Taylor on us Economy, Markets & Gold

May 7, 2002

Several bubbles remain in the U.S. economy. Housing is one of them. Recent growth rates in this sector are unsustainable if for no other reason than housing is a durable item that is built once in a lifetime. But given an extreme shortage of savings in America combined with reliance on foreign capital to sustain our living standards, higher interest rates could very soon become a reality that smothers housing.

The stock market remains another bubble despite trillions of dollars that have already been lost. As www.decisionpoint.com reported this week, the GAAP P/E ratio for the S&P 500 remains at an unbelievable 42.1 times!

Still another huge bubble that looks like big trouble is the U.S. current accounts deficit of which the trade deficit contributes about 80%. For many years now, the U.S. has been importing far more goods and services than it exports. This deficit has been growing so that at present, the U.S. is importing about $1.5 billion per day more than its exports.

Normally, this kind of deficit should result in a weaker currency. But the U.S. has succeeded in convincing foreigners to send their net trade earnings back into the U.S. in the form of dollar denominated investments. In fact, the demand to hold dollar denominated assets not only in America but around the globe has led to a dollar that is 30% to 40% overvalued in terms of trade flows. Indeed, dollar denominated capital markets have grown so much, that trade flows are a relatively small part of the demand for dollars.

Which leads me to the 4th major bubble in America which is, to a great extent a result of bubble #3. The willingness to recycle all of the trade surplus plus more into the U.S. has led to a rise in the value of the dollar to its current overvalued levels. Given the immense overvaluation of the dollar, one could make the argument that the entire U.S. economy is one huge bubble, built upon a monetary system that creates what is essentially worthless money out of thin air via the Federal Reserve banking system and then somehow cons the world's population to pay far more for it than it is worth.

Although the strong dollar that resulted from these capital flows into the U.S. has worked well for Americans there are now signs that this chronic deficit is about to cause us huge problems. Why so? Because many of the reasons foreigners sent their money back to the U.S. for investments were based on a host of falsehoods, spun out by an increasingly deceptive and dishonest Administration and Wall Street. Several areas of deception have been outlined in this weekly missive repeatedly over the years. In summary, they are:

  • A Rigged gold price that gave the world the impression that the dollar was a sounder currency than gold itself.
  • Hot air talk about the New Economy by high-ranking Americans including Mr. Greenspan himself.
  • Deceitful accounting practices with respect to corporate earnings which gave a further illusion of profits where in fact there were non ore if there were, they were grossly overstated.

Watch the Dollar for Key to Economic Collapse

In my November 1999 interview with Prudent Bear Fund manager David Tice, he spoke about the U.S. bubble economy. At one point I asked him what he thought would trigger the deflation of the bubble. David responded as follows:

"I guess there are a number of factors that could cause it, Jay. I think your question is very well placed in terms of no one wanting this to end. No one wants there to be a recession. But I think the old Fram oil filter commercial is analogous to our current market situation. You might recall that the punch line to this ad was 'You can pay me now or pay me later.' You see, there is this mistaken impression from policy makers that they can micro manage a multi-trillion Dollar economy and prevent a decline. However, they will not ever be able to permanently prevent a decline. They are simply prolonging the life of the bubble and they are doing it with increased credit.

"How this is made possible and the reason it has gotten to this extreme is because we have enjoyed the advantage of being the world's reserve currency. So foreigners have continued to fund our bubble. And we are now at a $25 billion monthly current account deficit and foreigners continue to buy our paper and exchange goods to us in return for paper. We believe that currencies and a decline in the U.S. Dollar is likely to be one of the pins that pricks this bubble. Our policy makers have been willing to let this bubble get bigger and bigger as long as foreigners continue to finance it for us. But the foreigners may serve as the ultimate vigilante to our profligate spending habits by refusing to continue to buy dollars at current rates."

Steep Declines for the Dollar This Past Week

David's belief that the huge current account deficit was most likely to be the catalyst to finally doom the U.S. economy is beginning to look more and more prophetic by the day. A sign that foreigners are beginning to exercise their vigilante powers was given on Friday when the dollar suffered its biggest drop since January following a higher than expected rise in unemployment to 6%. This unemployment figure is the highest in seven years.

At the end of the week, the dollar had plunged to 113.87. With the 50-day moving average at approximately 117.80 and the 200-day moving average at around 117.20, the dollar is looking ready to cut through its 52 week low of 113.00. If so, we may be poised to go much lower. Why the sudden weakness in the dollar?

The higher than expected unemployment number on Friday was an excuse for the plunge in the dollar. But to readers of this newsletter, this is not at all surprising. Indeed we have been proclaiming that the bubble days of the late 1990's were built on hot air rather than substance. Friday's unemployment number simply helped a relatively few number of market participants to wake up and smell the coffee. A small, but growing number of people are finally beginning to understand what we have been warning for quite some time now, namely that there will be little or no economic growth and what growth if any there is, it will be far from adequate to sustain current equity prices at anything like their current lofty P/E ratios.

We Americans have been living in fantasy land for the better part of a decade now under the "leadership" of a President who loved to spin and define truth as he so chose in order to best suit his own ambitious ends. Spin. Lie. Connive. Deceive. That was the modus operandi of the past administration. And while Americans were titillated with lies related to our President's sexual pleasures, some of his other deceitful actions would, from a human perspective at least, seem to have been far more significant.

From a big picture perspective, the past administration sold a lie to the public that any other socialist agenda tries to sell, namely that government can always intervene in the economy to make things better. So, starting with Mexico, Americans were "blessed" with a series of bailouts aimed at creating the mistaken impression that Bill Clinton was somehow a genius on economic matters. Following the Mexican bail out, we had a series of other joint efforts by the Fed and the Treasury to fool mother nature by creating billions and billions of dollars out of thin air to bail out Asia, Russia, Long Term Capital Management, and Y2K.

One lie begets another and another and another …………….

But as almost always happens, the first lie requires a second to hide the first from view. And likewise, a third lie is required to hide the second and so forth. The second lie told by the Clinton Administration to Americans was that natural market forces were driving the price of gold lower. With regard to the weakness in gold prices from about 1994 until the end of the Clinton Administration, we now know the following. 1) The Clinton Administration dumped gold on to the market by way of low priced gold leases and perhaps by way of other mechanisms such as gold swaps with other countries. 2) Thanks to an academic paper written by former Treasury Secretary Lawrence Summers at Harvard in 1988, the Clinton Administration understood that only if they "capped" the gold price, would their interventionist policies with regard to Mexico, Asia, Russia, Long Term Capital management and the potential Y2K crisis be effective. They also knew that if they did not cap the gold price, capital would cease flowing into the U.S. The Wall Street party would have ended and that would have been the end of Clinton politically.

Summers understood, based on the historical relationship between the price of gold and real interest rates, that if the U.S. were to engage in monetary bailouts, of Mexico and the other situations that followed, real interest rates would fall and the price of gold would rise vis-à-vis the dollar. And, if the dollar declined, that would put an end to the continuous and growing flow of capital back into the U.S. from abroad, which capital was earned from a chronic current account surplus with America. And, if capital stopped flowing back into the U.S., still another lie promoted by the Clinton Administration and others would be exposed. That lie was that America can indefinitely import more than it exports, continue to enjoy the benefits of a strong dollar while foreigners continue to own more and more of America. Supposedly this chronic trade deficit could go on forever. (For additional information on what Summers knew and when he knew it, visit www.goldensextant.com, and read an article pertaining to "Gibson's Paradox.")

Lower Gold Prices tells Larry Kudlow "All is Well in Ameirca!"

So, with the Clinton Administration, aided by the Fed manipulation the price of gold to ever declining levels, every Friday evening on CNBC, Larry Kudlow would, upon taking the temperature of the U.S. economy, declare "everything is well with genius America!" Larry took the temperature of the American economy by simply glancing at the gold price. With the gold price trending lower and lower, Mr. Kudlow would remind millions of viewers on CNBC that all was well. If anything, he said repeatedly Mr. Greenspan should create more money (lower interest rates further) because there was a world wide shortage of dollars. What Mr. Kudlow did not know was that he was taking the temperature of the U.S. economy with a defective thermometer. He and most all other Americans bought the Clinton Strong Dollar policy without ever questioning how that strong dollar policy was being implemented. In reality, the strong dollar policy itself was a sham because to a great extent it was achieved by capping of the gold price. By putting a lid on the price of gold, the Clinton folks deprived the markets of crucial information required for it to make an adequate reading on the dollar. A rigged outcome for the gold price, some of the most rapid creation of money in our history and constant chatter about the "New Economy" led to the most overpriced financial markets in history.

A Major Shift from Paper to Gold May May Now be Underway

That was then. This is now! There is a limit as to how extravagant lies can become before they are discovered. While sitting in a doctors office on Friday, I happened to read an article in the "New York" magazine about Bob Rubin's embarrassing attempt to get the rating agencies to avoid downgrading Enron as that company was rapidly heading toward bankruptcy. Mr. Rubin apparently contacted his old buddy and partner in the gold rigging Clinton years, Treasury Undersecretary Peter Fischer, to see if he couldn't get Mr. Fischer to force the independent rating agencies to hold off on the downgrading of Enron. The article made it sound as if this was one of Mr. Rubin's rare goofs and that he was rebuffed by Fischer. In fact, the thought occurred to me that this was just interventionist Bob Rubin as usual. Only now he didn't have the same old interventionist master Bill Clinton in the White House to collude with him to carrying out a rigging of the ratings. Indeed in two out of two major problems (Enron and Argentina) since the Bush Administration has been in power, they refuse to intervene. Given the Clinton Administration's track record of never passing up an opportunity to intervene, it is hard to the past administration not becoming involved in keeping Enron and Argentina afloat.

Reaching a Breaking Point?

The problem is, the U.S. economic patient has now become highly addicted to bailouts and a drug named money. The U.S. economy can be likened to that of a heroin patient who requires an ever increasing dose of heroin at shorter and shorter intervals, less the withdrawal pains become unbearable. In the case of the U.S. economy, increasing pains are being caused by the excess of its drug of choice, namely fiat money. Excessive amounts of that drug manufactured by the Fed out of thin air, has led to excessive amounts of debt and mal investment. Mal investments of the 1990's are now resulting in huge numbers of bankruptcies and investments that are bears very poor if any cash flows. So, in relation to the mounting debt and debt service requirements, our national income is in decline. Declining GDP growth is a bad thing for the U.S. economy especially at a time when an exponential growth in principal and interest payments combined with declining incomes from mal investment and rising unemployment mean that there is less and less money available to buy real things in the economy. Add to that a global supply surplus and cut throat pricing from China and other developing countries and you have the ingredients for a major economic decline in America and throughout the world.

That in a nutshell is why I believe Ian Gordon and Ron Gilchrist are exactly right in calling for a major depression and a gut wrenching deflation in America, the likes of which we have not seen since the 1930's. And I think signs are indicating David Tice was right to suspect the first real signs of big trouble for the U.S. economy will become visible when the dollar begins to tank. The spoiled rotten 60's generation (my generation), which took over the White House with Bill Clinton in the early 1990's, continues to live their adult lives as they lived youthful years. Live for today and to hell with the future. Don't worry about personal responsibility. Let the government take care of you and your family and its problems. Most folks never stop to think that attitude might result in declining levels of freedom.

But now the time has come when I'm afraid we are about to pay for the excesses of our past. As foreigners understand they have been deceived by market interventions and corporate lies and distortions, the reaction is not likely to be kind to America. We may now be witnessing the first glimmer of a transformation out of the dollar and into other currencies and gold.

Kondratieff Winter Temperature Grows Still Colder

The economic temperature continues to drop as we approach the Kondratieff winter. This past week, the unexpectedly high rise in unemployment to 6% sent the equity markets lower on fear that profits won't rise as much as expected. And signs abound that things are not as good as the politicians and Wall Street salesmen insist they be. For example, when earlier in the week a 5.8% GDP number was announced, what we learned was that 3.2% of that growth was caused by inventory replacement. The remaining 2.6% was in fact lower than during the prior quarter! So if anything, the recovery is slowing down rather than speeding up as CNBC would willfully wish you to think.

Gold

When trying to figure out what is happening in the gold markets, it is always valuable to understand one basic truth. Activist governments hate gold because its mere presence pressures politicians to be honest about money. But honesty to MOST politicians is like virginity to a prostitute. So how do they deal with gold? They lie, that's how they deal with it.

But in the God fearing home I was brought up in, I was taught early on that lies are eventually discovered because one lie leads to more extravagant lies used to cover up earlier ones lies. There are now signs I believe that the lies about the gold markets concocted by the U.S. government and any more countries could convince to join this great deception, are now beginning to surface. Despite a continuing and ongoing effort to trash gold, these efforts are now meeting with less success than in the past. The price of gold is continuing to show signs of strength with spot gold above the 50-day moving average and the 50-day moving average above the 200-day moving average.

But efforts to trash gold by the U.S. and other governments continue, as we would expect.

  • The Germans have of course recently talked and talked and talked about their aims to sell gold in the future. Clearly their goals was to spook buyers out of the market.
  • According to GATA, the Swiss, who have been corralled by the Gold Cartel, (defendants in Reggie Howe's lawsuit) are continuing to dump gold as fast as they can. gold as fast as they can.
  • The Cartel continues to hammer gold down with sudden and massive sales. But these events are much less frequent these days and we note that gold finishes higher in New York about as often as it finishes lower, unlike the days when gold finished lower 92% of the time in New York.
  • Gold lease rates are being held extremely low by central banks indicating their desire to lend out gold to keep the price from rising as was the stated modus operandi of Mr. Greenspan back in 1988.

A year or so ago, the line drawn in the sand by the Gold Cartel was at $290. That has gotten away from them and given their huge short position, that cannot make them happy. Remember at least in theory, they have an obligation to return the gold they borrowed from the Fed and other central banks back to the coffers of those banks. But now, world wide demand is beginning to compete with them for a finite supply of gold. And with the price of gold rising, central banks leave themselves open to considerable criticism for dishording their gold.

Consider the following new and growing sources of demand which is starting to hint at trouble for the Gold Cartel, named in Reginald Howe's lawsuit.

  • JAPAN - The Bank of Japan is expanding its money base at an extremely high rate. In April for example it ran an astounding 36.3% above last year and for March it was up 32% over the year earlier. This is the highest rate of money creation in Japan since the 1974 oil shock. Yet, there is no price inflation in Japan which indicates the public is running away from fiat money into tangibles most notably gold. Demand in Japan for gold has been one of the major reasons the price of the yellow metal is now convincingly above their $290 price ceiling.
  • Russia and China are both adding to gold as monetary reserves. They are gladly buying up cheap gold foolishly dishorded by western central bankers. (Remember as James Turk points out, gold always follows shifts in global wealth. Certainly wealth is being transferred from the West to China and at least for now, Russia too).
  • Islamic countries are demanding more gold since the rise in Middle east tensions and post September 11. In fact, Dow Jones reported last week that 10 central banks are forming an advisory body based in Kuala Lumpur to promote the application of Islamic law in their financial services industries. Islamic law looks favorably upon the honesty of gold as money. So, not surprisingly, there is growing sentiment in Islamic countries for the use of a gold dinar. We actually wrote about this topic a few years ago. But now, at a time when countries are really getting their fill of the U.S. dollar and when the currency is looking more and more vulnerable, not to mention political issues of supporting the dollar, the move toward to using gold rather than the dollar as a reserve currency seems to be building. Imagine what a boost to gold it would be if the yellow metal rather than dollars were used for payments of oil and other trade items, even if it were merely in the Islamic countries.

The two most frequently asked questions I hear as editor of my "J Taylor's Gold & Technology Stocks" are: 1) When is gold going to rise? and 2) How far will it rise? It s hard to think of two more obvious and important questions for a gold investors. But neither of those questions can be answered with certainty. So it would be foolish to pretend I know the answer to either of them with certainty. Only God knows the answer to those questions and in his infinite wisdom he has not shared that knowledge with me. So your $123 per year won't get you a direct answer to those questions. However, there are some interesting and I think useful observations that can be made to give us some direction with respect to those questions.

As to "when" gold is going to rise, it sure looks like we may now be on our way because the Cartel has failed to hold the $290 line. Also there are increasing signs that the world monetary system, which is built upon a fraudulent concept of money, is beginning to show signs of cracking and crumbling. Witness Japan. Witness Argentina. Witness Asia. Witness a U.S. economy that can barely get off the ground despite huge monetary stimulus. Witness a stock market that remains lower when the first of 13 rate cuts began. What is that telling us about the prospects for a growing economy, especially when you consider the fact that every time except one other time during the past 100 years, when rates were cut, the stock market rose one year later. Not in 2001-2002. AND NOT IN 1929!

James Turk's Fear Index May Provide A Useful Gold Price Target

With regard to an ultimate price target for gold, that is impossible to say, because it will depend on the degree to which confidence is lost in fiat money. In the 1968-1980 time frame, during the inflationary Kondratieff summer, the price of gold rose from $35 to $850 or 2,300%. At that time, the U.S. Money supply (M-3) expanded from $557.1 billion to $1,820.1 billion ($1.82 trillion) or 227%.

Our friend and brilliant gold market analyst/entrepreneur James Turk (www.goldmoney.com) has devised a proprietary measure of loss of confidence in paper money that he calls the Fear Index. I believe this index may give us a range of prices for gold as measured in U.S. dollars. This index which James labels as the Fear Index, is calculated as follows: (The price of gold times the quantity of gold held by the U.S. government divided by M-3).

Toward the end of the last Kondratieff summer, in January of 1980 to be precise, this ratio rose to a high of 9.45% in January of 1980 when the price of gold peaked.

During the last Kondratieff winter, when America suffered a major loss of confidence in the dollar and the banking system, in November of 1940 to be exact, James Turk's Fear Index rose to a high of 29.86%.

At present, the price of gold is at $312. The U.S. M-3 measures $8,054.8 billion. The Fed reports a gold reserve of 161.582 million ounces. So assuming you believe all the gold reported is actually held by the Fed, we can calculate James Turk's Fear Index at present at a measly 1%.

If, as the Kondratieff winter unfolds, we suffered just a moderate amount of anxiety over the dollar as happened during the last Kondratieff summer, we might reasonably expect a nine fold rise above the current price of gold to $2,800/oz. If on the other hand, during the impending Kondratieff winter, the ratio moved up toward 30 times as it did in last Kondratieff winter, simple arithmetic takes us to a price of $9,360/oz.

Of course all these arithmetic calculations are meaningless because what it tells you is that when our currency returns toward its true (zero) gold will also return to its true value as honest money. Unlike paper money, it cannot be created out of thin air. So, it retains its value. In dollar terms it will require huge amounts of paper - assuming it is accepted at all - to buy very common every day items while in terms of true and honest money, an ounce of gold will buy pretty much what it always bought.

In attempting to answer how high the price of gold might ultimately rise, it might be worth hearing what Richard Russell has recently said about that topic. He has been saying that his years of experience has told him that he sees a trend taking place where bull markets tend to go much higher than anyone can envision before they begin and that bear markets tend to go much lower than anyone can envision when they begin. I recall how no one could ever have imagined $35 gold ruing into $850 gold by 1980. But amazingly it happened.

All I do know is the following: 1) Gold is cheap by all historical measure. 2) Major stock indexes remain extremely expensive and 3) Over time, both markets tend to move in opposite directions with the Dow/Gold ratio returning back toward parity compared to the current extremely high ratio of 32 to 1. That's why we like the Prudent Bear Fund (BEARX so much. It will rise as stocks decline and as gold shares rise) Ownership in the Prudent Bear Fund is one very efficient way to play a return back toward a one to one Dow/Gold ratio.

MORE BULLISH NEWS:
"Mainstream Gold Letter Writers Remain Bearish on Gold"

The following written by Mark Hulbert for CBS Market Watch.com and posted on May 3, 2002 is, from a contrarian view point, very bullish for gold.

"The gold timing newsletters tracked by the Hulbert Financial Digest are not all that excited about gold right now. Their average exposure to the gold market is just 37.5 percent, with the remaining 62.5 percent allocated to cash.

"If you're a contrarian, their tepid feelings about bullion are good news, both for gold itself and the shares of gold mining companies. See Thom Calandra's StockWatch.

"I frankly am surprised that today's gold timers are not more enthusiastic. With the yellow metal exhibiting more signs of life than it has in years, I would have expected nearly ubiquitous exuberance among the gold-timing newsletters. After all, that is exactly how they reacted every other time in recent years in which bullion rallied to the $300 per ounce level.

"But not this time. After briefly jumping to 90 percent in early February when bullion rose to the $300 level, the HFD's gold sentiment index has steadily declined to less than half that level today. Yet bullion actually is higher today than it was three months ago.

"This is a textbook case of what is often seen at the beginning of sustainable rallies. As contrarians constantly remind us, bull markets don't like company; they thrive when relatively few advisers and investors have jumped on their bandwagon. This is why contrarians were not particularly surprised that gold's rally stalled in mid-February, the point at which virtually all the timers followed by the HFD had become bullish. Today, in contrast, gold at $310 per ounce has fewer cheerleaders than it did three months ago when gold was trading at a lower price.

"Incidentally, this sentiment picture for gold is just the opposite of what prevails for equities. In that arena the average adviser has been stubbornly optimistic in the face of a significant decline, which is why I grade sentiment among stock timing newsletters as bearish.

"Mark Hulbert is the founder of Hulbert Financial Digest. He has been tracking the advice of more than 160 financial newsletters since 1982."

A one-ounce gold nugget is rarer than a five-carat diamond.