Report from Paris

Report from Paris by David Kotok

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).


Paris was cold. Reading reports of a deep freeze in Europe is one thing. Walking on the Rue de Rivoli with hat, scarf, gloves, and three layers and having to avoid ice is something else. Even the highest-end jewelry sellers’ plaza in the world, the Place Vendome, could not keep its sidewalks clean and safe for venturesome visitors.

Three elements surfaced in our conversations with fund managers and bankers.

Russia, Ukraine, and the natural gas cutoff make it to the top of most lists. Putin is trying to unseat President Yushchenko and establish Russian influence over this pro-western country. This is consistent with Putin’s behavior regarding Russian expansionism. Readers are well advised to follow these events closely. The outcome will affect European economic policymaking.

The natural gas cutoff is now impacting half the European Union member countries and reaching as far as Italy and France. The Ukrainians cannot pay what Russia demands, and their ability for energy substitution is quite limited. Either (1) the Russians have to relent and “back down” or (2) achieve political success in Ukraine and establish hegemony as they have in Georgia or (3) the EU members have to pay the bill and submit to this extortion. Stay tuned.

Most investors and bankers are looking for the European Central Bank (ECB) to cut interest rates along with more cuts from the Bank of England (BOE). Expectations are rising that worldwide rates will be converging toward the very low levels already seen in the United States and Japan. We believe this expectation is reasonable and underway. Most of the debt in the world is denominated in these four currencies: euro (30%), dollar (39%), pound (4%), and yen (13%). A convergence means that the global short-term policy interest rate will be somewhere around 1% and the global bond interest rate will be around 2 to 2-½%. We expect that to be the case for all of 2009.

The biggest unknown is how the currency exchange rates (FX) will adjust. Agreement is nearly universal that the adjustment process will be in the FX markets. Japanese intervention is expected, and some of the conversations I had were about why we haven’t seen heavy Japanese intervention yet. The ECB, BOE, and our Fed are unlikely to intervene, so all eyes are on Japan. Ranges of dollar-euro forecasts are as wide as I have ever seen in the ten-year history of the euro. I heard cases made for a dollar collapse, and a $2-dollar euro argued. Four hours later I heard the other side; he made a case for a $1.20 euro.

Cumberland’s present position is for a stronger dollar over the intermediate term. We base that on the fact that the US became more stimulative faster than the other major economies and therefore the US will experience recovery sooner. We believe that currency strength will gravitate toward the faster-growing economies as we morph from recession worldwide into recovery worldwide.

The last point that struck me is how damaging the Madoff affair is to the image of the United States. Revelations like the failure of the Austrian Bank Medici are front-page stuff in Europe. Madoff’s tentacles reached far.

In my view, the regulatory failure is now a bigger issue than the massive swindle itself. It seems that in Europe there was a sense of trust in the Securities and Exchange Commission. There was a view that the US was the most reliable of the capital markets. Everyone knows that markets are not perfect, but the perception was that the United States was more honest or more transparent than the others.

Reports of the Markopoulos memo and others elements that show the SEC ignored warnings over a period of years are, perhaps, the most damaging. Europeans cannot trust US capital market functionality to the degree they could in the past. This structural issue is very serious and not well understood in the United States.

We do not yet know how much it will impact relative pricing of financial assets. We do know that the new Obama Administration and the restructuring of financial regulation in the US must be highly sensitive to effects that are global. The Congressional Barney Frank-Christopher Dodd nexus are rewriting our financial rules. There is much potential harm that can come from poorly conceived legislation or from US home bias or the protectionist influences that are working in Washington.

This last point is probably one of the most serious one that markets face in 2009. Global financial integration can proceed and that will mean a resumption of growth worldwide. To do so we must overcome the US-led financial failures of Lehman, AIG, Bear Stearns, etc. Success will require that the United States is believed and that our financial markets are trusted. The Federal Reserve knows this and is following a policy in that direction. Obama seems to know it and his close advisors like Volcker and Summers certainly do.

The risk is in the Congress. In Europe there is low confidence in elected politicians there. Their eyes are now focused on us, and they are watching the Congress closely. This is a bigger risk than many in America think. Reminder: it was the congressionally passed Smoot Hawley protectionism that took a recession and turned it into a depression in the 1930s. Woe to us and to the rest of the world if a modern congressional version is applied in finance instead of import goods.

Lastly we offer a restaurant review. Our friend Lillianne, chef-owner of her exceptional bistro, is still our first choice. This is not a fancy place. It’s just a superb meal of traditional French food in a charming 300-year-old room. She cooks everything herself. If you are not careful you can walk right by it and miss the entrance. The place is called Aux Anysetiers du Roy, and it’s found in the center of the Isle St. Louis at number 61, Rue St. Louis en L’Isle, local number from Paris 01-56-24-84-58. Tell her David sent you.


David R. Kotok, Chairman and Chief Investment Officer, email:

Cumberland Advisors supervises approximately $1 billion in separate account assets for individuals, institutions, retirement plans, government entities, and cash management portfolios.  Cumberland manages portfolios for clients in 42 states, the District of Columbia, and in countries outside the U.S. Cumberland Advisors is an SEC registered investment adviser.  For further information about Cumberland Advisors, please visit our website at

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