Fourth Quarter, 2002

"May you live in interesting times." It�s generally thought that this expression is a mild version of an ancient Chinese curse. As luck would have it, research on the phrase�s origin leads to no conclusive answers as to either its authorship or original phraseology. The phrase, as well as its confusing origin, seems oddly appropriate to the current economic and investment picture in the U.S. We (the U.S.) are in the midst of a battle of almost inconceivable proportions between the forces of deflation (defined as a decline in a broad price index such as the Consumer Price Index or as discussed below, the Wholesale Price Index) and inflation. The ramifications of which force wins over the other has profound economic implications over what types of investments you should own and what types of returns they will generate. Interesting times, indeed!

Deflationary winds are blowing hard in the manufacturing sector of not only our economy but also globally, courtesy of the Chinese economic miracle and supplemented by the rest of Asia�s manufacturing base. What we mean by this is that Chinese labor and factories manufacture products of quality which are desired by U.S. consumers and which sell for a fraction of the price that those same products would cost when manufactured at home.

China is in the early stages of transformation from an agrarian to an industrial society which is strongly embracing capitalist ideologies. Millions of farmers and peasants are moving to industrial areas throughout that country each year in search of stable employment, much like the population shifts which occurred in the U.S. during the industrial revolution in the late 1800�s and early 1900�s. Chinese manufacturing capabilities span all industries from relatively simple textile items to complex and technologically advanced equipment and machinery.

In virtually all of these areas of manufacturing, U.S. products made at home cannot compete in price with comparable goods made in China due to enormous wage disparities between the countries. While this is good for keeping prices low for all of us as consumers, it is bad news for domestic employment and for future economic growth at home. China�s economic might will continue to undermine our domestic industrial base for many years to come until perhaps some form of backlash develops which demands a political response. A situation like that will clearly be in no country�s best interest. We are not alone in being at a competitive disadvantage to China. Industrialized Europe and Japan also are losing their manufacturing base to that economic powerhouse.

A second deflationary force has resulted from excess manufacturing capacity throughout the U.S., a consequence of the irrational economic behavior of the late 1990�s. Capitalism�s destructive side is that the longer an economic boom continues, the greater are the economic excesses and unwarranted capital investments we humans make which must then be flushed out in the subsequent economic hangover. According to Economy.com, U.S. factories are now operating at 76% of capacity as our hangover continues. Even worse, high-tech industries are operating at 62% of capacity, according to the most recent government statistics. Until our economy gets a little more fired up, corporate investment in new plant and equipment will remain anemic, and businesses won�t have the ability to raise prices and improve profit margins. Moving goods into consumers� hands has, in the fourth quarter, been brought about by deep price discounting�75%-off sales were commonplace here in Atlanta before, during, and after the holiday shopping season. Talk about deflation in action! The Commerce Department�s just-released wholesale price index figures for 2001 indicate the first 12-month decline since the index�s creation 28 years ago.

Now come the forces of inflation to rescue us out of our present funk. That�s right friends, we said "rescue us". The long-time inflation fighter, Fed Chairman Greenspan, states that the inflation foe has been beaten into submission and will henceforth behave appropriately under the Fed�s watchful eye. In fact, with deflationary forces in the manufacturing sector now undermining our economic health, the Fed believes it�s time to bring a little inflation back! Recent pronouncements from Fed governors have made it perfectly clear that they will fight deflation with every conceivable tool at the Government's disposal. The primary tool in this trade is, of course, the printing press and lately it�s been printing paper dollars at shocking rates. The Fed�s present approach is classic in its simplicity. It�s also straight out of the text books of one of the world�s most influential economists, John Maynard Keynes: (1) Print as much money as is necessary to bring inflation back; (2) Keep interest rates as low as possible to encourage continued consumer borrowing and spending until business works its way through the current manufacturing capacity glut and starts its spending and investing again. Will the Fed�s strategy work? Nobody knows.

All actions have consequences. Here is how investment markets have responded since late November 2002, when the Fed declared its intent to bring inflation back:

1. The dollar has experienced a significant decline vis a vis the Euro and other major world currencies;

2. Gold (the best performing asset for 2002) has increased in value by 10%. As long as any country chooses to inflate their money supply, gold will increase in value in terms of that country�s currency;

3. Treasury inflation-protected bonds have outperformed other government bonds which lack an inflation protection feature;

4. Commodity indices have been hitting new highs;

5. Government bonds have continued to outperform stocks through the date of this letter.

So where are we headed with this information? First, the battle between the forces of inflation and deflation is tipping ever so slightly towards inflation at this early point as evidenced by items 1-4 above. This battle is in its early stages and may have a long way to go, so conclusions can�t be reached yet.

Second, deliberate inflationary actions at some point result in rising interest rates. The timing, however, is uncertain because it depends upon investor expectations and emotions. Raising interest rates before a solid economic recovery will kill off the housing markets, cause consumers to slow down their spending, and send the economy back into recession. The Fed is walking a delicate line between a severe recession caused by deflationary trends and a possible recession caused by rising interest rates and inflation.

The securities our clients own in their portfolios reflect a continuation of our past themes.

1. We have given them some exposure to gold mining stocks.

2. We have invested a small percentage of bond portfolios in a bond fund which purchases foreign-denominated government bonds.

3. We continue to maintain low exposure to the U.S. stock market.

4. Treasury inflation protection bonds are a part of bond portfolios.

5. We continue to raise the overall yield on client portfolios by exchanging lower-yielding securities for those with higher yields. We believe that dividends and interest paid into the accounts will constitute a significant portion of clients' overall return in 2003.

6. We are maintaining bond portfolios with relatively short-term bonds.

A phrase comes to mind which seems particularly appropriate when searching for direction in the current investment climate: There are no correct answers; only choices.