.7 per cent growth rate is roughly what the
CBO has projected as an average for the out-years of 2004-2010.
Extrapolating from the historically aberrant past 50 years of complete and
continuous positive performance of US GDP growth, the CBO has used these
anomalous long term average GDP growth rates to construct very similar
linear projections for future years. (During the 150 years prior to 1947 the
number of years with declining US GDP's roughly equaled the number of years
with growing GDP's)

All CBO projections of future governmental tax receipts and disbursements of
discretionary and nondiscretionary spending are premised on a linear
continuation of this average or near average past GDP growth rate
performance. From 1962 total federal annual outlays have been confined to a
very narrow percentage of the real GDP - from 17.5-23 percent with the
majority of years within a 4 percent band from 18-22 percent. Even social
security during the next forty years will do adequately well- if - if GDP
growth remains within the CBO projected targets. The whole house of cards,
dependent upon the linearity of continued GDP growth, is up against the 70
year cycle of consumer saturation macroeconomics, the second such 70 year
cycle for the Second Great Fractal starting in 1858.

In the decision making process to raise or lower fed fund rates and thereby,
interest rates, Mr. Greenspan's primary focus exactly parallels the CBO's
targeted GDP growth. Without maintaining ongoing growth, the whole system
unwinds necessitating larger and larger, and finally impossible, percentages
of the GDP to be consumed in taxation or additional federal borrowing to
maintain entitlement programs and essential discretionary spending such as
for defense. Against this primary focus is Mr. Greenspan's real
understanding that irrationally-too-low or reasonably-low-too-long interest
rates leads to exuberance in new speculative asset arenas, invariably
culminating in collapse. Prospectively from the vantage point of the Second
Great Fractal evolution, there is really no 'just the right way or amount'
for the Fed to cook the interest rate porridge to escape the consequences of
the current global overcapacity and worldwide consumer forward consumption.

It is important to recollect that the CBO has been incredibly wrong in the
recent past with its use of linear GDP projections. The euphoric trillion
dollar budget surpluses predicted in the late nineties by the CBO were
turned inside out and upside down into massive federal deficits with the
implosion of the NASDAQ asset bubble. Enter that inevitable collapse. With
the high tech 32 month slow motion crash in 2000, real GDP growth contracted
to about .4-.5 percent in 2001, 1.6 percent in 2002, and 2.7 percent in 2003
- all substantially below the 3.7 percent desired equilibrium level. With
the Federal Reserve's implementation of a rapid lowering of fed fund rates,
the incentivised US consumer stepped up to the plate and borrowed his and
her way to a 2004 real GDP growth of 4.2 percent. Compare this scenario with
the 45 percent decrease in nominal GDP from its high of 103.5 billion
dollars in 1929 to 56 billion in 1933, non-coincidentally 32 months later,
and Mr. Greenspan will, at the least, have to be given temporary applause in
his levitation act for delaying the inevitable. Cyclewise, the Chairman is
at a bad point in history.

The downside of the lowering fed funds to 1 percent, was the development of
the speculative housing mania which has eerie parallels to the practice of
buying on ten percent margin by the shoeshine boys of the late twenties.
With LIBOR interest-payment-only loans and no money down, the proportional
leverage for the individual investor in the last five years was on a
magnitude significantly greater than the prospects of the ten percent on-
margin stock acquisitions in 1929. The 20's small-time investor was required
at least have the ten percent up front to pay the margin broker with
expected interest payments of 7-13 per cent. In the twenties this might
represent an initial leveraged investment of ten to fifty dollars for the
bulk of saving, thrifty spit shiners. As well most Americans in the late
20's did not participate in the stock market. At the nadir of the fed fund
rates in 2003, no-principal payment loans were available with no money down
and an entry level interest rate of near one percent. Under these conditions
just about every wage earner who could afford the price of a monthly rental
could do much better with a house mortgage. After the crash in 1929,
regulatory action was brought to bear on the risky and imprudent loan
practice of ten percent marginal buying. Seventy years later there is a
surprising lack of intelligent anticipation and proactive federal regulatory
action to prohibit the same sort of deju va lending problematic practices in
the housing mortgage arena.

On 29 July 2005 the Wilshire 5000 (TMWX) had its third unretraced exhaustion
gap occurring at 10AM EST at a level of 12450 gapping nonlinearly upward to
a four year high at 12453-4, adding thereafter a few extra points. The
exhaustion gap and peaking phase lasted only seven or so minutes before a
reversal below the 12450 level occurred. July 29, a very odd and
caricaturized key reversal day, was, nevertheless, technically, a key
reversal day. Once again reflecting on the enormity of the 15 trillion
dollar Wilshire summation index and the two antecedent un-retraced
exhaustion gaps to new multiyear highs, this caricature of a key reversal
day - will most likely - have to do.

It would be instructive to see if the Wilshire has ever, in its entire
history, had three unretraced exhaustion gaps each going to a major
multi-year high. Software available to the general public cannot acquire
minutely charts for the March 2000 peak.

The three major European markets: the DAX, the CAC, and the FTSE all
demonstrated key reversal days on July 29, 2005 with (exhaustion) gaps to
multi-yearly highs followed by decay fractals ending at or near the low of
the trading day.

While it is still possible for further equity growth within the 22/54/52 of
54 week maximum theoretical fractal time frame, the latter third and final
52-54 week terminal fractal composed of daily fractals numbering 51-52/130/
and 66 of a theoretical 103 maximum days, substantial further valuation
growth is now much less likely to occur within the context of the above
multiple-equity-indices, very characteristic, technical apogee footprints.

As a postscript to this piece written before the August 2 trading day: the
terminal portion of that trading day indicates an equity blow-off is
occurring. The daily base pattern for the Dollar index is 30 days vice 28,
placing 3 August 2005 on day 73 of a 75 day pattern. Expect a nonlinear
decrease in the dollar index to occur in the next 3 days. Gold and the Swiss
Franc should track oppositely of the Dollar index to a level of 86.25 or so.
The low in the dollar index could well correlate with a maximum equity
valuation with a x/2.5x/2.5x maximum daily fractal sequence or 12/30/30
putting the equity market peak on Friday August 5.

 G. Lammert