Taylor On Markets & Gold
Jay Taylor
Financial Markets
Inflation/Deflation - Two Sides of the Same Coin
QUESTION: Dear Jay: With regard to the debate as to whether the U.S. will experience deflation or inflation, are you aware of any country that had a fiat money monetary regime that had a deflationary blow off? In case you're thinking of Japan, the only reason, in my view, that Japan has not
self-destructed is that the Bank of Japan manipulated interest rates to
zero, thereby postponing the evil day of massive debt default. Such a
default would be dealt with by a colossal bailout, which, as Mr. Greenspan
has pointed out, would be a highly inflationary event, which is what I
forecast to happen here. Best Regards, Dr. Larry Parks, Executive Director,
FAME, Foundation for the Advancement of Monetary Education, Box 625, FDR Station, New York, NY 10150-0625. www.fame.org.
ANSWER: For those of you who may not know Dr. Larry Parks, he is the
founder of www.fame.org, and I consider him a very good personal friend.
From time to time, he and I meet for a sushi lunch on 1st Avenue and 63rd
Street in Manhattan. Larry now has a Manhattan television cable show that
airs once a week in New York, and it is my understanding that you can view
it on the Web at www.freemarketnews.com. Larry has devoted quite a few
years to the cause of free markets and freedom, and I frequently quote much of his excellent work.
That's enough personal stuff. As to Larry's question, first of all I would
like to compare the impending deflation not as a "blow off" but rather as
an "implosion." At some point in time in these long Kondratieff cycles, all
efforts to expand the bubble are ultimately overcome by the physics of debt implosion. In other words, income will be insufficient to service debt to
such an extent that the inflationary expansion of debt money moves in
reverse with one bankruptcy triggering another and another and another,
until all of the air escapes from the bubble and you go back to ground zero.
But Larry's question is too important to answer quickly with little
thought. I'm going to do some digging to come up with historical examples
to back my views on deflation. I believe there are five major bubbles in
major financial centers throughout history in which central bankers were
unable to stave off deflation by printing more money. I want to research
those more thoroughly before I finish answering my good friend's question.
The one financial bubble that I have given the most thought to is the 1920s
bubble and its aftermath of the 1930s. In fact, I would say that my
interest in economics and why I ultimately decided to major in economics at
Rutgers University many years ago resulted from the experiences that my mom and dad related to me. My dad, Evan, and my mom, Evelyn, are now in their early 80's. Both of them had to leave high school after their sophomore years to work for the family so they could have the most basic things in life like food and shelter. So I have given a lot of thought to the 1930s, and what I am convinced of is that U.S. monetary and fiscal policy of that time is almost identical to monetary and fiscal policies in the U.S today,
since our stock market peak in 2000.
Murry Rothbard, in "America's Great Depression," points out that President
Hoover wasted no time in pushing through extravagant deficit spending
programs. Nor did the Fed waste any time in employing a stimulative
monetary policy. Indeed, the argument for the Fed's existence in the first
place was that by making money lavishly available, business downturns and
depressions could be avoided. So what happened? In spite of enormously
expansionary monetary and fiscal policy, the U.S. had the worst
deflationary depression in its history!
Yes, we did have a gold standard, or at least a quasi-gold standard, at the
start of the Great Depression, but that did not stop the same policies from
being implemented then as are being implemented today. Monetary and fiscal
stimulus failed to stop deflation then. They will ultimately fail today.
The main difference between now and between the 1930s is that
everything-the poisonous debt, mal investment, the fiscal and monetary
stimulus policies geared to overcoming those problems-is all so much larger
today than it was in the 1930s. The sheer size of this bubble and the lack
of any gold discipline have enabled our debt-induced bubble economy to
remain inflated longer.
Yet, no matter if you are talking about the 1930s or now, the underlying
dynamics of debt deflation do not change, because just as certainly as
night follows day, there are limits to debt and there are limits to
inflation. Debt is by nature deflationary. Debt is the raw material from
which fiat money is manufactured. Therefore, all attempts to outrun
deflation by printing an ever-accelerating amount of money are doomed to
fail because as debt grows much more rapidly than nature's limits allow
income to grow, reversing the inflation of the money supply to a deflation
is inevitable.
In the 1930s, the term "pushing on a string" became common. Why? Because
although banks pumped money into the system, they failed to keep the
overall money supply from expanding. Why so? Because the cash flows from
income were so inadequate in service debt, and balance sheets became so
illiquid or insolvent, that banks would not lend and borrowers would not
borrow. The same will inevitably happen again. The only question is one of
timing. There will be a mass exodus down John Exter's inverted pyramid, as
discussed in our April 2004 issue.
More recently of course, we have had the spectacle of Japanese deflation. I
do not believe the debt deflation is finished, although it has temporarily
faded. In this Kondratieff cycle, Japan is quite a few years ahead of the
U.S. But I remain convinced it has only been delayed by monetary and fiscal
stimulus. When this next leg of the U.S. stock market decline resumes, I
believe we will see Japan heading into its grand finale. Assuming the world
holds together in this awful process, those who have managed to retain some
wealth through it all may find Japan a good investment opportunity long
before the U.S. becomes a good place in which to invest.
I agree that the policy makers will fight deflation tooth and nail just as
they have been doing. However, the deflationary forces of debt will
ultimately prevail. Next week I hope to provide additional historical
justification for that contention.
I would like to mention one more thing, and that is the declining rate of
inflation in the U.S. from 1980 until now. Yes, I agree with Congressman
Ron Paul that inflation is understated. But that was also true in 1980. I
remain convinced that while inflation numbers are subject to doctoring by
the government for its own political purposes, the trend has been sharply
lower since 1980. I believe this is consistent with Ian Gordon's work,
which shows that the explosion of debt during the Kondratieff autumn season
acts as a deterrence on consumer and producer price inflation. And it is
that decline in prices that provides the excuse for such abusive monetary
policies as we have seen in the U.S., especially since 1971, and even more
so since Greenspan's "irrational exuberance" speech in 1996.
Is the Indian Autumn Over?
With the market rallying off its lows and given its performance over the
past 12 to 18 months, exuberance abounds. Today's Wall Street Journal
declared the bear market is dead when it pictured a bear being bundled like
a mummy and thrown overboard. Earlier today, I spoke to my friend and
astute market observer, Chuck Cohen, who noted that the latest sentiment
readings for market professionals are astoundingly high with 62% bullish
and 10% bearish.
Yet market fundamentals are breaking down badly with new 52-week lows
outpacing new 52-weeks highs at an accelerating rate of speed. As I glanced
over the 36 industry sector charts I review each week, I saw an astounding
decline from just last week. This would suggest that a potential inflection
point for the equity market has been reached and that the trajectory moving forward may be steeply downward for stocks.
Here are the sector comparisons from last week to this:
For the week ending April 23, we had 29 bullish sectors and 9 bearish
sectors. The bullish magnitude was 82, and the bearish magnitude was 21.
For the latest week ending April 30, we had only 5 bullish sectors and 33
bearish sectors. But more astoundingly, the bullish magnitude fell from 82
last week to just 15 this week, while the bearish magnitude leaped from a
reading of 21 last week to 73 this week.
The only bullish sectors this week were: Consumer, Consumer Non-cyclicals,
Services Stocks, Health Care Providers, and Pharmaceuticals. However, all
five of these sectors were perched very near all moving averages and thus
could very quickly also fall into the bearish camp.
Sectors that had fallen below the 200-day moving average and as such are
considered very bearish include: Airlines, Box Makers, Disk Drive Index,
Insurance Index, Computer Hardware, Computer Technology, Amex Gold Bugs, Networking, Real Estate, and Semiconductors.
A host of stocks which were below their 50-day moving average are close to
falling below the 200-day moving average. Some of the very important
sectors like Financials (which represent 22% of the S&P 500) and the
Brokerage stocks are very close to violating the 200-day moving average to
the downside.
While the turn downward in the equity markets last week may well represent
a false alarm, it strikes me that with so much bullishness present even as
conditions appear to be deteriorating in the market, we could indeed be
poised for a resumption of the next downward plunge in the bear market. The psychology now would seem to be very similar to that of the 1930 correction in which people assumed the bear market was dead. In other words, I think the odds favor the rise in equity prices during 2003 as being one of the greatest suckers rally of all times.
Rising interest rates look like they could be the bogeyman that could break
the back of this equity market. If we are on the verge of another major
decline in a secular bear market that began in 2000, the next leg down is
likely to be the one that breaks the spirit of investors and leads to equity prices more in line with historical bear market norms. Remember, at the bottom of bear markets, stocks sell at PE ratios of below 10 times and pay dividends in the 5% to 10% range. The trick is to try to retain your capital during the bear market so you will have some financial resources with which to buy stocks at bargain basement prices. That, more than making money, is what we will be seeking to do with our Model Portfolio. Although this year the bull market in stocks, combined with a very significant correction in gold and gold shares has led to a loss of 7.82%, vs. a loss of just 0.042% for the S&P 500, since the bear market began in 2000, we have managed to increase a hypothetical $1,000 investment to $1,947-,for a 94.7% gain, vs. the S&P 500, which turned $1,000 into a loss of $246 or 24.6% to $754.
GOLD
QUESTION: Dear Jay: I have not received your e-mail updates for the last two weeks. How low do you think gold can go in this pullback? Sincerely,
Paul Appelbaum
ANSWER: I don't know but my sense is that if we can hold above $375 we
should be alright. If we can build a base in the $386 to $390 range, we
should be ready for another assault on the $430 range in the
not-too-distant future. We are now facing the worst six months for stocks.
I have a hunch (and that is all I have) that the bear market may return
this fall in what should be phase II of this secular bear market in stocks.
This phase should be the capitulation phase during which time confidence in
the dollar and our fiat currency system could be severely tested. If so, I
do not have any trouble seeing gold reach $500 before the end of the year.
Certainly, as discussed below, the establishment will do all they can to
keep this from happening. But ultimately they will fail and when they do,
you MUST own gold. The key is to own it before the masses wish to do so.
Hang in there!
QUESTION: Hello Jay. I am a subscriber and look forward to your newsletter analysis every week. Recently, along with the weakness in metals (and especially the junior mining stocks), I have been reading some analysts'
comments regarding extremely bearish intermediate and long-term forecasts for precious metals.
Their bearish projections are based either on the "9 year gold cycle" -
which (in their opinion) peaked with the recent top in gold or on the Elliott Wave point of view that we still have to a 5th wave down to complete the gold bear cycle which started at the 1980 top.
In addition, the recent internal weakness in the overall market is said to be partly due to a shift away from investors' year-long appetite for risk or speculation - possibly why we have seen less resiliency in the mining stocks than in the bullion price.
Or, this could quite possibly be the beginning of the "C" wave of the bear
market, which could take the mining stocks part or all the way down with it.
My concern is the beating that my junior mining stocks have taken in the
past two weeks and how long it will continue. I remain a believer and I am
holding the line, but starting to sweat. My question is this: Is there a
threshold on the downside where, if crossed, we should liquidate the mining
stocks and hold for lower entries? I know this is an individual decision,
but I wanted to ask if you have a point of view regarding the issue.
Thanks for your insight,
Neil
ANSWER: Since I am not technically oriented and thus not in a position to
answer with any authority on Elliott Wave theory and because now two
Elliott Wave technicians seem to see the same thing, I'm going to defer to
another subscriber who I think answers your question better than I could.
Here is what Trader Roger Wiegand had to say about recent anti-gold
propaganda from the "Financial Times."
"Jay: I had a trial subscription to FT for a little while. This was enough to persuade me that this rag and most of the other Wall Street propaganda
papers are just lap dogs for the elitists who encourage the sheeple to keep
buying while they utilize the resulting high markets to exit and get out of
the way. Just review for a minute all the really big Wall Street stock traders who have bailed out like Michael Steinhardt, Michael Price, etc. etc. These people knew in 1999 or sooner, what was coming and exited at the
peak or just before. Just guess how much gold and silver they own or are
buying; Warren Buffet, George Soros and yes, Bill Gates. They all own big
metal holdings. Soros has so much money he bought an entire mine plus
3-400,000 in processed bullion. These people got rich because they are
smart, not stupid. A favorite trick of an old partner of mine was to point
the crowd west while he was going east. It works every time. Keep up the
great work. You, Russell, and Peter Zilhman are my favorites. Trader
Rog-Roger Wiegand."
The anti-gold bias of the establishment is amazing and it points out just
how stupid we as a nation have become. The other side, namely the
Keynesian/monetarist establishment, which either knowingly or not exists
for the purpose of clandestinely imposing communism on America, is perhaps
too ignorant to think intelligently about the pro-gold or anti-gold
argument for gold as money. Rather than engage in an intelligent
conversation, people like Mr. Smith and others at organizations like
Goldfields Survey and the World Gold Council, all of whom would rather see
all gold shipped to the moon than to be used as money, resort to name
calling and innuendo. With reference to gold bugs, this is what Andy Smith
had to say in an anti-gold missive dated April 14, 2004. "Most trivially,
there were those [somewhere, in the back woods, with very bad teeth and
possibly playing banjos] who believed that the Frankfurt Agreement on
Gold's 5-year 2500-tonne quota would not be filled. Now we have France's
500 tonnes to add to Germany's 600 tonnes to add to - let's make a wild
extrapolation - a similarly fraternal amount from Italy [as local press
there intimated last week] to add to a few [cake?] crumbs the other] 1
signatories; et voila!"
Is Andy Smith that stupid? Does he not understand the work of GATA? Or does he, like Alan Greenspan, know very well what the gold score is? Is Smith talking out of ignorance or has he, like Greenspan, turned traitor against private property and human freedom and dignity for the sake of personal gain? I don't know the answer to that question. But when people resort to name calling rather than taking the time to have an intelligent discussion (which is certainly possible given the intelligent "pro-gold as money" arguments of the Austrian economists and Alan Greenspan himself),
questioning motives is certainly fair game.
After years of anti-gold propaganda, which I can argue as well as anyone
else (my economics degree was based on Keynes and monetarism, too), and
after spending far more time thinking about gold as money than Andy Smith
ever did (I'm confident of that), I know with certainty that the fiat money
system, which Mr. Smith is seeking to defend by these outrageous word
pictures, is in the process of self destructing and, by the looks of things, at an accelerating rate of speed. Never has it been more urgent to ignore this kind of nonsense and propaganda from establishment sources like Andy Smith and the "Financial Times"! While Smith implies that massive
amounts of gold are being sold (or at least he wants you to think it will
be sold), he fails to point out that someone very big is not only buying all the gold that governments admit is being sold, but much, much more gold that is being "leased out" by central banks. And not only are massive amounts of gold being bought but in the midst of this massive dishording by western central banks, the price has been rising! Smith has wrongly taken the bearish side of the gold market time and time again. To be persuaded to sell gold by this obviously biased anti-gold bug would be very foolish and
very costly indeed!
May 3, 2004
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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