first majestic silver

Taylor on the Markets & Gold

April 16, 2002

Stock market bulls have a big problem on their hands. U.S. stocks remain enormously overvalued. At the end of this week, the Earnings Yield on the S&P 500 stood at a measly 2.28% compared to a 10-Year U.S. treasury yield of 5.15%. And the dividend yield on the S&P 500 was only 1.41% meaning that the highly hypothetical retained earnings stood at only 0.87% for stocks.

But the biggest problem of all faced by the bulls is that improving profit margins are now where in sight. We have a deflationary problem, and now that the Enron debacle has forced a degree of honesty on America, it is harder to lie about profits than it had been during the Clinton years when lying for the sake of profit and pleasure became institutionalized.

Morgan Stanley economist Stephen Roach said last week, "….by now the carnage of the past year has been well documented: The nearly 20% plunge in S&P operating earnings in 2001 was the worst performance of the entire post-World War II era. Then he said, "What I find most astonishing is that this earnings collapse occurred in the context of what could have been the shortest and mildest recession of the post-World War II era. Its hard to imagine how businesses would have fared had there actually been a garden-variety recession!"

Later I the article, Roach noted that corporations have been doing everything they can to cut costs in order to restore profitability but profit margins are still under pressure. He suggested that having done nearly everything possible, the worker may be the next to bear the brunt of cost cutting measures through aggressive job cutting. As that happens he worries that the consumer may finally stop supporting the economy.

Why have profit margins been so low? Roach suggests trade liberalization and synchronized business declines around the globe all happening at once have been contributing factors. But in his view "the bubble" was the most significant contributor. Essentially he is talking about "mal investment" which he blames on new economy hype and a loss of discipline and control of spending and expansion into no profitable ventures.

To that I would like to suggest that enabling this behavior was indeed the bubble. But the bubble was caused not by hype, but by mountains of money created out of thin air. That is in fact the pathology of our monetary system. And few people, including Mr. Roach who's Morgan Stanley is a primary beneficiary from pedaling a drug named "fiat money" want to face that fact. Banks like Morgan Stanley help print money which they then sell into the market in the form of loans and underwritings while exacting huge fees for carrying out this dishonest business. This fiat money system of ours has been a growing problems since the Federal Reserve was created. It first reared its ugly head during 1929. The Fed which was supposedly created to reduce the extremes in the business cycle, was at the helm when the biggest cycle ever, the boom and bust of the 1920's and 1930's took place.

In his book "A Bubble That Broke the World,", Garet Garret wrote the following: "We forget that credit in any form represents debt in some other form. We know about ourselves that we have seizures of ecstasy and mass delusion; that again a time may come when the temptation to throw the monetary machine into wild motion so that everybody may become infinitely rich by means of infinite debt will rise to the pitch of mania, as it did, for example in 1928 and 1929. With this intelligent knowledge of ourselves we make bargains beforehand with reason; we agree that money, credit and debt shall not be inflated beyond a certain ratio to gold, under certain penalties such as we shall be very loath to pay and yet such as we cannot refuse to pay under worse penalties still.

"So long as convention is reasonably kept in the faith of credit nobody wants gold. People know what the fiction is. They may read for themselves in the published figures of the bank that is liabilities exceed its gold ten-or twenty-fold, and yet they feel no anxiety about the gold value of their deposits. They may read for themselves in the figures from the public treasury that the gold reserve is only one half or one third as much as the amount of paper money in circulation. Yet they will treat that paper money as if it were gold. Nobody would dream of supposing that a country, no matter how rich, could redeem its bonds in gold. Yet its bonds will be treated as if they were gold, as one who happens to want gold for them may freely have it. All so long as the convention is kept."

The problem is, the convention has not been kept! Nixon detached us from gold entirely. So while Garet Garret talks about a third enough gold to match paper money in circulation, the U.S. has printed so much money that there is less than 1% backing of M-3. By comparison the Euro has more than 15% backing and various central banks have a significant amount of gold in their vaults outside of the European Central Bank requirements.


Gold bugs comprise a tiny (but now growing) group of human beings these days. But those of us gold bugs who believe deflation rather than inflation is our biggest threat comprise an even tinnier group. I would venture to guess that 90% or 95% of all self-proclaimed gold bugs own gold because they fear the ravages of inflation. Almost as certainly as the main stream media and economists believe the "Holy Trinity" of the monetary world, (the Fed, Alan Greenspan and the U.S. Treasury Secretary) can divine away the business cycle, almost all gold bugs believe printing money will result in higher consumer and producer prices. Included in our tiny smidgen of gold bugs who fear deflation are the likes of David Tice, and Ian Gordon. Recently we interviewed Ron Gilchrist, a student of John Exter, a former central banker who argued the deflation case. You can read our 1999 interviews with David and Ian at to pick up on their deflationary arguments. And now Richard Russell has picked up on this theme in last Thursday's column. More about "Richard's Remarks" below.

David Tice pointed out back in our November 9, 1999 interview that the amount of new debt required to create $1 of GDP in the U.S. has grown steadily from about $1 in the early 1960s to about $1.50 in the mid 1960's. Then by the-mid 1990's, the U.S. had to create $3 of new debt to generate $1 of new GDP. When we interviewed David in 1999, he noted that it was taking about $5.30 of new debt to generate $1 of new GDP at that time. Since 1999, the money supply (and thus debt) has skyrocketed even as GDP is showing almost no growth in this current recessionary environment.

Why is it necessary for the Fed to create more and more debt in order to create the same or less GDP? The reason is because, when a country "frees" its currency from the discipline of gold or some other asset money like silver, it begins to enslave itself by inevitably buying into the big fiat currency lie! What is the fiat currency lie? Its kind of like any satanic lie. "Go ahead, cheat on your wife. She will never know. Besides, think how much fun you will have with that beautiful young babe." Or, for the alcoholic, "Go ahead. Take another drink - just one. What could just one drink do to you? Besides, you have done it before and you are still ok. Go for it!"

When it comes to fiat money, the great tempter says something like the following to the bankers and politicians: "Don't you see how damaging the gold standard is? You have so many economic needs that are unmet because there is a shortage of capital to go around. Get rid of gold and print money. Use this paper. As long as you persuade the people that there is gold in the bank to back it up, they will never try to exchange paper for gold because paper is much more manageable and transportable than gold. If you get rid of this barbaric notion of gold as money, you can print more and more paper money. Then, our economy can prosper because there will be no shortage of capital to build businesses to employ people, etc. And besides, you can put some of it in your own pocket and you can share some of it with your friends who can help you get your favorite laws passed! It's a win, win, win situation especially for you! Try it. You'll like it!"

So our bankers and politicians tried it and indeed they liked it! The problem of course is that you cannot create wealth by printing money. All you can do is create a claim against wealth that someone else has created. You also create an illusion of wealth that causes society to make some very stupid investments as we saw happen in America during the late 1990's. Yet, throughout history clipping the coins or printing paper or one form of currency debasement or another is a means of theft that rulers and bankers have seldom been able to pass up when given the opportunity. However, once a country starts down that path, its rulers and bankers commit the population to a process of enslavement that is every bit as pathological and addictive as alcohol is for an alcoholic. And the longer the process continues, the harder it is to turn back and the greater will be the pain experienced when the attempt is made. Ultimately the patient dies.

The banker and politician who begins engaging in the practice of printing money can't stop himself at some pre-determined level of paper in relation to gold because printing money becomes a powerful addiction. And so, over time the supply of currency grows much faster than the amount of gold held in the vaults of central banks and relied on to provide intrinsic value to back worthless paper. And over time, the rate of paper money growth accelerates while gold growth remains flat or as in the case of the U.S. it actually declines. So what we are left with is worthless paper that is backed by nothing of value. Now in the U.S. our currency, which is less than 1% backed by gold, is little more than liability money. And as we are witnessing now, the amount of paper money growth, which has been more than 10% during most of the past few years, far exceeds economic growth rates in the U.S.


What happens if the central bank tries to slow down this growth in money? Printing money becomes very addictive. So we saw the result of Mr. Greenspan's attempt to slow money growth at the end of the 1990's. He tapped ever so lightly on the monetary brakes. As a result, the NASDAQ bubble burst causing investors to lose $4 + trillion of imaginary wealth. Politicians began calling for Greenspan's head! Senator Bunning for one was mad as hell and let Greenspan know he wasn't going to take it any more! And Bill O' Reilly, in his ignorance blamed Greenspan's tightening for the NASDAQ crash. What O' Reilly and most politicians never seemed to understand was that stock market excesses have presented an illusion of wealth that was driven by excess money creation in the first place.

Out of fear, Greenspan took his foot off the brake and on to the gas pedal. By January of this year, an unprecedented 13 rate cuts failed to get the economy moving. And the stock market remained lower than when Greenspan began printing money to orchestrate the first of those 13 rate cuts! The only other time during the past 100 years that two or more successive rate cuts failed to lead to a higher stock market was in 1929.


Another major problem with fiat money system, money is that it is manufactured from debt. Therefore as the money supply accelerates, so does debt. And as we saw, rapid money growth resulted in some very stupid investment decisions in America during the second half of the 1990's, especially in the tech sector. Those bad investments have resulted in very low or non-existent cash flows for the investors. Countless numbers of bankruptcies have resulted thus far and many more are awaiting their turn. But bad investment decisions do not negate the need to make interest and principal payments on the debt that was used to manufacture the money used to make those foolish investments in the first place. The combination of declining cash flows and rising debt service coverage is lethal for the economy. Like the drug addict or alcoholic who continues to inject more and more toxins into his body, eventually, the economy reaches a threshold of lethality. Demand declines because a growing amount of income (which is also declining thanks to mal investment) must be repaid to the banks. Profits plunge, workers are laid off and the pathology feeds on itself until, as Ian Gordon points out, the mountains of debt can no longer be paid and the system collapses under its own debt burden. Debt repudiation paves the way for a new 60+ year Kondratieff cycle. Ian reckons we are now in the early days of the Kondratieff winter. I agree.


If the ultimate outcome is so certain as I am sure it is, why have we not heard about it in the mainstream press? That's another question we don't have time to address in detail now. Suffice it to say, the Keynesian and monetarists are the only two main stream schools of thought that are taught in most universities today. Neither of those economic schools of thought addresses this issue. The Austrian school does understand the pathology of fiat money, but it has been most unfairly discredited by a status quo who helped put into effect the Federal Reserve Bank for their own benefit. This system allows them to enrich themselves, at the expense of the common man by printing money. Setting aside issues of immorality for a moment, (as our bankers and politicians clearly have) would you want to give up a printing machine that allowed you to counterfeit money used to enrich yourself at the expense of society at large? That's exactly what the establishment is doing, though thanks to the Keynesians and Monetarists, the actual story of lower interest rates, and money creation is disguised from most of the population, just as a Mafia counterfeiter would desire to do.

So, America has bought into a major lie that is eating away not only at our economy but also at our moral fiber, not to mention the U.S. Constitution. Unfortunately, the big lie about how wonderful the dollar is and how wonderful our economy is, is also told daily on CNBC by virtually all the talking heads. Notable exceptions are friends like Jim Rogers & David Tice, whom we have interviewed in "J Taylor's Gold & Technology Stocks" newsletter.


Standing up for what you truly believe, whether it is an academic view of the markets or your faith in God in the midst of our humanistic society, is sometimes a very lonely experience. The vast majority of people need to have others agree with them or they begin to doubt what they believe. Some of us are a little stronger than others, so we go it alone longer. But ultimately, it not only feels good, but also is necessary to have intellectual and spiritual companions with whom one can share.

This past week, Richard Russell warmed my heart when he talked about the DEFLATIONARY forces that are quickly compressing the U.S. economy from all angles. Not that deflation brings joy to me, but the threat of deflation is, in my view the major economic danger that lies ahead for Americans. Incidentally, if you do not subscribe to Richard Russell you should. He is fun to read and he has so much experience, insight and smarts, that I consider him to be the single most important independent newsletter writer in America, including yours truly. Visit his site at

In Thursday's "Richard's Remarks" Mr. Russell noted that Hamilton Bolton, the founder of "The Bank Credit Analyst," talked about the deflationary impact of debt and how it took more and more debt (money supply) to produce less and less in terms of Gross Domestic Product. Richard then goes on to say that the reason the Fed is "flooding the system as never before with oceans of liquidity," is because "the rising mountains of DEBT are exerting a deflationary force on the US economy. On top of that, we have to deal with the deflationary pressure of vicious competition from overseas."

Later in his column, Richard said "Let me put it another way. The Federal Reserve system of debts and credits is faltering. Twenty-five years ago if the Fed had acted as it has over the last year inflation would have roared -- it would have exploded. Today with the pressure of debt and competition and bankruptcies -- inflation really can't get started.

"So what is the poor investors supposed to do? What he's doing is 'investing' outside the system. He's buying a home with the cheap money and the low interest rates that the desperate Fed has afforded him.

"Wait, could the surging housing market be telling us something? I think it is. It's telling us that we're at the beginning of a major generational move -- out of financial assets and into tangible assets. Consciously or unconsciously, people are sensing that they're "spinning their wheels" in the stock market, but if they buy a house or land or something of tangible value, well, they're better off.

"There's a great battle going on. One army consists of stocks, bonds, financials in general. The other army consists of homes, real estate, land, commodities, water, gold, silver base metals, anything that is not liable to go bankrupt, anything outside the money, debt, credit system which is controlled by the fading power of the Federal Reserve.

"What about the timing? It's happening now. It's happening slowly in some areas and it's happening rapidly in other more obvious areas like housing. But it's happening, and it's the beginning of a tidal force.

"How do we deal with this tidal change? Boy, that's a toughie. I only have two ideas along these lines. The first is that you have to be in very safe income producing items like short bonds, notes, top-rated utilities, preferred, whatever produces safe, reliable income. And you absolutely must compound that income -- as the money comes in you've got to reinvest that money in other income-producing items.

"On top of that, you should own your own home, and you should put some money into gold shares. I don't care if Newmont goes up or down, I don't care if Agnico-Eagle goes up or down -- you hold them because they represents a solid asset, because it represent the production of gold, because they represents insurance -- because they produce something that is outside the system.

"You might also buy stocks which represent assets, lumber, basic metals, water, oil, even electricity via utilities.

"Remember, what's happening in the Mideast isn't the only war going on. The central banks of the world are fighting a war too. They're fighting a war to preserve the system that they've created. And the system is in trouble. The system has built up too much debt, the system has created too much "legal tender," the system has generated too much production.

"Too much production? That's right. We're seeing a battle for manufacturing survival. Every nation on the face of the globe is trying to export. China alone could produce damn near everything the world needs in the way of items. Yet China's biggest problem is unemployment. China can't even keep all their own workers employed. The world is producing too much. And when that happens prices decline. It's price deflation in the face of monetary inflation."


Richard Russell alerted his readers to a wonderful essay titled "The Next Big Thing." It was written by James J. Puplava, Editor of "Financial Sense On-Line." In that article Mr. Puplava quoted Marc Faber, editor of "The Gloom & Doom" report. Marc noted that investors could have done very well with just a handful of decisions. "In 1970, a long-term investor should have bought gold, silver, and oil (commodities); in 1980, he should have sold his gold and oil and bought Japanese stocks; then, in 1989, he should have switched out of Japanese stocks into the S&P 500 or, ideally, into the Nasdaq, which he should have sold at the beginning of 2000."

Faber was further quoted as saying, "At such milestones in financial history, the rules of the investment game are altered; but alas, the vast majority of investors continue to play by the old rules and therefore either lose money or miss out on the substantial capital gains which the new opportunity or leadership brings about….I suppose that one reason the road to ruin is broad, is to accommodate the great amount of travel in that direction… The key to successful investing is to understand that, with nearly 100% certainty, the bursting of a bubble leads to a permanent change in leadership."

James Puplava then noted that he is in agreement with Marc Faber that commodities may be the investment markets next leader, especially gold and silver. James said he concurred with that view.


Can Rising Interest Actually Help Boost the Gold Price?

Another bit of information provided by GATA and coming from Morgan Stanley suggests rising interest rates could actually be good for gold.

"Next Interest Rate Hike to Boost Gold Prices? It's happened six times in the past twenty years. According to Morgan Stanley, when the Fed has started to raise interest rates, some very predictable consequences follow. On average, stocks have lost 13.8 percent in the first three months that followed the first interest rate hike. Evidence went on to show that even after a 12 month period following the first hike, stocks were still down over 3%.

"On the other hand, gold rose. After the Fed hikes rates, gold has had the greatest predictability of profitability of any investment. The Wall Street Journal recently said, "If history is any indicator, Gold is set to Rally in a Big Way." That "first hike" is expected to happen at the Fed's upcoming May 7th meeting. So be prepared.

The term “carat” comes from “carob seed,” which was standard for weighing small quantities in the Middle East.
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