Today's situation is very dangerous for the ill informed, or malinformed, as the case may be, relative to the stock market.
Brazil has devalued its currency the real by about 50% in a two-week period. This is just another disaster waiting in the wings. The barbarians are at the gates and no one seems to notice. First it was "we have to bail out Brazil to save us from the deflation/devaluation monster" and now it's "oh, this little devaluation won't hurt us". Just a little cognitive dissonance, wouldn't you say? Bet the spin-doctors were poised and ready. What kind of lesson does this send to Indonesia and Korea when the IMF imposed harsh measures upon bailing them out?
One of the latest victims is China. Their banking system is largely insolvent, though less so than Japan's. So-called "red chip" stocks, yesterday's emerging market darlings, have crashed. China is in trouble because it is a strongly cheap export driven economy and many of the competing Asian currencies have devalued, putting strong pressure on China to likewise devalue to stay competitive. That this is certain seems to be a commonly held view, the only question is when, and with this event comes more hair-raising devaluations round the world.
Japan is braced for further impact. Their economy shrunk by about 2-3% last year, I believe, and predictions are for this year to see modest growth like 0.5%. I don't believe it; 1999 should be another contractionary year. Japanese consumers still save every dime; they don't spend it. Government infrastructure programs aren't working. The politicos are paralyzed and don't know what to do, except to spew as much fiat yen into the system as possible. Even planned tax cuts won't help. Government debt is skyrocketing. Now it's 150% of GDP and increasing rapidly. The tone of the average Japanese citizen is somber and worried, for good reason.
Europe, while remaining healthy, isn't growing as fast as the US, and is in fact noticeably decelerating. The US, oblivious to the spreading Pox Humana, continues down a merry spending and debt path with seeming immunity.
If only regular folks could learn from well-informed, unbiased sources, just what the real situation is! On the other hand, if they were to learn, many innocents would doubtless lose their job! I think all the financial media propaganda does is just postpone the inevitable. The longer the truth is withheld, the harder will be the crash.
Who will be vulnerable to a crash? There are several areas in the economy which I think will see large shrinkage should it happen. The initial sector is basic commodities like the farm sector, which is already seeing contraction and debt meltdown, principally in the Midwest. Also commodities like steel are crashing. There have been severe layoffs in West Virginia and elsewhere because foreign steel is half as costly. Cries for protectionism are loud. With a stock market crash will come very big layoffs in the financial services industries. Your broker may be polishing apples soon thereafter. This is a huge industry having seen big growth in tandem with the stock market in the last 5 years. Think of all the large companies that have delved into the credit card, home loan, car loan, and general debt-financing field in the last few years.
I believe government jobs won't be as secure, because there is so much public debt and an unusual and temporary abundance of capital gains tax money that when a crash happens, the public till won't be full any more. Of course, they could print money to keep afloat, but I think the resulting inflation would be catastrophic for the economy.
Fancy or frilly services like flower delivery, pet grooming, and pool cleaning will fall by the wayside as discretionary spending dries up.
What few secure fields there are may be in basic goods and service industries. The energy and food industries come to mind. I believe information technology will continue growing, although costs will by necessity shrink rapidly, and that will put increasing downward pressure on wages.
Unfortunately, should an economic crash occur, there will be the usual clamor for government to step in and correct the situation, as if it didn't cause the situation in the first place, aided and abetted by its henchmen, the banks and financial brokers, and that government could do something constructive anyway? I think not, and a critical review of the only large-scale government intervention in a deep economic calamity, the Great Depression, demonstrates that government didn't prevent or help the situation but in fact started and prolonged it! It started it by loose money policy. It prolonged it by doing everything wrong - interfering in the free market, favoring the debtor over the creditor, sponsoring cartels, creating unnecessary McJobs (remember Alphabet Soup?), and propping up wages and price levels which, ironically, in the process increased unemployment in the productive job sector to as much as 25%! This delayed the healthy liquidation of bad debt and the mobilization of productive resources by 10 YEARS!
An eager reader wrote to ask me a pertinent question about gold's behavior during deflation. It is believed by some that deflation in the US will occur and this will be bad for gold. I don't think so. Let me explain.
Everything being equal, if we all woke up tomorrow and discovered there were fewer dollars in the world then yes, gold along with everything else would decrease in value, BUT such a case is purely fictional. The government generally doesn't just sit around twiddling its thumbs while people lose bills down sewer grates. There is a reason for a decrease in dollars in the world, and that is as a result of debt meltdown, not dollar attrition.
Instead, the government, enjoying a monopoly on printing fiat dollars, generally puts far more into circulation than is "needed" just to replenish worn out bills. [I'm using the phrase "printing money" as a catch-all term for monetizing debt, selling bonds, etc.] In fact, they generally send more dollars into the economic stream than is warranted even by Monetarist "requirements" dictated by production increases in GDP. I write requirements in parentheses because Monetarist theory is a fiction, but that's beside the point. Anyway, the government prints too much money and spends it on bad or otherwise unhealthy enterprises, resulting in distortions to our economy, like inflation, unemployment, bad loans, unsustainable debt, a perpetual welfare state prone to vote buying, the business cycle, and ultimately deflation, which is a sudden pathological decrease in the money supply due to debt meltdown. This is what is generally meant by "deflation" and why it is so scary to the world's bankers. Deflation is, generally speaking in the loose sense of the word, not of the benign type that accompanies a stable money supply and production and efficiency increases, a phenomenon in which prices fall for positive reasons. If only we had that deflation variety, then our economy would be healthy.
Now let's talk about gold. It is generally thought that gold acts as a commodity like pork bellies. This is not the case. Virtually all the gold ever mined is available in above ground stock. It is not consumed. It is hoarded as money, as a store of economic value, and as such is in direct competition with fiat currency. Gold is eagerly bought when there are problems with the buying power or quality of fiat, such as during inflation (when there's too much of it printed) OR when there's a devaluation (the local currency has decreased in value relative to foreign goods and currency) OR when there is a threat that it may become worthless otherwise. Such is the case when the government which has exclusive printing rights has trouble meeting its debts, either it is threatened with overthrow internally, or if a country were under a threat of invasion and conquest.
That gold is a powerful hedge against inflation is a widely held notion. At present, the world is witnessing double digit increases in money supply. This is partly why Asian currencies crashed in 1997. Japan is now doing this willingly to kick-start their economy, or so they think. Witness the 70's as the classic example of gold holding its value against inflation.
A devaluation is when the government willingly accepts that the nations currency should be cheapened, either passively by not stepping into the free market and spending foreign exchange reserves to buy up dollars, or by purposely producing too much of it (as Japan is doing now).
When the last large deflation occurred between 1929 and 1932, gold was officially $20.67 in this country. That price didn't change through the economic and monetary contraction, and after Roosevelt called in all the gold in 1933, he devalued the dollar by increasing the value of gold to $35 in 1934, a forced devaluation. The purpose of this move was to relieve domestic strife by making the dollar more competitive internationally. From 29 to 32, during the worst of the deflation, a single dollar progressively bought more goods, and the buying power of gold increased as much too. But the real kicker came during the devaluation, because it demonstrated how much the dollar had to fall internationally to keep our goods competitive. It is ironic that in this time, even though the dollar bought more goods domestically, it bought fewer goods internationally. Gold increased its purchasing power through the 30s.
During a deflation, there is a direct threat to the quality of money. A government strapped for cash and deeply in debt as ours is would be sorely tempted to print its way out of a deflation downdraft. This is one good reason to hold gold.
That the US has a foreign trade deficit running nearly $300 Billion this year will put strong pressure on the dollar to devalue internationally.
There is another factor affecting gold. When it is held as a monetary asset of last resort and when times get rough, this gold is liquidated. We saw that in Asia early last year. That's partly why gold prices fell. Will that happen again? This is unknown, however should the West see heavy deflation, I doubt there will be wholesale gold liquidations simply because very few private parties in the West own much of it as a percentage of total assets. In fact, after the big spike in the gold price in 1980, when an ounce hit $850, gold in the rich Western countries has been relentlessly dishoarded by private hands. Do you know anyone with appreciable assets in gold? I doubt you do. This is in stark contrast to Asian countries, where private stashes form a monetary backbone for most people. Asians are now buying back much of the gold dumped during those times. The last 3 months of 1998 saw the largest gold demand of any quarter in world history, according to the World Gold Council who compiles such statistics.
Statistics prove that in the long run, gold is a very stable medium to store wealth. Every single fiat system devised since the 8th Century China has crashed and burned. The US dollar has lost 90% of its value since 1950. Do you think the last 10% is sacred?
For those interested in the data of how gold has fared from 1560 to the present, read "The Golden Constant" by Roy Jastrom, or read Dr. Dan Ascani's articles entitled "Gold in Deflation" found at Gold Eagle: http://www.gold-eagle.com/editorials_99/ascani021599.html
The purchasing price of gold has always reverted to the mean through the centuries. At present the long-term value of gold is about $600 in today's dollars, giving you an idea of how undervalued it is as an asset.
"Dr. Bob Dobbs"
28 February 1999