Taylor On Gold Stocks & US$
Enter Ben Bernanke & His Helicopter Printing Press
One of the key jobs of the establishment is to con the population into
believing all is well. Running the confidence game well is of course important, because if everyone believed as your editor does, that we are heading inexorably toward a deflation, people would begin to behave in a manner that would in fact ensure that outcome. If everyone did what I did-sell their house and put the money in the bank, by definition our inflationary economy would run into reverse. In short, it would deflate and we would indeed face a 1930s replay or something much worse. Policy makers see it as their task to avoid that outcome.
And so, a couple of years ago, when the Federal Reserve, in looking at the
Japanese experience, really became worried about deflation in the U.S. and lost confidence in Keynesian and Friedman economics, the trotted out Ben
Bernanke to assure the American people that the ideas of Keynes and
Friedman were not barbaric relics, but in fact could and would work. In his
infamous speech, Ben Bernanke assured Americans that deflation could not
ever happen here because now we are much smarter than anyone who tried to avoid deflation by implementing fiscal policy in the past. Not only are we
much smarter than the Japanese and our grandparents were in the 1930s, but now we also have very high technology printing presses and if needed we
could even equip helicopters with monetary printing presses and shower the
money out over the population to avoid deflation. So forget about it.
Deflation is dead! So eat, drink, and be merry. Life has never been better.
Anyone who thinks government cannot avoid deflation via monetary and fiscal
policy is simply an uninformed crank.
And so not only did Greenspan and Bernanke at the Fed print money like mad,
President Bush and the Congress began to run enormous fiscal deficits by
cutting taxes and engaging in a war. And guess what! It worked-at least
until now, when that monetary and fiscal stimulus, like a narcotic, is
beginning to wear out. One of the best measures of monetary growth is the
U.S. Dollar Liquidity Growth statistic, shown on the chart on your left.
This chart displays a rolling 52-week growth rate of the U.S. monetary base
plus foreign bank holdings of U.S. dollars. You will note that along about
March 2000-exactly the time when equities peaked, this measure of the money supply peaked. When Mr. Greenspan began to decrease the money supply because of the outrageous equity bubble, U.S. dollar liquidity declined to just over 0 percent (0.38 percent) in February 2001. That was about the
time policy makers began to express fears about deflation in the U.S. and
when Mr. Bernanke promised us helicopter money if we need it.
Since the economy was displaying depression-like characteristics-especially
in terms of the labor markets-they believed we needed more rapid monetary
growth. So the Fed stomped rapidly on the monetary accelerator and away we went, only this time, rather than peaking at 15 percent in money growth, as we did in March 2000, we approached 22 percent by May 2004! This of course drove real interest rates to levels sufficiently low enough that the Fed has succeeded in creating still another bubble, like Japan did, namely, a
real estate bubble. And now, the Fed is faced with breaking the real estate
bubble.
Actually, ever since Nixon caused the United States to default on its
obligation to pay foreigners gold in exchange for dollars at the rate of 1 oz. per $35 in 1971, our policy makers have had quite a party at the expense of the American public because they have been able to print money and spend it to buy votes like never before in our history. The chart on your left, which measures the U.S. money supply in terms of M-3, illustrates the point. From $776 billion at the end of 1971, M-3 has grown to nearly $9.6 TRILLION, or more than eleven fold since the dollar was detached from gold.
Yet despite this massive growth in money, if one is to believe Milton
Friedman's monetary theory, a very strange thing has been taking place.
Friedman always preached that inflation in terms of prices of goods and
services would rise more or less along with the growth in the money supply.
Yet, since 1980, when consumer producer prices peaked in America, we have
been experiencing a steadily declining rate of inflation, as evidenced by
the following chart.
The CPI began to rise fairly dramatically, starting in about 1965 as the Fed began to print money to pay for Vietnam and America's version of socialism. (In fact, that was a primary cause for a run on the U.S. gold supply, which subsequently prompted Nixon to default on America's gold payment obligations.) At the end of 1965, M-3 stood at $482 billion and then grew to $1.8 trillion by January 1, 1980. It was about that time when the U.S. CPI reached the peak shown on the chart on the left and it was about that time that the "stock" of Milton Friedman and his monetary line of thinking became highly regarded. Friedman stated categorically that the only reason in the long run that prices rise and fall is because of increases or decreases in the money supply. Seemed logical enough in 1980 because we who lived through that time frame witnessed an explosion in the money supply at the same time consumer and producer prices exploded.
But that argument broke down very badly from 1980 to present when M-3 grew from $1.8 trillion to $9.5 trillion in June 2005! Just as in the Japanese
experience, we are finding that an ever-expanding rise in the money supply
not only fails to result in higher prices, but is accompanied by disinflation (a decrease in the rate of inflation). That certainly is a refutation of Friedman's monetarist theories. I will grant you that the official U.S. government price data understates the actual cost of living. All manner of games are played to accomplish a lower CPI, including hedonic pricing schemes and the elimination of house prices. But there are few if any reputable economists who would argue that the trend in the cost of living has not declined markedly since the peak in 1980.
Mounting Evidence of Disinflation If Not Deflation
Markets are forward looking and so I think we need to pay attention to what
the 30-Year U.S. Treasury is suggesting about future prices. If the markets
could see a hint of deflation, it seems likely the 30-Yr. Bond would be tanking now rather than continuing in its bull market. Yet the bull keeps
moving onward and upward, a trend that started back in the early 1980s,
when the inflation cycle was broken.
With respect to the stock market, the greatest stock market bubble in
history was broken in 2000, when the NASDAQ dove to earth like a shooting
star from 5000 to 1000 and the S&P 500 lost nearly half of its value. Since
the market crashed, and starting in about 2001, fear of deflation caused
the Fed to put the pedal to the metal, causing M-3 to grow by $1 trillion
in 2001, $1.5 trillion in 2002, and $1.1 trillion in 2003. In spite of this
torrid pace of money creation, as the following charts reveal, the equity
markets have not even come close to reaching their old highs, in spite of
this rapid monetary growth and in spite of a huge fiscal stimulus pumped
into the economy by the Bush Administration for the Iraq war and other
massive outlays. In fact, if you look at the tech heavy NASDAQ, it looks
very much like the Dow after the 1929 crash. Of course it was the Dow
stocks that were all the technology rage during the 1920s.
So in spite of long-term money stimulus and especially great amounts of
monetary and fiscal stimulus since the stock market bubble was partly
pierced in 2000, we see little signs of inflation in the consumer price
index, the bond markets, or the equity markets. But there is inflation in
the commodity markets, isn't there? Well, certainly there is some nominal
inflation in the commodities and there is definitely an inflationary bubble
in the housing industry. But if you look at commodity prices in terms of a
constant dollar, the CRB is still 33 percent below where it was in 1984, as
the following chart illustrates.
What is going on? It seems clear to this observer that both Keynesian and
monetarist theories are no longer credible. Of course absolutely no
attention is paid to Austrian economic thought, which does provide some
answers as to why monetary and fiscal policies will ultimately fail. But
Austrian economics, like any economic theory, is limited by its own
definitions and thus disallows answer seekers from thinking outside of
their strictly confined box. I do believe the Austrian economic model is
the most realistic of all economic theories in explaining how economic man
functions. However, if we try to explain major economic trends and cycles
purely from a pre-defined economic theory and exclude other forces of
nature and human behavior, some of which is highly irrational, I believe we
handicap our quest not only for answers to economic questions, but also in
perceiving what may lie ahead of us in the future.
Gold's Behavior in a Deflationary Environment
At the New York gold show, at least two serious investment professionals
asked me if I had any information on how gold performs during a deflationary event. I told them of a paper written by Dr. Sam Hewitt of Sun
Valley Gold Company. If memory serves me correctly, that work was sited by
Barton Biggs when he reportedly told his clients a few years ago to begin
buying gold in preparation for an economic and stock market meltdown. Biggs
quickly recanted his pro-gold views on CNBC the first business day
thereafter. But in the meantime, the cat was out of the bag so to speak. A
Wall Street icon had done the dirty deed. By suggesting to his clients that
they buy gold you might say Biggs betrayed the Wall Street establishment,
because if and when the public opts out of paper money and back into gold,
Wall Street will lose its license to steal by way of the creation of paper
money.
In addition to the paper written by Dr. Hewitt, I had studied and compiled
stock price data for Homestake Mining Co. during the 1930s Depression and
found that an investment of just 15 percent in Homestake and 85 percent in
Dow would have largely prevented equity market losses during the 1930s and
1940s. Keep in mind that the Dow at one point lost almost 90 percent of its
value -- a loss that, as shown above, is similar to the loss the NASDAQ
suffered from 2000 through 2002.
Here's Homestake vs. Dow Jones Average comparative performance during the Great Depression:
June 8, 2005
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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