Madrid, Saturday Night, January 30, 2010

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).


Goya, Velazquez and El Greco provide an excellent distraction from world economics as we walk in the Prado with some NBEIC colleagues. We are here for the quarterly meeting of the National Business Economics Issues Council.

Madrid is cold but the skies are clear. The moon is full. Lovely young women in short skirts with great legs wrapped in black tights and black boots on three-inch heels, strut with their arms entwined with young men with short-cropped hair and close beards. The squares are full of life. The tapes bar/restaurant scene is robust, crowded, and vibrant.

Six of us enjoyed the cuisine and the scene. Some Rioja added warmth. Recession aside, Madrid is alive and tourists are evident. A few mostly older gray-haired or balding economists provide contrast.

NBEIC meetings are closed to the press and operate under the Chatham House Rule. This makes for a lively and fruitful exchange of views and data. It also allows us to compute what a beneficial value-added proposition NBEIC is. Cumberland now has two of the 40 members: Bob Eisenbeis, who established his NBEIC role while with the Fed, is one. The other is me.

Our gathering in Cordoba starts Monday night. The agenda includes an extensive session on the financial markets and the issues surrounding currencies and sovereign debt, and exit policies. We are looking forward to the presentations and discussion.

Tonight at the end of dinner four of us talked about Bernanke and Geithner. We speculated about the forthcoming Fed-Treasury accord and wondered if we need to go and reread the story of the last one, which followed the end of World War II. Elements on the table for conversation include the fact that Bernanke has a bias because of his study of the Great Depression. He does not want to be the Fed Chairman who presides over a repeat of the history of 1937, when the Fed tightened too soon and sent a fragile recovery into a downturn.

But we all agreed that Bernanke has character and is untainted by ethical lapses. The risk may be lack of symmetry in his views, but that is not in the area of ethical standards. We contrasted this with Treasury Secretary Geithner. He is neither respected nor trusted. It started with his various behaviors at the New York Fed and continues with the onslaught of questions about his policy making. One colleague asked if I feared retribution because I was willing to be outspoken in my criticism of Geithner. I answered that I still be believe that our great country protects editorial freedom. I hope I am right.

We will probe the issue of sovereign debt burdens at the meeting here in Cordoba. They are rising. And there is ample evidence in the research literature that a rising debt/GDP ratio causes a rise in the real interest rate. That may not show in the nominal rate, but it is estimable in real terms. Rising debt burdens do act in a deflationary way. Studies show that each increase of 1% in this debt/GDP ratio can add 3 to 4 basis points to the ongoing equilibrium real rate. At Cumberland we pay very close attention to this work when we apply strategies to our fixed-income accounts.

There is great history here in Spain. It is reflected in the art, where the great painters were courtesans, and in the culture, which has modernized but stayed intact in many ways right through today. And now it is being written anew in the way Spain deals with its position in the Euro zone and with its economic downturn. My sense here is that comparisons between Spain and Greece are very wide of the mark. Frankly, it is hard for me to see a default by either country, notwithstanding Greece’s very public budget pressure. But I must say that it is hard for me to see a default by New Jersey or California, as well. Sovereigns have little incentive to default and have many and varied reasons to restructure and pay their debts and bring their budgets into alignment. The penalties are very high if they fail.

We leave for Cordoba early on Monday. The weather report says it will be cold but no snow is expected, so travel delays are not anticipated. Now jet lag is catching up. Adios.

David R. Kotok, Chairman and Chief Investment Officer

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