Taylor On US Markets & Gold
Financial Markets
The Fuel for the Greatest Bubble in 100 Years
Last week I expressed amazement at a fairly high profile economist's lack
of knowledge about M-3. Presumably he knew something about what M-3 was,
but he didn't have a clue about the quantity of M-3. He thought it was
somewhere in the $2.5 Trillion to $3.0 Trillion range. That economist also
argued that Greenspan and the boys at the Fed were hung up over some silly
notion of guilt about having a good time. He equated it to his own experience as a Methodist where he says he learned that having a good time was sinful. There was no reason he contended that the Fed should ever have tapped on the monetary breaks in the early part of 2000 as the stock market blowout was taking place. Nothing bubbly about the market he claimed. Just some old fashioned prudes at the Fed with outdated ideas about having a good time. Had Mr. Greenspan simply kept printing money fast and furiously as he had been doing, trillions of dollars would not have been shaved off of America's net worth. Permanent prosperity could have been ours forever he claimed, if only the Fed not tightened interest rates.
Amazingly, this economist didn't seem to think there was any relationship
between the quantity of money printed by Greenspan and the banking system. The two charts noted above plus some simple common sense suggest otherwise. As David Tice correctly reminded CNBC viewers time an time again as the market was reaching its peak, the printing of money was the PRIMARY cause of high stock prices. In affect, the money supply was increased at a far greater pace than economic growth. A rocket scientist you need not be to understand that can't go on forever without inflationary and /or deflationary consequences.
You may be getting tired of seeing the chart below because we publish it
time and time again. But I publish it so frequently because it illustrates
the following very important points that in fact do show that "the economic
wages of sin are death."
- National income, or GDP (Blue Line) is growing more or less in a linear
relationship to time.
- Total Debt (Red Line) in our fiat currency system is not constrained by
natural limits of our economy. It can grow as fast as the bankers and their
political cronies are able to run the money printing presses.
- In our fractional reserve banking system, debt is the raw material from which money is manufactured. Note the similarity of the growth pattern of the M-3 Chart shown above with the Total Debt Chart.
- Printing money does not create wealth. What does create wealth are
manufacturing, mining, agricultural activities as well as those who managed
those companies and improve their efficiencies by developing new
technologies. The printing of money by way of debt only gives citizens a
false sense of wealth which in turn prompts them to do some very irrational
things with "their money," like invest in an endless number of fantasy
stock stories during the late 1990's. These investments in ill-conceived
businesses, are termed "mal investment" by the Austrian economists because
most of them are not economically viable.
- Yet, a lack of income resulting from mal investment does not negate
indebtedness. Banks demand the loans they made which were used in the
process of manufacturing or "printing" massive amounts of new money are not willing to excuse debt simply because people were prompted by excess cash balances to make bad investment decisions. The bankers demand their loans be repaid regardless of whether the borrowers were successful.
- With mountains of new debt being created at an accelerating pace, the
amount of cash flow generated from what's left of profits allocated to
servicing debt increases dramatically. In other words, the demand side of
the economy becomes weaker and weaker as more and more of cash generated from economic growth is used to pay principal and interest on debt because debt is growing much faster than income.
- Also, with so much money pumped into the economy so fast, businesses and
consumers become overly optimistic about the future such that excessive
amounts of production capacity is created thus reducing profit margins for
business. In the past bubble, (or as Doug Noland maintains, the bubble that
still largely remains unpopped) this was obvious not only in the "new
economy" companies but in the old economy companies too. For example, the
airline industry has thousands of aircraft sitting in the desert.
- Excessive capacity not only within the U.S. exerts downward pressure on profit margins, but at present, enormous news supplies have been introduced as a result of globalization. In particular, China with many low cost advantages in addition to numerous government subsidies are causing
American companies to go out of business. As a result of huge excess
supplies, downward pressure on profits remain which in turn retards plans
to hire new employees and purchase new capital goods.
- Eventually, a point is reached that can be referred to as an "economic
threshold of lethality" for the economy. My good friend Dave Morgan, who
publishes an excellent newsletter on silver (www.silverinvestor.com.) and
I, have talked about this "threshold" debt dynamic of our economy on
various occasions. At our recent conference in Chicago, Dave who is an
aerospace engineer, equated the economic threshold of lethality for the
economy to the 'breaking points' for various metals. Up to a certain
critical point, things appear normal but then suddenly, the system breaks
down.
Are we There Yet?
As noted above and as Ian Gordon has pointed out time and time again, debt
is deflationary. And this is a very basic economic fact of life we as a nation and as an economics profession have seemingly chosen to ignore. Ian's work demonstrates that the threshold of lethality takes place in the "Kondratieff Winter" of the 60 to 70 year Kondratieff cycle. The Kondratieff winter before the present winter, began as they all do, with the stock market peak in 1929 and it lasted for 20 years, until 1949. The Kondratieff winter that we have just entered, according to Ian's work began with the equity market peak in January 2000.
Famed central banker John Exter, himself a member of the CFR, a Harvard
Professor, ex-central banker and Citicorp big wig, was one of the few truly
establishment people to warn that the expansion of liability money would
end in a deflationary collapse. And we have in this letter, interviewed Ron
Gilchrist a stockbroker and former student of John Exter. (See Ron's phone
number below among recommended brokers) Mr. Exter was clearly early in
predicting an imminent deflationary collapse back in the 1970's. I believe
one of the insights Ian Gordon adds with respect to the workings of the
Kondratieff cycle that was missing from Mr. Exter's work was that the
Kondratieff summers (the last occurred from 1966 to 1980) are characterized by runaway inflation, not deflation. This is true because the debt load has simply not yet built up to the levels that start to cause the economic system to break down. Then comes the Kondratieff Autumn, a period in which the strains of debt begin to weigh on prices, thus causing a DISINFLATION.
In other words, the rate of inflation declines but overall, prices do not
outright decline. And while the demarcation line between disinflation and
deflation may not occur exactly on the day the cycle moves from the fall to
the winter, there is no denying that the direction of prices is downward as
the Kondratieff winter winds blow decidedly cooler as time progresses.
And so, this past week, in an effort to keep people from worrying about
deflation, Mr. Greenspan talked about a reduction in the rate of inflation.
The Fed is clearly worried about the continuation of declining prices and
the prospects for declining prices to continue to put downward pressure on
economic activity. That of course has been a problem in Japan over the
past 10+ years but it is likely to be an even bigger problem for the U.S.
because of our enormous debt burden, not only among ourselves but also to
the world. Debt is not such a problem in an inflationary world because you
pay with cheaper dollars in the future. But it becomes an insurmountable
problem when you are a huge debtor because you will be forced to pay for
more expensive, hard to come by dollars in the future.
So, unfortunately, the predictions made by Ian Gordon made in June 11, 1999
interview are now coming to pass. Judging by the prominence of "the
declining inflation issue," the Fed seems to be approaching a panic mode,
and in my view for good reason. Since World War II, two or more successive
Fed rate cuts have always managed to stimulate higher stock prices within
one year. But now, twelve rate cuts have been ineffective over the past two
+ years in doing so. The reason for that failure we think is very clear. The dynamics of excessive debt are starting to reach the threshold of lethality. In fact, as I discussed with Tom Arnold on a radio program yesterday (go to www.TFNN.com and click on Tom O'Brien to listen) we are now at the point in the Kondratieff cycle where the cure is worse than the disease. Remember, debt is the problem. So whenever Mr. Greenspan lowers the interest rates by printing more money, he is essentially printing more
money by creating more debt. In other words, at this point in the
Kondratieff cycle, the cure is worse than the disease.
The M-3 Money supply as well as the Global Money Supply pictured below has
been growing very rapidly. Of course, that means that debt is also growing
very rapidly. A former London banker named Teddy Butler Henderson reported to both Bill Murphy of GATA and Ian Gordon that Greenspan once told him over lunch in the late 1960's that he hoped to be the Fed Chairman one day. And that if he were Fed Chairman and if he were given the prospects of a deflationary collapse as we had in the 1930's, he would print money as fast as possible in the hope that he could outrun deflation. He also reportedly said that if that fails, the outcome would make the 1930's economic depression look like a Sunday school picnic. Given the growing stealth discussions by the Fed (Greenspan talks of declining inflation rather than deflation) it now seems that the moment of truth in this grand economic experiment for the Green man may be rapidly approaching.
You can print money but not wealth. Judging by the drubbing the U.S. dollar
has taken again this past week, the rest of the world seems to understand
that, even if we refuse to understand this very basic and logical concept.
Notwithstanding the chart above, which measures the U.S. Monetary Base plus foreign holdings of U.S. dollars, this past week, the dollar index fell to
94.97. The next short term support level on the longer-term chart appears
to be around 90 and from there, down to about 80. The last time the dollar
saw 80 on the index was in the late spring of 1995, about the time that the
Clinton Administration announced their strong dollar policy. We are
confident that policy was instituted by applying the academic theories of
Lawrence Summers as outlined in his paper on Gibson's Paradox. (See
www.goldensextant.com to learn more about the Summers paper). What followed was an artificially strong dollar that defied gravity. Even as the U.S. was expanding the supply of dollars at double digit rates, the dollar kept getting stronger and stronger. Why? Because a rigged gold price allowed Larry Kudlow to go on CNBC every Friday and say, "the Fed has to print more money because the gold price is declining." And people believed that with the gold price declining and stock prices rising, we indeed were
experiencing a new paradigm in which old laws of economics no longer
applied. But the strong dollar was basically a lie fostered by a President
who preached and lived THE "virtue" of lying and spinning half-truths.
But now we are faced with the reality that there is no easy way out of this
mess. The only cure is to bite the bullet by suffering through massive debt
defaults, bankruptcies, unemployment, deflation and a depression. The
politicians and central bankers will all that tooth and nail Justas they
have been fighting off lesser problems in the past. But the accumulation of
debt from past policies aimed at avoiding economic reality now appears to
be reaching a breaking point. Like the Japanese policy makers, ours too
will print more and more money and engage in more and more fiscal
stimulation, but to no avail because the laws of nature and markets have
been pushed to their limits. In the end, nature and market forces win. And
with respect to the exponential growth in debt in relation to the linear
growth of GDP, simple mathematical reality ensures that trillions and
trillions of dollars of debt used to manufacture fiat money out of thin air
will never be repaid which in turn means that our currency, like all other
fiat currencies before it, will eventually become worthless. The
Kondratieff winter will have its way in destroying debt which is why we
must protect ourselves the systemic risk of fiat money by stepping out of
our dollar liability system into an asset based monetary system, where the
value of your money is not dependent on others to repay their debts. In
other words, you need to own gold and perhaps silver, both of which have
served as a store of wealth when currencies disintegrate in value.
What about commodities? Well commodities also retain intrinsic value. But
aside from gold and silver, most commodities are perishable or cumbersome
to use as a store of value and medium of exchange. And in an outright
deflation of the severe nature we anticipate in the depths of the
Kondratieff winter, we believe commodities, even in terms of a rapidly
declining dollar are not likely to hold up as well as gold.
GOLD
The above charts are provided courtesy of www.decisionpoint.com.
The gold markets are looking much stronger now even as the equity markets
continue their bear market run. As we have said in the past, our service is
not devoted to short term trading strategies. We will leave that to others
and I hope to work closer in the future with some other people in passing
along some of their guidance and strategies in terms of shorter term
strategies. People like the Aden sisters and Harry Schultz, who have agreed
to future interviews in this newsletter, provide trading strategies. Your
editor feels more comfortable focusing on macro and micro economic
fundamentals and concentrating on the work of people like Ian Gordon, David
Tice and his associates and the likes of Richard Russell to identify primary tends in the markets.
With respect to the primary trends, we think the charts above suggest those trends are now more in focus than they were a few weeks back, at least with respect to gold and the dollar. Technically, we think the equity markets could have considerably further to run on the upside before they resume their bear market trend. If equity markets decline this year, it would be the first time since the 1930's that they declined four years in a row. And given the presidential year politics, we think the chances may be 50/50 that we could see a small gain for the year in the major equity indexes. However, just as likely in our view is the potential for a major decline and the next phase of the bear market which will be marked finally by capitulation. That the capitulation phase of this bear market has not yet
been reached is evidenced by still extremely high equity valuations. At the
end of this past week for example, the GAAP trailing PE ratio stood at more
than 33 times! As we have pointed out in the past, bear market bottoms are
marked by PE ratios under 10.
Is a Gold Conspiracy by Uncle Sam Impossible?
One of the primary arguments advanced by people who think a gold conspiracy is impossible is that they assume that in order for a conspiracy to be carried out, a large number of people would have to know about it. And,
that being true they argue that it would be impossible to keep this crime a
secret.
With respect to the alleged gold price manipulation that began during the
mid 1990's, I do not believe that is true at all. All that was allegedly
needed was for a handful of people at the very top (perhaps limited to the
President and the Treasury Secretary and Fed Chairman) to implement policy measures they believe is in the best interest of the country (or perhaps their political interests) and then let the self interests of the market place take over. For example, with respect to the apparent gold
manipulation starting around 1994-1995, all that would have been required
to pull it off would have been to make gold available to the bullion banks
as a very low cost of funding and then for the Fed Chairman to promise, as
he apparently did, that the bullion banks would not need to worry about
covering their shorts because, "central banks stand ready to lease gold in
increasing quantities should the price begin to rise." The traders at
Goldman Sachs would not need to know nor would they care that their
borrowing of gold at 1% , sale of that gold and reinvestment at 6% in the
U.S. treasury markets was part of a manipulation scheme. All they knew was
that Alan Greenspan was telling them they had a risk free means of
enhancing their bonuses.
But what about the need to EVENTUALLY pay back the gold to he U.S.? After all, if an ever increasing amount of gold has been lent out or swapped out to the markets by various central banks year after year as GATA alleges, such that perhaps ½ of the gold reported on central bank balance sheets is now out in the market, the need to cover that short position in the market would logically cause the price of gold to skyrocket.
But do governments play by the same rule we mere mortals are asked to play
by? Hardly. We know for starters that the IMF requires member banks to use Enron like accounting, such that they report their gold loans as actual
gold held in their vaults. Private sector accounting of that nature might
send a CEO to jail. But the IMF, which is controlled by the U.S. not only
permits this kind of fraudulent accounting but actually demands member
countries use it. (See articles at www.gata.org regarding the Philippines
and Portuguese central banks). With respect to the repayment of gold to the
central banks, one of the world's gold market experts believes that in fact
that central banks are making plans to forgive the repayment of gold and
will in stead accept currency as payment, then simply consider the loans as
gold sales rather than gold loans that need to be repaid.
May 12, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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