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Taylor on the Markets

May 14, 2001

NEWS-GURU Doug Gillespie Suggests Rate Cut Won't do Much for Stocks.

My fellow News-Guru, Doug Gillespie who like myself frequently contributes his ideas, without charge, to, had the following to say yesterday about interest rates and the stock market.

"I expect a half-point cut in both the Federal Funds and the Discount rates, a likelihood that Federal Funds futures are also currently indicating. This would bring these measures to 4.00% and 3.50%, respectively, 250 basis points lower than where each began the year. This is what the stock market is expecting (demanding), and the stock market remains Greenspan's master! I continue to believe there are investors planning on taking advantage of the anticipated rally the rate cut will spark. Thus, I also continue to believe that stocks get sold on the news, with perhaps even a little "front-running." The longer-end of the Treasury curve continues to be uneasy about what's unfolding, registering a substantial increase in yields yesterday. As long as you don't eat, heat or drive, there's no inflation and none in sight, or that's what the pundits keep telling us. But bond investors remain unconvinced.

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"Treasuries were clubbed with the 10yr getting beat for more than point as yield rose to 5.48%. From a chart hugger perspective, we could see 6% in short order, and it looks like we may want to sell off right into the Fed meeting. With Uncle Al, the printer, cutting rates as fast as he can, gold starting to awaken, and energy prices still on fire, the bond market is understandably spooked about inflation. As we discussed before, I continue to believe that we saw a major low in yields in Q1. The April PPI showed a 0.3 percent rise after a 0.1 percent decline in March on the back of moves up in the stuff we all use every day like food and energy.

"So, as we go into the FOMC next week we've got the bond market starting to get into trouble, the gold shares and the metal getting some interest, and stocks looking extremely tired. That's not exactly a bullish recipe. Anybody thinking that Uncle Al and the Fed took a look at today's stronger data and is now reconsidering their current aggressive easing course that they're on is dreaming, I think. The Fed has made it very clear that they're going to keep cutting, and that inflation is not a concern. So, we'll probably get our 50 bp chaser on Tuesday to follow up the BOE's and ECB's 25 bp cuts this week, and we'll see what people can do with it. I doubt they can do much as this rally looks to be showing the early signs of falling apart. I'd start strapping in Tuesday morning if I were you. Once the initial reaction to the cut is over and done with, we could hit some air pockets on the downside...DO WE HAVE AN INFLATION PROBLEM?

The answer to that question is an unequivocal "YES" because by definition, inflation is an increase in the supply of money. And Mr. Greenspan is printing like there is no tomorrow. In fact on a rolling two year basis, we are experiencing one of the fastest growth spurts in M-3 in the last 100 years. Only during World War II and in the highly inflationary 1970's has money been growing more rapidly.

So we are starting to see a rise in the price of many of the things we have to use every day. Home prices, rents, restaurant, utility bills, gasoline, are all sharply on the rise. Of course, the CPI does not necessarily reflect the real cost of living because those real honest folks known as politicians have chosen to take certain things out of the basket in order to make things look good and to reduce transfer payments for social security recipients. For example, I believe it was during the Regan years when housing was taken out of the CPI on the theory that you don't have to buy a house because you can rent. So, if any of you really believe the government's CPI numbers are anything close to accurate, I have a bridge to sell you just a couple of mines from where I live here in Queens.

Stock prices of course got out of hand because of the insane amount of money created out of thin air by the Greenspan Fed. And with memories of devastating losses fresh in the minds of so many Americans, it is not as easy as it was to sell common people on the notion that in the long run you are going to get rich in the stock market. The longer the market trends sideways or down, selling stocks will become even more difficult.

Because of an increasingly fragile global monetary system, the Fed continues to more money. But because so much of it has been printed, it has no useful place to go. Stocks are overpriced, and people are losing confidence in equities, so money seems to be moving into real estate, which is most likely the last bubble to be pierced before the real cold winds of the Kondratieff winter begin to blow.

Mountains of Debt Ensure the Winds of Winter

My friend Ian Gordon, who I believe has a firm grasp of the historically predictable Kondratieff cycle, has steadfastly suggested that you should forget the arguments from the establishment that somehow we are smarter now than during the 1930's or that we have figured out how to keep the economy from unraveling as it did back then. The problem with the various meddling by government into these markets is that as Greenspan put it with reference to 1928, the government mistakes "the cure for the disease."

While government intervention may delay a severe decline in the short run, the more it meddles, the greater will be the eventual decline. This is necessarily so because in the end what government and their commercial bank friends do is print money. And the reason that does not work is that the longer into the Kondratieff cycle you have progressed the more debt that must be created to generate economic growth. Eventually debt service requirements overwhelm economic growth by robbing the economy of what Keynes called "effective demand."

The purpose of the Kondratieff winter then is to wipe the slate clean so the next cycle can begin. How does this take place? At some point, when debt burdens get so high, the payment of principle and interest snuffs robs the economy of so much effective demand that sales begin to decline. With sales declining, profit margins plunge. As profits and profit margins plunge, massive layoffs take place, which further erodes effective demand both from the consumer sector as well as the capital goods sectors. The vicious circle continues until it cannot spiral down any further. Then, from a nearly dormant economic state, new life evolves and a new Kondratieff winter begins.

The last such event took place in 1950 following a 20 year long Kondratieff winter that began with the 1929 stock market crash. As Alan Greenspan himself implied, the reasons the 1930's were so difficult was because the gold standard was pushed aside, thus avoiding the self correcting mechanism of the markets during prior cycles. Government intervention may have made people feel better for the moment, but it prolonged the period of time for the market to return to equilibrium. Now that we have much more intervention now than during the 1930's, one can only expect the next winter period to either be longer or deeper than that of the 1930's. INFLATION OR DEFLATION IN THE WINTER?

Dr. Ravi Batra, who also believes we are headed into the most devastating economic decline since the 1930's told our readers that when we face the upcoming economic depression, it will be accompanies with inflation rather than deflation as was true during the 1930's. He says this is true because the U.S. is now the world's largest debtor nation. So, when our economy tanks, foreigners will trash their dollar holdings which will mean that imported goods will become extremely expensive for Americans.

I think this argument has some additional credence now also because during the Clinton years, we have sent heavy industry overseas, so that the U.S. is no longer nearly as self sufficient in producing basic materials as it was in earlier years. Thus, as we import we may be paying horrendously high prices in terms of our own currency.

Still, a depression results in massive idle human resources as well as plant and equipment and that puts downward pressure on prices. So, while in the early days of our Kondratieff winter (which Ian Gordon believes began in march 2000 with the peak in our stock market) prices may rise – perhaps dramatically in the months ahead, ultimately, I believe we are going to see collapsing prices which in turn will wipe out the unimaginable levels of debt created by the most irresponsible monetary promiscuity in the history of man. If Ian is right - and I think chances are good that he is, Americans may be facing one of the most challenging periods in our history.

The solution for all of these potential problems? Let me suggest "the two G's", namely Gold & God, not necessarily in that order. Gold will help you face the tough times on this earth because it is likely to be about the only money that people will accept when you need to buy life's essentials. If history is our guide, that will be true whether the CPI is rising or declining.

Faith in God of course, will be required to endure the hardships that await us - even if my gloom and doom outlook proves to be completely wrong because eventually we all will be faced with a time when life on this earth is over. And of course, if you believe as I do in God as creator and savior, faith will be every bit as important as Gold when the end draws near.

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