Taylor On US Dollar & Gold
The Dollar . . . Is This the Beginning of the End?
We have discussed frequently how the Strong Dollar Policy was, to a very
great extent, a hoax. The Clinton Administration, just like any good
Democratic Administration, believed government should actively involve
itself in the markets by intervening to make them better. The notion of
free markets and freedom in general conflicts with that party's ideology.
And with one crisis after another, the Clinton Administration leaned on
Greenspan and the banking system to run the monetary printing machine at a
torrid pace so as to provide a temporary economic relief from any normal
market adjustments that came along. So, with each new global monetary
crisis, starting with the Mexican Crisis in 1994-95, then Long Term Capital
Management, Russia, Asia, and Y2K, the banking system began to print money
like it was going out of style. M-3 exploded from $4.2 trillion in 1994 to
over $8 trillion by 2003.
Trouble is, with so much money being pumped into the system during the
Kondratieff autumn, real interest rates (rates adjusted for price inflation) were beginning to decline. Why was that trouble? Are not declining interest rates a good thing? Well perhaps they are if such decreases are based on real free market action-except for a little recognized but thoroughly proven economic relationship known as "Gibson's Paradox."
One very influential person in the Clinton Administration was very much
aware of Gibson's Paradox, which Keynes noted was one of the best
documented relationships in all of economics. Gibson's Paradox stated that
if "real" interest rates decline, the price of gold will rise vis-à-vis the
currency. BUT THE CLINTON ADMINISTRATION KNEW FULL WELL THAT A RISING GOLD PRICE WOULD HURT THEIR ABILTY TO LEVERAGE AMERICA'S FUTURE FOR THEIR OWN POLITICAL GAINS. Hence, the Clinton Administration began to intervene in the gold market to "cap" the price of gold, just as Lawrence Summers clearly noted they must do in a paper he co-authored while a professor at Harvard in the late 1980s.
How was the Strong Dollar Policy implemented?
The Clinton Administration never said how they accomplished it. They implied it was because of the "New Paradigm" economy, which they claimed resulted in such outstanding productivity in the U.S., thanks to our advantage in new information technologies. We know now that those productivity gains from technology were largely overstated if not entirely bogus. Whatever productivity gains there were, they were nothing unusual and certainly not as great as at other times in our history, such as the 1960s. No doubt, whatever productivity gains there were, the strong dollar, which reduced the cost of imported goods used in American production, was more responsible for productivity gains than technology gains.
In fact, I always viewed it as strange that the dollar was getting stronger
from the mid-1990s, which was exactly when the supply of dollars exploded.
But now we know the reason that the dollar was strong. Lawrence Summers put his academic work to use when he went to work for Robert Rubin and then later as Treasury Secretary himself. In other words, the strong dollar was a mirage that provided the world (not just Americans) with a false sense of security. A weakening gold price allowed Larry Kudlow to say week after
week on CNBC, "See, the gold price is declining. The Fed needs to be more
accommodating. America is a genius nation with unbelievable productivity
and capitalistic know-how. I am so proud to be an American."
Would a Gore Administration have kept the illusion of wealth and prosperity
going a while longer? Perhaps a little longer, but certainly not through the first term of his Presidency. He would no doubt have been more an
interventionist than the Bush Administration. Remember when Enron blew up? Remember who called the White House to have them intervene to try to save the company? Remember it was Bob Rubin who anticipated or hoped his
Citigroup could be bailed out much as he had arranged a bail-out of Long
Term Capital. Yet for reasons we continue to harp on in this weekly
missive, there are limits to bubbles, even for interventionist Democrats.
Is the Dollar Ready to Unravel?
The point to all this discussion is that we need to understand that the
Clinton Strong Dollar Policy was a phony policy. Our tricky President's
slight-of-hand, combined with the fact that the dollar is used for
approximately 75% of international currency transactions, led to the
dollar's strength even as the U.S. economy was beginning to display some
serious signs of pathology. For example, total indebtedness and trade
imbalances mushroomed during the Clinton years, and high priced
manufacturing jobs continued to leave the U.S. Many of our manufacturing
jobs were destined to be lost as the world moved toward globalization. I
have no argument with that reality. But the point I am making is that much
of the so-called brilliant economy during the Clinton years was nothing
more than an illusionary bubble.
The reality of the U.S. dollar now appears to be really sinking in. And so
we are hearing that various nations like Russia, India, and China adopt
policies that increase the use of gold as a monetary asset. This past week
a report from a German government source said Russia may soon demand
payment in Euros for its oil. That is significant because Russia is now the
second largest exporter of oil, behind Saudi Arabia. Some people thought
Saddam's downfall was not weapons of mass destruction but rather his
belligerence against the U.S. in demanding payment for oil in Euros rather
than in dollars. And another issue that is downplayed in our press, but
which I think could be very significant, is the move among the Islamic
world, led by Malaysia to use the gold dinar as a medium of exchange for
trade among themselves. All these signs of the dollar's demise are, I
believe, very bearish for the dollar, the bond markets, the real estate
markets, and the U.S. economy in general.
The Dollar/Treasury Markets
Steve Forbes made a point the other day on CNBC, saying he thought interest rates would rise for "good" reasons rather than bad reasons. The good reason for interest rates to rise, he said, was because of a stronger
economy. What is a bad reason for interest rates to rise? We talk about
that almost every week because we think that is the key to why the U.S.
economy is destined to falter. When interest rates begin to rise because
foreigners are selling their U.S. investments, it will be "game over" for
the U.S. economy.
Remember, the Clinton Strong Dollar Policy was important to make the
economy look good on Bill Clinton's watch. That was true because in order
to maintain an illusion of prosperity during the Clinton years, foreigners
had to lend us an ever-increasing amount of their surplus trade dollars.
Without those recycled dollars being sent our way, interest rates would
have risen dramatically, thus choking off economic growth and a booming
stock market. So we have become addicted to this monetary narcotic and like any addiction, over time, it becomes life threatening. What I have been
watching for each week is an indication that interest rates are rising
because foreign money is leaving the U.S. A sustained decline in the dollar
index shown below, coupled with rising interest rates also shown below,
would provide evidence that this dangerous trend is underway.
GOLD
We have believed for quite some time that the gold market price has been
manipulated by dishording of gold from central banks, and that this policy
has led to a major overvaluation of the dollar and played a major role in
expanding the financial bubbles of the late 1990s which, for the most part,
still prevail. We are equally convinced that in time, the forces of the
markets will overwhelm the establishment's manipulative ploys and when that
happens, major gains will be made by those who have positioned themselves
in gold well ahead of the masses doing so.
With our tradition of limited government, many if not most Americans naively find it incredible that the people that run our country and the
powerful consortium of extremely rich and powerful elite, who are the real
power behind the throne, would actually manipulate markets. After all,
isn't it the government that prosecutes and incarcerates private citizens
for market manipulation? How could any government official have the
audacity to involve themselves in market manipulation? Indeed even some
very savvy Wall Street pros who have rubbed shoulders with some of the
manipulators themselves, find it incredible that our government would
manipulate the gold market. For example, in my March 10, 2000 interview on
the issue of a gold conspiracy, I had the following exchange with Jeff
Christian, who heads a well regarded commodity firm named the CPM Group:
"Christian: You know I made the comment before, and it really is true. You
mentioned GATA. When they came out with their initial allegations I was
talking to one of the major bullion traders in the world and he was asking
me who are these people and what are they saying? He had only heard about
them tangentially, and when I told him about what the allegations were, he
just started laughing and he said, "Do these people have any idea how the
bullion markets work?" And my answer was, "Honestly, I don't think they do."
"Taylor: Well I believe some of them have been active traders and
speculators and others students of the gold market, though perhaps they
have never worked for the bullion dealers as you have. That is partly why I
wanted to get a person like yourself, who has had a view from the inside
out so our readers could get that perspective, as well as the view from the
outside looking in. I believe intellectual honesty requires me to present
both views. What we really want to achieve is the best understanding
possible about objective truth so that we are prepared as well as possible
to make prudent investment decisions in the future.
"But on the other hand, I know that some of the people who believe some
funny stuff is going on are good, honest people. That is one reason I have
spent so much time on this issue. James Turk for example, a former banker
and editor of Gold & Money newsletter and also an advisor to the Midas
Fund, has written about allegations of a former Ohio industrialist named Ed
Durrell. Before he passed away, and reportedly when he was still of sound
mind and body, Mr. Durrell cited evidence that President Johnson had
arranged for gold to be smuggled in the middle of the night from Ft. Knox.
Mr. Durrell and others lobbied Congress to have Congress mandate a major
accounting firm to provide an independent third party audit of the gold
reserves at Ft. Knox. Have you heard anything about that and if so, what is
your reaction?
"Christian: Yes, I have. Actually someone asked us that question in Calgary
and the point that I made at that time was that you have a number of people
that for decades, probably even before the Johnson Administration, have
been concerned about what the government has done with their gold. Let me
say that as someone who works with the Treasury on some applications, the
Treasury is overly protective of the U.S. precious metals assets. They go
out of their way, forego profits, and pay more than they should to store
the gold in a way that assures that every piece of an ounce of gold is
accounted for and held by them in their control at all times. The reason
they do this is because of the historic paranoia about the idea of secret
treasury sales disposals. From my perspective, they manage the metal cost
ineffectively because of this paranoia. So the first thing that I would say
is that it really doesn't make sense. If you look at the Fed and the
Treasury, they report everything. They report how many pencils they buy.
For them to be so cavalier about the gold just doesn't make sense. It would
be so out of character.
A Short-Term Bearish View on Gold
Most subscribers will recall that we interviewed John Crawley in our August
7, 2003 monthly newsletter. We don't always agree with Jim, but we do value his perspective on many markets, including the gold market.
Anyone who thought making money in gold would be easy is being taught a
lesson now. Especially in the early stages of a bull market, there are bound to be some very challenging moments for the bulls like those of the past couple of weeks.
For quite some time now, John Crowley has been short-term bearish on gold.
Like your editor, John is also a deflationist. John passed along the following email to me this past week regarding the gold market. John has graciously agreed to allow me to pass this message, intended for his hedge fund clients, to you. You may not like what John has to say, but we want to avoid at all costs the temptation to "see what we believe rather than believing what we see." Here are John's thoughts on the gold market.
I hope you had a chance to analyze the charts sent by Ian McAvity this
morning, which further reinforce my contention that gold may have exhausted itself on the upside. It is interesting to have such a distinguished bull in our camp. But Ian lives by his charts and they tell the story we have
hinged our strategy on for some time. Predictably, the psychology, especially from the "newbies," has gotten way ahead of itself and has rallied on stale news and perception. Note how the shares in relation to gold have broken down and are in danger of violating several key moving averages that will wake up the momentum-traders and prompt them to sell, as the shares relate to the price of bullion itself.
From my technical standpoint, the HUI, the surrogate for all the non-hedgers, has done the most technical damage for obvious reasons-they
were discounting $450 gold. I liken the correction ahead to the first real
correction gold had in the original bull market of the '70s, where in an
environment of extreme bullishness, from January 1975 to June of 1975, Gold lost 55 % of its value-in just 6 months! If such a sell-off occurred from
the highs of last week, we are talking about a pullback to $177/oz.!
I don't foresee Armageddon for gold, but a real scare and debacle of
bullish sentiment would be achieved if we went back and retested the June
1999 lows, which gold bugs profess as "heresy." Whatever you label it, it
is a scenario that would totally demoralize them if that range was remotely
challenged, which gives me encouragement that it is very much in the cards
over the next 12 months. If such an event occurs, the shares would be a
steal, and I would move aggressively into gold stocks. I see an extreme in
bullish consensus all the way down to $320. That's where we have to go to
smash confidence.
Meanwhile, you can expect gold to respond favorably when we have severe
dollar weakness, such as recently, when the yen hit a new multi-year low of
109.50. I can see a Euro at 1.25 near term before a counter-trend rally in
the dollar emerges. However, I expect gold to move counter to the Euro and
other currencies in the near term due to unrealistic expectations for the
metal in the current climate and the possibility of "Official Sales."
One the Other Hand……
I just finished reading Richard Russell's Remarks as of October 11, 2003.
Richard passed along some bullish comments on gold. For example he pointed
out that the "Commercials" (gold fabricators, some gold mines, gold banks,
banks that deal in gold and make gold loans) have reduced their short
positions by 11,000 contracts and increased their long position by 10,000
contracts. The commercials are usually right in the short term so this
could suggest a shorter term bounce in gold at this time.
Richard also pointed out in his October 10th Remarks that the gold shares
have not confirmed gold bullion on the downside.
The main point I would like to make is that in the short term, anything is
possible. However, the fundamentals over the next several years appear to
be hugely bullish for gold. With Central Banks printing huge amounts of
money at a faster and faster clip just to try to keep the international
debt bubble from collapsing, what is there not to like about gold as money?
October 13, 2003
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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