We start the year off with a little controversy. This week we take the long view of a problem created by current government policy as a result of the War on Terror that may not show up for 20 years, but if not corrected will have far-reaching consequences for the global balance of power and the US economy.

This week's letter will be a little shorter than usual, for a variety of reasons, not least of which is I am both taking a little time off and also doing a lot of research for next week's 2005 Forecast Issue. At the end of this essay, I also mention a way for you to personally help in getting $5.5 million dollars of medicine to Sri Lanka for $.02 on the dollar, a very good investment, if I do say so.

But before we get into this week's essay, let me note that I have recently finished two pieces for the Accredited Investor E-Letter and have a third in the works. One of my top of the list New Year resolutions is to write more Accredited Investor Letters. The current letters are available through my associates at Altegris Investments. If you are an Accredited Investor (typically net worth of $1,000,000 or more - see my web site for details) and are interested in learning more about hedge funds and alternative investments, I invite you to go to www.accreditedinvestor.ws and sign up for the letter. I work with Altegris Investments to offer information and access to alternative investments to accredited investors. You can find out more about the process on the website, as well as read information about the risks. I now have an arrangement with Absolute Return Partners of London to work with European investors, and work with ARP along the same lines as I do with Altegris.

I wish I could make the offer more universal, but the rules do not allow me to do so. I hope that at some point in the future Congress will decide there should not be two classes of investors, but until that time the rules are quite clear. (In this regard, I am the owner and a registered representative of Millennium Wave Securities, LLC, an NASD member firm. See more disclosures on the web site and at the end of this letter.)

And now let's look at America's Creativity Crisis.

Stupid Government Tricks

Decisions have consequences, we preach to our kids. Often these consequences are unintended. The list of unintended consequences of government decisions is long and mostly sad. In my reading this week, I came across several stories which when brought together paint a not altogether happy scenario for the future of an unintended consequence in the present. But it does not have to happen.

The United States has seen its wealth and power greatly enhanced by its leadership in computers and information technology. What a different world it would have been if things had been different and the communication and information technologies which were the backbone of our economy had been developed somewhere else.

It all seems so natural now as we look back. Nascent telecommunications and computer industries were born during the war effort in World War 2, and defense needs and commercial opportunity led to an onward and ever upward progression of development.

But it didn't have to be. The United States was not the only computing power at the end of the war, and it may not have even been the leader.

Those clever Brits, led by Alan Turing, needed to be able to crack the secret codes that Hitler was using, and in a timely fashion. As Hitler used ever more complicated codes, Turing and team had to develop better techniques and tools. Using 2400 vacuum tubes and a number of servomotors, they built a machine Turing had theorized back in 1934. Even though it could not be built at the time, he conceptualized the stored program computer with programmable instructions. He called it the Universal Machine, as it could figure out any algorithm depending upon how it was programmed.

When it was built and made operational in December of 1943, it gave the Allies a huge advantage in deciphering Nazi codes, learning about enemy troop movement and plans before D-Day. It was not much as computers go today, but it was better than anything which had been built. "It was called the Colossus, and since it could change its program based on which code needed to be deciphered, it was a true Turing programmable computer." At the end of the war, there were 10 of them, cracking code and advancing technology.

(From How We Got Here by Andy Kessler, a great book on how we went from the steam engine to the internet, as well as how the markets that financed it all came to be. Andy has privately printed the book to give away to engineers and other students. www.andykessler.com)

So, why isn't Bill Gates British? Kessler tells us the sad tale.

"... when the war ended, the British were scared stiff that Russian spies would infiltrate Bletchley Park and steal the design to the Colossus for their own secret intelligence. They destroyed all 10 Colossus machines and burned the plans. Some believe two of the machines were used by the British government for a few years, probably tax department, and then destroyed. The existence of the Colossus was classified until the 1970s. What? Destroyed? This turned out to be a costly mistake.

Because of Turing, they had a shot at repeating the steam engine story [which was the basis for the pre-eminence of the British Empire]. These computers were no different than steam engines, they added value to raw materials, in this case knowledge instead of iron or cotton. But some paranoid bureaucrat cost Britain its shot at leading the coming computer, semiconductor and communications revolution. It's as if they had destroyed John Wilkinson's cannon barrel boring tool after Napoleon's defeat. From here on in the saga [of technological innovation], you won't hear too many British names or inventions. Amazing."

America's Creativity Crisis

The team at the Williams Inference Center read thousands of articles from all sorts of world wide media every week, looking for the beginning of trends, trying to pick up the inference before it is a well-known fact. As Donald Coxe notes in his Rule of Page Sixteen, which is, "You don't make or lose serious money from a story on Page One: you make or lose serious money from a story on Page Sixteen which is on its way to Page One." I really like their work, and spend serious time looking through the stack of files they send me from time to time. (www.williamsinference.com)

Jim Williams graciously let me re-print this report. The conclusions afterwards are mine and should not be blamed on him.

"India does not have one Bill Gates, it has five." -- Ben Verwaayen, CEO British Telecom

"America's growth in the last century comes from its openness to new ideas. Stanford University economist Paul Romer asserts that the great advances have always come from ideas. Immigrants have played a large part in America's growth. Intel, Sun Microsystems and Google - all were founded or co-founded by immigrants from places like Russia, India and Hungary. Nearly a third of all businesses founded in Silicon Valley during the 1990's were started by Chinese- or Indian-born entrepreneurs, according to statistical research by University of California at Berkeley.

"Students are a leading indicator of global talent flows. The countries that attract them often retain them. For decades, international students have flocked to the U.S. to take advantage of its world-class education. Recently, however, a report by the Council for Graduate Schools found that international student applications for fall 2004 admission had dropped sharply at 90 percent of the schools in its survey. The total decline was 32 percent.

"It is not just students who are affected. The Homeland Security Dept.'s annual report on immigration released in September shows the total number of immigrants - those granted the right to stay in the U.S. permanently - declined 34 percent in 2003. More importantly, the immigrants with the most to offer seem to be having the hardest time getting in. The number of workers with advanced degrees or exceptional skills who were admitted to the U.S. fell 65 percent last year. For the first time in modern history, top scientists and intellectuals are choosing not to come to the U.S.

Talent Flow

"Even established American intellectuals are starting to look elsewhere. Roger Pederson, one of the leading researchers in the field of stem cells, left the University of California to take up residency at Cambridge University's Centre for Stem Cell Medicine. Steve Chen, a Taiwanese-born American who is a leading scientist in supercomputer design, has left Cray Research in the U.S. for opportunities in China. There is no stronger form of technology transfer than to have a world-class expert go off with all his knowledge.

International Competition

"The percentage of population represented by immigrants is higher in Canada and Australia than in the U.S. These countries understand that today's global economy centers on competition for people rather than for goods and services. Pete Hodgson, new Zealand minister for research and technology, explains, "We no longer think of immigration as a gate keeping function but as a talent-attraction function necessary for economic growth."

"Richard Florida, author of The Rise of the Creative Class , has created a Global Creative Class Index to compare the size of the creative class in 25 different countries. Far from being the leader, the U.S. is not even in the top ten in this index. In the area of patents, America's formidable lead has been eroding, also. Today, foreign-owned companies and foreign-born inventors account for nearly half of all patents issued in the United States.

"Cities in other parts of the world like Brussels, Toronto and even Dalian, China, are becoming creative-class centers to rival Boston, Seattle and Austin. Dalian is a special example. It symbolizes how much China's modern cities are rapidly grabbing business as knowledge centers, not manufacturing hubs. Dalian has 22 universities and colleges with over 200,000 students. General Electric, Microsoft, Dell, SAP, Hewlett Packard and Sony are all there.

"The Chinese people, historically, were the employees and working for big foreign manufacturers. After several years, they have learned all the processes and steps and can start their own firms. Software will go down the same road. Young Chinese who are employed by Dell and Microsoft, in time, will be on their own.

"Perhaps Richard Florida is correct when he asserts that the creativity crisis could be the greatest economic challenge for the U.S. since the dawn of the industrial revolution. The looming creative outflow to foreign countries may rob the U.S. of the capacity to adapt to the next major change."

In talking with academic sources, a large part of the crisis is simply due to the fact that foreign grad students cannot get visas because of the enhanced security due to 9/11. While it won't show up today, this policy if not altered will begin to have an impact over the years.

English only universities and graduate programs around the world are beginning to appear, taking away one of the primary reasons(learning English) for foreign students to come to the US.

The world is getting ready to go through a fairly serious upheaval as the global imbalances brought on by America's deficit must be brought back into a more reasonable equilibrium. Clearly, the United States cannot continue to absorb an ever-increasing part of the world's savings. It is already over 80% and continues to grow every year.

But breaking the cycle will not be smooth. What happens when the American consumer will no longer be the engine for world trade? It will not be a smooth transition. The US will have to save more and lower, or eliminate, its government deficit. China and the rest of Asia will have to become their own consumer engines for growth. Europe will be forced to reform its social system.

Understand, the world will not stop, but it will change. The process will not be fun for many people, but the end result will be a more balanced world order. It is not a one time event, but a process. I believe that process may take 15-20 years to sort out.

That being said, when we have sorted it out, what will the world look like? Pretty positive, actually. The nascent biotech, nanotech and robotic technologies will have either started or be starting their innovation booms, perhaps all at the same time. The mature phase of the information boom will be going strong. We may even be seeing a new energy paradigm transform the way we access power. It could well be the brew for the greatest expansion of human progress ever seen, with change accelerating at an ever-increasing pace.

The initial phase of any innovation cycle generally takes decades before the first real growth part of the cycle, whether it is steam engines or computers. People have to figure out how to apply the new technology. It is reasonable to expect the sources of change mentioned above to have the same trajectories.

But the question is whether the lead change agent will be the United States or other parts of the world that have done better at attracting the most creative innovators.

It is fair to say that Asia, many of whose countries are graduating more engineers and scientists than the US, will be a major source for innovation. All that innovation brings jobs and prosperity, not only for their nations, but for the world. We are all made richer by the advance of human progress and freedom. I am all for them giving me new and better tools and medicines.

But for the United States to maintain some relative ability to compete in a world of change that is even now hard to conceive, we must continue to attract what Richard Florida calls the Creative Class.

Instead of throwing up barriers as we have done in the past few years, we need to open the doors to grad students and encourage the best of them to stay. Instead of making it difficult for the Creative Class, we need to make it simple.

Now I know that many will talk about how "they" will be taking "our" jobs. That is a very short-sided way of looking at things. "They" will be helping us build industries that will create more high paying jobs in the future. Just like almost every immigrant who made his way to America. Just like the 99% or so of us who come from immigrant stock.

Or, we can burn our Colussus, our innovative machine, in a bid to protect our jobs and our homeland, an effort which will do neither. If we don't stay creative, if we are not at the edge of innovation, our jobs will go away.

I am not talking about an open border immigration policy. I am talking about a thoughtful, sensible approach to making sure that the people we need the most, the people who will help us build the future, are at the top of the list, rather than toward the bottom where they are now.

And while I do not want to take another five pages, let it be noted that our education system below the college level is becoming an increasing source of problems. The recent TIMMS study shows that we are continuing to fall behind in math and science. Much of our public education needs to be reformed. Vouchers which would give parents a choice about where their kids will go would do much to help, creating a system where competition would create the drive for improvement. But that's another story for another day.

Sri Lanka Desperately Needed Aid Relief

My good friend Sir Ed Artis of Knightsbridge is heading up a massive relief effort to Sri Lanka. He has found $5.5 million of medicine and supplies, enough to fill a 747, and will be going to Sri Lanka, along with Dr. James Laws and other volunteers, to personally see that the supplies get to where it is needed most. Of course, he maxed his credit cards out at $108,000 to get the medicine, trusting that friends and donors will be found to help with the bill.

I don't have to tell you how urgent the need is. You see it on your TV every day. Ed and the team are forming up and leaving as you are reading this letter.

Knightsbridge is an all-volunteer NGO (non-governmental organization) that has brought aid to some of the most dangerous and roughest spots in the world. These are the really, really good (if somewhat crazy) good guys. They have been featured on National Geographic and papers worldwide. When you donate to them, 100% of your money goes to the field. There are no salaries, "overhead expenses" or fund-raising costs.

I know that there are some very wealthy readers of this letter. For $130,000 plus your on ground expenses, you and your friends can outfit your own mission. Knightsbridge can show you where to get the discount medicine, help arrange shipping and diplomatic contact to get them in country and will either meet the plane or be on it with you. Now that's an adventure to tell the grandkids about, and you will save the lives of 1,000's of someone else's grandkids and grandparents. Call me direct if you are interested.

Every penny is needed. You can help. You can learn more about Knightsbridge by going to www.kbi.org and send a tax-deductible check (it is still 2004, at least in your checkbook, is it not?):

Knightsbridge International
PO Box 4394
West Hills, CA
91308-4394

Thanks from the bottom of my heart.

Happy New Year and Many Thanks

I love a new year. I always get so optimistic at this time of year about the future. And once again I find that with all of the hassles and vicissitudes of life, I am in a better place as the year closes than I was when it began.

And a big part of the reason is because of you, gentle reader. I am grateful that you allow me the time to come into your home or office, taking the time to read and respond. It is truly one of the joys of my life to write to you each week. This will begin my fifth year, and the growth from a few thousand readers to over 1,000,000 from all over the world has amazed me. Being free helps of course, but I am delighted that so many find my musings of value. I will continue to do what I can to shed some light on the world around us, only every now and then straying from my assigned beat of investments and economics.

And if you think about it, next week feel free to forward my 2005 forecast to your friends and suggest they go to www.200wave.com and subscribe for free for themselves.

And now, as our New Year begins, it seems right to me to close out the old year with the standard benediction we all know:

May the Lord Bless you and keep you,
And let His countenance to shine on you, and give you Peace.

Your looking to the future analyst,

John Mauldin

P.S. If you like my letters, you'll love reading Over My Shoulder with serious economic analysis from my global network, at a surprisingly affordable price. Click here to learn more.

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