TAYLOR ON THE MARKETS
FINANCIAL MARKETS
QUESTION: How often is your Global US Dollar Liquidity calculated? Where
can I find the information? Thanks, Don
EDITOR'S ANSWER: Don, you can find the information you need to calculate Global U.S. Dollar Liquidity in Barron's. It is the sum of foreign holdings of U.S. debt and the monetary base, as reported by the St. Louis Fed.
I began tracking this number in the late 1980s during the Asian Crisis.
Truthfully, that was a mini-global deflationary collapse that the policy
makers were able to contain before it spread to a complete global meltdown.
I heard an analyst on CNBC mention this statistic; he gave credit for this
measure of liquidity to Charlie Clough, who I believe was then chief
strategist at Merrill Lynch. But I was fascinated with this measure of
liquidity because as the Austrian economists understand, true deflation
requires a shrinking money supply and shrinking liquidity, just as true
inflation requires an expanding money supply and expanding liquidity.
So in fact, during the Asian deflationary crisis, we did indeed see the
U.S. Dollar Liquidity Growth shrinking in 1998. The earliest 52-week
comparison I have was from July 6, 1997 through July 6, 1998. During that
annual period, global U.S. dollar liquidity shrank by 0.27%. But from then
until September 21, 1998, this measure of liquidity continued to contract
more until it reached a negative growth of 4.55%. From that date on, this
rolling 52-week measure of liquidity growth expanded until it peaked at
15.14% in mid-April 2000.
The contraction that followed mirrored the partial collapse of the stock
market bubble that still has much further to deflate, even though trillions
of paper profits were lost during the first leg down in this secular equity
bear market. But that deflation has been put off when a cyclical bull
market within the bear market, combined with the biggest bubble of
all-namely, the real estate bubble-has allowed most folks to partly forget
the pain of phase I of the current secular equity bear market.
I would like you to cast your eyes on the expansion of U.S. global liquidity that began in 2001, following the September 11 attack on America. Remember it was soon after that that the Fed began to openly worry about
deflation, and with good reason. They looked at Japan, which had done
everything it was supposed to do in accordance with Keynesian and
monetarist dogma, but to no avail. And so, Greenspan's Fed began to pump up
the money supply, and the result was a partial comeback in equities; but
more important was the housing bubble, which, this go-round, served to
avoid a credit collapse as predicted by Ian Gordon in his Kondratieff
winter scenario. But the expansion of global U.S. dollar liquidity reached
a torrid 21.86% by April 26, 2004, compared to the peak of 15.14% in the
prior inflation extravaganza. Not only was more money created during this
latest inflationary episode, but also, as you can see from the chart above,
the duration of the expansion was considerably longer, lasting from late
2001 through April 2004. Lord have mercy!
As with a drug addict, each expansion of the toxin must be at a higher
high. And as with the drug addict, the tolerance at the bottom of the cycle
becomes lower with each cycle. And so here we are now, with the current
growth rate of global U.S. dollar liquidity still growing at a rate of just
under 10%, and we are already seeing some serious liquidity problems
surface, most notable of which is the Refco debacle.
This is potentially a very significant deflationary problem and, irony of
ironies, it seems based on information in the popular press, it may in fact
be involving Mr. Inflation himself, James Rogers. But wait, won't the Fed
simply create more money and credit to bail out Refco or at least contain
any deflationary problems it may trigger? I think it might in fact like to
do that, but will it be able to do so? That is the big question in my mind,
because it seems to me that some major headwinds may now be blowing against the U.S. that were absent during the 1990s when Mr. Greenspan printed enormous amounts of money with each major crisis that occurred. (Think Mexico, Orange County, Asia, Russia, Long Term Capital Management, and Y2K.)
What kind of headwinds may make it tougher for the next Fed chairman to
simply print the global economy out of trouble? Check out our Model
Portfolio discussion this week as well as my answer to the next subscriber
question for a clue as to why I think it may now be impossible for the Fed
to continue printing money to keep the global economy from teetering into
the Kondratieff winter.
QUESTION: Jay, during the 1929 to 1932 period, we were on a gold standard and suffered a depression. Today, we have abandoned the gold standard and have a totally fiat monetary system. It seems to me that only inflation can occur now just like Germany who, I think, was using a fiat currency. How then can we suffer another depression like in 1928-1932? Karl
ANSWER: Karl, you have done a good job of repeating the propaganda that we have all been given, and for that you deserve and most likely would get an
"A" on your economics 101 exam. We have all been taught in our college
economics classes and from years and years of mainstream propaganda that
the Great Depression could not have happened if only that darned stupid
old-fashioned gold standard had not been in place. If only the bankers
could have had more "flexibility" to increase the money supply to keep
enough liquidity in the system so that policy makers could have defied the
laws of markets and overcome deflationary pressures. And if only people
could have been educated to keep going into debt and keep spending rather
than saving as their jobs were in jeopardy so that the dark days of the
1930s depression could have been avoided. We have all been propagandized to believe this nonsense. We have been programmed to believe that if only
bankers and politicians were not governed by sound banking laws and sound
money-if only they could print endless quantities of money, we could
overcome the natural laws of economics. That is a big fat lie, because
markets need to exhale as surely as they inhale. They must contract as
surely as they expand. Attempts to have them only exhale will ultimately
lead to the death of the economic patient.
There are many problems with the lies we have been fed, and I talk about
them frequently in these pages. One has to do with the Austrian concept of
mal investment. Force money into the system, and you get a whole lot of
terrible investment decisions. We saw that during the 1990s in the dot-com
companies as well as the telecom companies. Many companies went bankrupt,
and their share prices went from very high levels to zero or near zero. Yet
the debt that was used to create the money that blew up the tech bubble
remains in place even today, although there is no income now from those
enterprises with which to service that debt.
Related to this problem is the fact that debt is the raw material from
which fiat money is manufactured. Once again, I show you the debt/GDP chart and ask you to think about what is going on here. Note the exponential rise in total U.S. debt compared to income. Every time more income is created, it is done so by creating a huge amount of debt, and as you can see in that chart, debt is growing much, much faster than income. So what you are suggesting when you argue that money creation can always overcome
deflation, is that the amount of money that has to be taken out of the
economy to pay interest and principal does not represent a drag on the
demand side of the economy. I beg to differ. Also, I believe Ian Gordon is
right in suggesting that during the K-winter, issuing more money actually
becomes deflationary because of the exponentially rising debt levels
associated with the need to accelerate money growth (and hence debt growth) to continue stimulating one new dollar of income. During the Kondratieff summer, such is not the case. During that season of the Kondratieff cycle, hyper inflation would be possible, because debt levels are a mere pittance compared to the explosion of growth that takes place during the K-autumn and during the early days of the K-winter when policy makers attempt to outrun deflation. During the K-summer, debt burdens are, by comparison to the winter, extremely low, so that new money creation is free to stimulate demand without the huge drag of debt service coverage during the K-winter. Hence we had a substantial double-digit inflationary episode in the 1970s.
But What about Exploding Inflation Now?
Now we are having rising levels of inflation. Indeed the numbers are even
becoming reminiscent of those of the 1970s. (See more discussion of this
below in our discussion of our Inflation/Deflation Watch and in our Model
Portfolio sections below.) So, I can't deny that we are still facing an
inflation problem.
Inflation threatens our currency, and so to defend the currency, the Fed is
raising interest rates. However, unlike 1980, when Paul Volcker stopped the
money supply growth cold in its tracks and sent interest rates to double
digits, our debt levels are manifold greater now than they were then. Thus,
any kind of tight money policy poses a threat of a much, much worse
business and credit contraction now than during the early 1980s.
Remember the recession that ended in 1982? It was the deepest since the
1930s. I believe there are at least two reasons ways that the current
situation could turn into a depression. Unfortunately I believe it is likely to happen. First, I believe banking interests control our government and its policies, and the bankers will not, if they can help it, have their loans repaid to them in worthless currency. In other words, the bankers are the silent power behind the throne, keeping our political system bound within certain parameters that are acceptable to them. Thus I think it is likely that the Fed will surprise all but a handful of market players by being surprisingly tight on its monetary policy once it becomes clear their status is threatened by higher inflation. And I think the data that came out this past week is reason enough to expect the Fed to start raising interest rates much more aggressively than 99% of Wall Street anticipate. In fact, I think at some point, they will slam on the brakes to demonstrate they are serious about our lack of saving and profligate spending habits. At some point, given our high level of debt, I believe it more than likely that we will spin into a deflationary implosion.
Secondly, even if I am wrong about who runs America, every infusion of new
money aimed at overcoming deflationary forces will cause debt and debt
servicing requirements to grow all the faster, so that at some point in time, debt-imposed deflationary forces will overwhelm the ability of debtors to pay those debts. Again, I ask you to look carefully at the debt/GDP chart above. Think about what is going on in this picture, and then ask yourself: "How can more debt money solve the deflationary problem when debt is THE problem?"
What we need to understand is that, contrary to the propaganda we have been given, recessions are necessary events, because they serve to restore
equilibrium in the economy. We did not need to face the horrible depression
that we now are going to have to face, if the politicians and bankers with
whom they "sleep" had not tried to overcome the laws of economics with
intervention piled upon intervention. Friedman and Keynes are the culprits.
They have provided a poisonous mix of monetary and fiscal policy foolishness that has misled us into believing policy makers can outwit the laws of nature. Mere humans are not smart enough to overcome natural economic laws. Our Founding Fathers understood that, but in our arrogance, we shall have to learn the hard way, because the monetary and fiscal lies we have willingly accepted will just as surely lead to economic death as massive heroine injections ultimately lead to human death. But, just as it is impossible for a physician to predict with certainty the time of a patient's death from taking heroine, it is impossible to predict with certainty when this economy will reach its debt pathology limits. And so we wait and watch and try as best we can to determine the inflation/deflation tipping point.
October 23, 2005
Jay Taylor, Editor of J Taylor's Gold & Technology Stocks
www.miningstocks.com
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