Rafael Carrillo bursts with enthusiasm and effervescing hospitality.  His family-run restaurant is El Churrasco Restaurante.  His family-run hotel is La Hospederia de El Churrasco.  You can find them in the old city of Cordoba on Romero Street near the ancient Jewish quarter, the mosque, and the old city gate, Puerta de Almodovar.

Lunch was delicious and deserves rave reviews.  Try the fish soup.  Rafael was kind enough to show us his 10,000-bottle wine cellar.  Late tonight, after our NBEIC group dinner, a few stalwarts plan to open an aged tempranillo at his bar.  In a future trip I will return to Cordoba for two reasons.  First, to enjoy Rafael’s hospitality.  It was good enough for the King and Queen of Spain three years ago.  My brief visit affirms that Their Majesties chose well.  The second reason is to probe this remarkable history, where Jews and Muslims spent centuries in proximity, and lived peacefully.  Cordoba is the birthplace of Maimonides.  The first Jewish inhabitants arrived almost two millennia ago after the Roman’s destroyed the temple in Jerusalem.  Jews flourished in Spain for centuries, until the Spanish Inquisition murdered, converted or expelled them.  The guide at the Jewish Museum tells us that today there are only “three or four Jewish families in Cordoba.”  The ancient synagogue is a monument to the past.  It does not function as a current place of worship.

Here in Cordoba economists continue to discuss sovereign debt, deficits, currencies, political discipline or lack of it and with trepidation attempt guesses about the future.  Greece and Spain and others in Europe appear to be taking steps to rein in their deficits.  These governments know that the penalties for political failure will be severe in economic terms.  The European Central Bank seems committed to maintaining its vigilance over the value of the euro.  Inflation is not an option for President Trichet.  Neither will inflation be an option for his likely successor, Axel Weber.

President Obama’s proposed budget is approximately 10% of America’s GDP in each of the next two years.  That’s proposed and before Congress makes it worse. 

Note:  The US proposed deficit-to-GDP ratio is higher than the European Union’s requirements for Greece’s compliance.  Also note:  When comparing the US dollar and the euro, Greece is 3% of the Eurozone GDP.  California is 13% of the US GDP.  The credit ratings of California and Greece are the same.  What makes Americans think our debt and deficit ratios to GDP are better than the European versions?  The facts on the ground demonstrate the opposite.

Central banks face the deflationary impact of rising debt/GDP ratios.  This is true for the G4 currencies:  the US dollar, euro, yen, and British pound.  These four currencies collectively denominate about 90% of the world’s debt. 

Rising debt/GDP ratios cause real interest rates to be higher than they would otherwise be.  That means less inflation, slower growth, and protracted high unemployment will persist in the G4 for many years. 

We expect the average short-term policy-driven interest rate for the G4 will be between 0% and 1% for all of 2010, maybe all of 2011, and possibly into 2012.  If one of the G4 raises its short-term policy rate, currency values and market expectations will immediately alter pricing so that a new alignment of the G4 currencies occurs.  Trichet understands the need for a coordinated and slow exit strategy.  So does Bernanke, whose term “extended period” is the linguistic code for same.              

Tools that may assist portfolio managers during this period include credit default swaps, inflation-indexed bonds, and various currency hedges.  Their use is developing but caution is warranted.  These securities did not exist in prior periods.  Their newness combines with counterparty risk in the post-Lehman environment.  Use them with care.

Today the US dollar is about 65% of the world’s reserves.  The euro is about 25%, and 10% is all the rest.  The only certain thing about tomorrow is that those numbers will change.  How much, how fast, and with what degree of shock remains to be seen.  During its first 10 years, the euro started at 1.17 USD, reached the low 80s, and then climbed above 1.50.  It has adjusted from over 1.50 to under 1.40 at high speed.  This volatility introduces a risk premium.  For now, that premium is in euro-denominated debt, while the US dollar has replaced the Japanese yen as the world’s carry-trade funding currency.  We shall see where these FX rates lie when Cordoba’s winter gives way to the summer heat.  My best guess is that the euro weathers the sovereign debt storm and resumes its strengthening trend.  Our Global Multi Asset Class portfolio has been in strong-dollar mode recently, but we believe this may be a rally in a long-term strategic-dollar bear market.

The sun has completed its task of warming Cordoba on this winter day.  The hills and terraces of olive groves reflect the light with a soft green hue.  Soon darkness will come to the Old City walls and our group will reflect on this place of history as we debate the economics of tomorrow’s world.