This week we take a look at the dollar and global trade imbalances. I will use the draft chapter from my book-in-progress on the topic.

I need to thank so many of you for your book title suggestions. We have had almost 1,000 proposed titles come in over the last two weeks. Some of you put in a great deal of thought, did cover designs and detailed analysis. I wish I could write each one of you personally, but I need to keep writing on the book. I want to finish this month.

Let's go straight to the book.

The past two weeks I have had so many people email me an article by one Geoffrey Heard of Melbourne, Australia that I am going to comment on his nonsense. Because it is so wrong and yet his arguments seem so seductive, it offers an excellent opportunity for us to learn how world currency transactions really affect the price of gold and oil and other commodities. Warning: I am taking off my gloves in this letter. This is one of the more boneheaded pieces of conspiratorial economic garbage that I have read in quite some time. I normally don't respond to such ranting, but because it is seemingly being read and repeated in a lot of places, it deserves some attention.

In most issues of this weekly letter, I spend our time together looking at specific trees and various flora, commenting upon how they affect the overall economic forest. Today, it is time to drop back and look at the forest as a whole, given that we may be on the precipice of events that could change the very character of the forest in which we live.

I am going to do so as a way to frame what I think of as the rationale for my economic world-view. I believe we are in a Muddle Through Economy for a long period of time, and probably the rest of the decade. I have had more than a little criticism of this belief, on scores of websites and in letters from readers, either from those who would suggest that it is Doom and Gloom, or from those who think it naively Pollyanna. I prefer to think of it as neither of the poles, but as a more straightforward and realistic assessment of our future. It is lonely in the Muddle Through middle, and I enjoy the few who share the space with me.

This week I had the pleasure of talking with Nobel Prize economist Dr. Harry Markowitz. We discuss that conversation, and how it ties in with my continued unease with deflation, Paul McCulley's recent essay, the lack of candor from the Federal Reserve, the implications of the dollar bear market, Iraq and more. It will make for a fast-paced e-letter this week, so let's jump right in.

Markowitz received his Nobel prize for a 1952 essay which marked the beginning of Modern Portfolio Theory. Very simplistically, he said you can reduce the overall volatility of your portfolio by diversifying your investments among a group of non-correlating asset classes. When one asset class (such as stocks) was going down, your diversification into bonds and real estate would help hold the value of your portfolio steady.

We cover the globe, currencies, the US economy, bonds, stocks, deflation, inflation, gold, oil and more!

For the last three years, making annual predictions has been relatively easy, at least as compared to this year. You try to discern the dominant theme for the year and then everything else usually flows from there. In 2000, it was an over-valued stock market. In August of 2000, the interest rate yield curve went negative, and as I wrote at length at the time, Federal Reserve studies (among others) showed that a recession always followed a negative curve by about 12 months. I saw no reason for that not to be the case this time. I suggested strongly to readers that the safe move was to get out of the stock market entirely at that time.

Today we are going to look at the world economy, muse on why the dollar is holding its own and when and why it will drop. Then I make a few comments on the current stock market rally. Finally, in a departure from the normal letter, I am going to close the regular e-letter, but add a PS in the form of an essay on the risk of derivatives for those who find the subject interesting.

The US Muddles Through

The world economy is clearly not healthy. Let's look at the US, and then we will go around the world. The US economy grew at 3.1% for the last quarter, which ahs been loudly trumpeted by the cheerleaders on Wall Street. But digging down into the details, we find that if you take out the explosive growth in automobile sales caused by 0% financing, the growth was only 1.5%. The predictions are for a weak holiday buying season. Car sales are now down. Housing was down 11.4% in October, capacity utilization is almost back down to recession lows and the trade deficit widens. Retail store sales are slightly down.

Today we examine the deluge of month end data, which continues to confirm we are in the Muddle Through Economy. I politely respond to George Gilder (even after he called me a Keynesian and an economist) and look at the very long term implications of tax policy. There is a lot of very interesting ground to cover, so let's get started.

As long time readers know, I am in the process of writing a book called Absolute Returns . The basic premise is that we are in a long term secular bear market cycle, which is likely to last for at least the rest of this decade. Therefore, investors will be wise to look for investment strategies that yield absolute returns. History and economic data suggest traditional mutual fund and index fund investors are likely to be disappointed over the rest of this decade, and perhaps longer.

Today we are going to try and help you understand the strange action in the stock and bond markets. We are going to look into the future, and see if we can get a feel for what's around the curve in the road. Is it smooth driving, or are there some rocks in the road we need to avoid?

Last week I asked, "What if they gave a Dollar Devaluation Party and no one came?" After a quick review, I am going to follow up on the implications of this theme, as I believe this is going to have a big impact upon the economy and your investments.

Today we are going to examine a war going on in the central banks of the world. The central banks of the world continue to do what is necessary to make their respective nation's products attractive to the American consumer, doing the best they can to make their currencies cheap. There are increasing calls for the US to let the dollar fall as a weapon in the war against deflation. Both can't happen at the same time. You don't want to let your investments get caught in the crossfire. There will be casualties.

I am working later than usual on this letter, as thinking through the implications of a number of reports I have read this week is giving me some cause for concern. I am somewhat envious this evening of Roman soothsayers. I think it would be easier to analyze sheep entrails than the conflicting economic data coming out this week. At least we would have lamb chops afterward.

September is the month set into my personal rhythms, and that of my generation, as a time to reflect upon the past and look to the future. The first week of school was always a time for review and to get a sense of what we would be looking forward to in the new school year. Even though school has been in session for several weeks, to those of us who went to school in the 50's and 60's, it does not feel right until after Labor Day.

With that cycle in mind, it seems that we should briefly look at the broad investment themes that have been so much a part of this letter, and speculate as to their future usefulness. That will give us a launching pad to look at some very disconcerting economic news from around the globe, and see how it all fits into our personal investment portfolios. Pay attention, class. There will be a test.