Taylor On Deflation
Deflation is On Its Way!
Most people believe Ben Bernanke, who said that with today's ability to create digital money and to throw money from helicopters, the Fed will always be able to generate inflation. Most people, especially my fellow gold bugs, have a hard time not believing Bernanke's promise that deflation can always be overcome by printing more money. Please note that Bernanke is now heading up the Council of Economic Advisors to President Bush and he may also be positioning himself to succeed Alan Greenspan as Chairman at the Fed. If ever there will be a test of the notion that deflation can always be inflated away, it looks like we will get it in spades!
Modern-day Republican politics demand a Bernanke approach because the Republicans are spending money like drunken sailors. They don't want to tax (or at least admit they are taxing), but they are sure willing to impose the disguised tax against Americans in the form of debt money.
Against this backdrop, is deflation a real possibility? Richard Russell wonders about it in almost every issue of "Richard's Remarks" these days. But he isn't quite sure. Others like Ian Gordon, Bob Hoye, and Robert Prechter (who I am scheduled to interview for my March 2005 issue) are very, very sure that deflation will become a horribly well-recognized fact of our economic lives in the near future.
All three of these gentlemen are convinced that when deflationary pressures take over, Americans are going to suffer through financial stress that may be as bad or worse than that of the 1930s. I might add that Professor Antal Fekete provides some very interesting insights into inflation/deflation dynamics that are also well worth considering. Because we think this issue is of paramount importance in terms of shaping our portfolios, we do spend a fair amount of time on the subject. And in fact, this week we are going to make some portfolio adjustments in accordance with our view that we think the dollar will strengthen, not weaken, in the weeks and months to come.
Why will the dollar strengthen and not weaken even as the Fed runs its modern-day, high tech printing presses 24/7? We think Bob Hoye provides some good insight into that question in the interview I just concluded this past week with him. That interview will be posted in our February 2005 monthly issue, which is scheduled to go to press this coming week. For those who don't know Bob, his service is expensive for most individuals. It is geared for corporations (mostly oil and mining companies) as well as institutional advisors and high net worth individuals. Here are a couple of quotes from my February 3 interview with Bob that I think you will find of interest.
Hoye on the Subject of Liquidity
"The (recent) sharp drop in the stock market has reduced liquidity as hinted by widening corporate bond spreads. The concept of liquidity is badly abused. For example, in the summer of 2000, the street was so fully bullish because there was so much liquidity to buy the stock market. They didn't understand or grasp the importance that it was the stock prices rising that enabled all speculators to leverage up their positions. But that is borrowed money. That isn't liquidity. But this was the same position that the market is in now. While an asset price is going up, it gives the appearance of liquidity, and then when that asset price heads down, all of a sudden liquidity disappears. So that is what we are dealing with now."
Hoye on the "Dollar Short" Position & Senior Currency Strength
TAYLOR: Richard Russell talks of a gigantic short position in the dollar, and if I'm not mistaken, this is a concept you have also spoken of. Perhaps Richard Russell acquired this concept from you.
HOYE: It could be, because I turned that one loose a year ago in January. It provoked quite a bit of controversy. Many of the comments that I read had not really understood what the concept was but they attacked it anyway.
TAYLOR: Could you explain the concept?
HOYE: First, let's talk about bubbles. Bubbles characterize a new financial era. There have only been six of these bubbles 1720, that being the South Sea Company in England and the Mississippi Bubble in Paris. Each of those had the same setup. You had a huge blowout and inflation-that was the old era. Then you had the crash of commodities and tangible assets that then sets up the new financial era, and everyone thinks it is going to run forever. Then it crashes. So this is the history I am talking about. And the pattern is one of going from a great boom in tangible assets to a great boom in financial assets and then into a period of long contraction.
TAYLOR: So we had the boom in commodities in the 1970s.
HOYE: And, there were a few, like gold, silver, and oil in the 1980s. Then if you look at the commodity index, it had an important high in 1988. The way I ended up describing it was that the 1988-89 boom was the last business cycle of the old era inflation. That then set up the new era of financial asset inflation, which ran for nine years, which is typical. Then you get the first crash and then you have the rebound. Then you have another bear market. But the point is that after all those five pervious stock bubbles, the feature of the contraction eventually was a relentlessly strong senior currency. It was strong, relative to most other currencies most of the time, and strong, relative to most commodities most of the time.
Back in the time of the South Sea bubble, the financial capital was in London. They went around to places like Bolivia, Turkey, Chile, and Egyptian banks and everywhere else because the demand for paper like that was endless. So they floated a whole lot of bond markets-I'm sure they did so as well in other financial markets like Amsterdam and Paris. But the way this seems to work, once the party is over-you have these lesser countries who had a windfall because the money just flowed to them like mad so they could do all these spending projects without any thought of repaying it. Then they have to repay it into a faltering economy. So what they have to do is sell someone else's currency or sell their own raw materials in order to get their hands on sterling, which was then the senior currency, in order to meet their debt obligations in London.
Hoye on Gold and the Dollar Moving up Together
TAYLOR: In your "ChartWorks" publication of January 25, in which you addressed the gold markets, you noted that the U.S. dollar and gold were poised for a joint advance. Could you tell our readers what prompted you to predict that and could you also provide some indication of your target levels and time frame for the advance in both the dollar and gold?
HOYE: At previous points in the last 10 years or so, you have had time when you have had gold and the dollar to rally together, and it looks like we are getting to that point again. One doesn't affect the other. This tandem move just appears to be in the charts, so that for a brief while I believe we will see gold and the dollar move higher together. But then eventually, both gold and the senior currency become relentlessly strong, relative to everything else.
TAYLOR: What is your best prediction in terms of timing for that to happen?
HOYE: If this current sell-off in the stock market continues and we go into a recession and a credit contraction, that's it, it starts. We will know by September or October whether we are now really into the hard deflation.
TAYLOR: So we could be on the verge of a serious decline in equities, is that your view?
HOYE: Yes. If this is fully defined as a bear market. We are not there yet, but it sure looks like we are going to get there. Once you get the bear, then it would be a natural that the first lows (in the secular bear) would be the lows of October 2002.
Hoye on the Gold Market Now
"At any rate we are in year 4 in probably a 20-year bull market for gold. So we have had the first correction. Gold was down with the bubble and then it improved with the bear market in stocks that ended at the end of 2002. And then gold's real price had a cyclical setback while all the rest of the world was enjoying a cyclical recovery. But now we are set to go the other way where we are going to have a cyclical contraction in the orthodox world, but that is going to be offset by a cyclical recovery in gold's real price."
I had a fascinating discussion with Bob Hoye. Be sure to read our February 2005 monthly issue, which should be in your computers before the end of next week.
February 13, 2005
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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