The Steve Puetz Letter

May 19, 1997

CAUSE AND EFFECT

In the mid-December issue of The Privateer (P.O. Box 2004, Noosa Heads, Queensland 4567, Australia), Bill Buckler wrote: "in the study of the nature of cause and effect, the only permissible variable is TIME. When cause and effect is not fully understood, the length of time between the enactment of a particular cause and its discernible -effect can [create confusion]. The longer it is, the more easily the visible link between cause and effect is lost. But it is here in that time interval, the period during which the eventual effect is not easily observed, where valid theory really counts. With such a theory in hand, one can state that the cause has been enacted and that though the eventual effect is not yet here, that effect will indeed arrive. It is with valid theory in hand that one can then state that if the now inescapable effect is to be made less dramatic, then corrective action has to be takenBEFORE the effect hits. To delay, knowing in advance the nature of the eventual outcome, is, quite literally, to act irrationally!

SADLY, IT IS GREENSPAN, NOT THE MARKET, WHO IS IRRATIONAL."

The theory Buckler has referred to is: All credit inflations eventually lead to credit deflation. And the corollary: The greater the inflation, the greater the subsequent deflation.

During the 1960s, Greenspan wrote extensively about the Federal Reserve's negative role in supplying the speculative credit that led to the 1929 crash. The present quandary is: Why, if Greenspan knows that supplying massive doses of credit to financial markets eventually leads to a crash, does he allow it continue?

Perhaps, Greenspan's complacency arises from the erroneous belief that the stock market inflation is still small and can be controlled. Greenspan's "irrational exuberance" comment may have been an attempt to halt credit flows into the stock market before they became uncontrollable (in his opinion). It may have been a shot at redirecting credit flows into the weak real economy. But the Federal Reserve is not able to direct credit flows. Central banks only have limited control over short-term interest rates.

Greenspan and the Federal Reserve would have been better prepared to deal with the circumstances of the 1980s and 1990s if they understood and followed credit theory to the letter. The cause of the stock market boom is inflation credit. The inescapable effect is a deflationary crash. Combining the theory and its corollary, a small credit inflation leads to a mild deflation. And a large inflation result in a large crash. In the present case, the greatest stock market inflation ' of all time will certainly end with history's most massive deflationary crash. The nagging question remains: When?

DEFLATION

In the January 1997 issue of The Richebacher Letter (12254 Nicollet Ave. S., Burnsville, MN 55337), Dr. Kurt Richebacher explains how credit inflation leads to a "debt trap", which in turn brings about credit deflation: "With a few brief words, Fed Chairman Alan Greenspan has managed to shock financial markets worldwide... But that wrenching move, in turn, left the market wrongly positioned for the next random piece of news, which happened to hint of economic weakness and low interest rates in both the United States and Japan. The equally predictable result: a volcanic reversal that quickly propelled the Dow back [upward]. What are we to make of these increasingly volatile swings? Only that they confirm the validity of Mr. Greenspan's fears -- and demonstrate the Fed's utter impotence in the face of them [without massively restricting credit]... Bubbles can only be prevented, never cured... It is far too late for the Fed to do anything but prick the bubble before it collapses of its own accord from an ever more wildly inflated level. Either way, the collapse of the boom will spell catastrophe for the industrial economies, which already teeter on the brink of a deflationary spiral. After reviewing the public debt figures for the major countries, we see ominous signs that many already are caught in the 'debt trap' -- the late and usually final stage of chronic indebtedness in which the debtor's interest payments begin to exceed his new borrowings... As governments struggle to reign in compounding interest costs, primary budgets must be driven ever more ruthlessly into surplus, implying mounting fiscal drag on the real economies. The dire consequences can be seen clearly in Europe, where complying with the Maastricht Treaty's limits on budget deficits has proven an intolerable economic burden. Japan, too, appears headed toward a future debt crisis, as it invainly struggles to reflate its depressed economy with liberal doses of government spending. In America, it is private consumers who now seem to have reached the limits of their excessive borrowing, while the US government must rely on the forbearance of its foreign central bank creditors to avoid its own debt debacle.... The signs of a looming deflation are there to see. We are heading into it, and loose money, far from preventing it, can only make it worse in the long run by stoking ever greater excesses now. Admittedly, over-indebtedness is difficult to define and measure.... The best gauge is what has been labeled the 'debt trap.' A debtor sinks into the debt trap whenever the interest payments on his existing debt begin to exceed his new borrowings. After the public borrowing orgies of the past twenty years, virtually all governments in the industrial countries now are caught in this trap, and are being driven deeper into it by the monster of compound interest."

Bubbles can only be prevented, never cured... It is far too late for the Fed to do anything but prick the bubble before it collapses of its own accord from an ever more wildly inflated level. Either way, the collapse of the boom will spell catastrophe for the industrial economies, which already teeter on the brink of a deflationary spiral.

GERMANY

Not only do Austrian economists, such as Dr. Richebacher, see the threat of deflation, some Keynesian economists are noticing the same. On January 6th, Knight-Ridderreleased this news clip from its New Orleans bureau: "Prominent economist Rudiger Dornbusch warned today that the risk of 'serious deflation in Europe' is the next likely world financial crisis. In remarks at an American Economic Association conference here, Dornbusch called for an 'aggressive expansionary monetary policy' in Germany to prevent Europe from failing into serious recession. Dornbusch, who works for the Massachusetts Institute of Technology, ... earlier said German monetary policy has been too tight and that too much focus is being put on deficit reduction as part of efforts to achieve monetary union in Europe."

While Dombusch recognizes the impending deflation, his call for an "aggressive expansionary monetary policy" is simply more of the same old Keynesian medicine that has gotten all industrial countries where they are today. Furthermore, his statement, that too much focus is being put on deficit reduction, ignores the consequences of making the German 'debt trap' even larger. He pays no attention to the tighter financial noose that results from an even larger debt.

Germany's dilemma -- of reducing its budget deficit, bringing down unemployment, and complying with the Maastricht Treaty -- was brought to light in the followingAssociated Press item, released on January 9th: "Unemployment numbers in Germany breached the 4 million mark last month, soaring to their highest December level in postwar history.... The jobless rate rose to 10.8% last month, from 10.3% in November.... Nearly 4.15 million people were out of work, close to last January's postwar high of 4.16 million.... In another troubling sign ... [Germany's] budget deficit rose to 3.9% of gross domestic product last year.... The European Union has agreed on a [maximum deficit] target of 3.0% for countries that want to join the single currency due to debut in 1999."

Once entangled in the web of a debt trap, escape is impossible. The very instant that creditors realize that their capital is at risk is the same instant that the debt trap transforms itself into violent deflation. The rest of Europe, Japan, and the US face a plight similar to Germany's.

GOLD AND SILVER

The precious metals remain in a deeply oversold state. For market advisors, this is the longest period of sustained bearish sentiment for gold and silver during the past decade. This bearish opinion is mirrored by the extreme negative sentiment figures of the public - without precedent. Such periods of extreme sentiment always represent excellent buying opportunities when the fundamentals are strongly long-term bullish. The value of all gold in the world relative to the global supply of fiat-credit stands at an all-time low -- even lower that 1971 when gold traded at $35 per ounce. In other words, gold is cheap. All that's needed is the coming global financial collapse to precipitate the gold price explosion.

Social pressure from the multitude of investors engulfed in the global financial mania makes gold bulls and stock market bears an unheard and scorned minority. Nonetheless, logic will prevail over emotion.
The stock market will crash, and the price of gold will revive.

Gold is still being mined and refined at the rate of almost 2,600 tonnes per year.