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Taylor on us Economy, Markets & Gold

January 30, 2002

Our Model Portfolio is up 6.20% during first twenty-five days of 2002, while the S&P 500 has declined by 1.29%. Leading the way are energy stocks (+25%); Producing and non producing junior gold mining shares (+21%); and technology (+13%).

Our Merchant banking, gold and silver sector are down 13%, thanks mostly to the poor share performance of Proprietary Industries and the Prudent Bear Fund has fallen 2.2%. However, as the next down leg in the bear market gets underway, the wisdom of owning the Prudent Bear Fund and the Prudent Safe Harbor Fund should become apparent. The Prudent Bear Fund, which shorts the stock market and holds a long position in gold shares should do exceptionally well. And during the next leg down in the bear market should bring the dollar back down closer to the reality of its true intrinsic value. In that event, the Prudent Safe Harbor Fund (PSAFX) which invests in high quality debt instruments denominated in currencies mostly other than the dollar, should do exceptionally well. The Prudent Safe Harbor Fund also holds a significant long position in gold and gold shares.

Of course, the year is very young. How we finish in on 12/31/02 is what counts. But with just a slight alteration from our 2001 Model Portfolio, we are off to a good start.


In a Wall Street Journal editorial last week, Milton Friedman spewed out his usual views about money and how printing endless amounts of it at this time will allow the U.S. to avoid entering another Great Depression. To his credit, Dr. Friedman was at least honest enough to call into question the parallels between the 1930's depression in the U.S., and the 1980's "stagnation" in Japan. Most economists and commentators, except those in our newsletter and precious few other "fringe" publications, are in total denial of any possibility that we could face another Great Depression in America.

In his article, Friedman pointed out that "the U.S. quantity of money fell by more than a third from the cyclical peak in 1929 to the trough in 1933." By contrast, the Japanese quantity of money fell by only 2/3 of 1% in the first year after the cyclical peak and then rose by 2.5% per year in the next two years. And, in the U.S. during the current contraction, he points out that the quantity of money in the U.S. has already risen by more than 11% during the first five quarters after the cyclical peak.

Friedman concludes that the Japanese downturn has been rather shallow because of its willingness to continue running the printing presses during its economic downturn. And he also says that the U.S. can now expect to avoid a catastrophe like that of the 1930's because it is of its very rapid money growth. Toward the end of the article he concludes that, "Central bankers, like other students of money, have learned this lesson, which is part of the reason that there has been no repeat of the Great Depression in the post World-War II period despite repeated scares. The Federal Reserve under Alan Greenspan is currently applying that lesson, which is reason to believe that the current recession will be mild and that expansion will soon resume."

Friedman then goes on to say that money growth in excess of 10% is "perhaps" desirable as a defense against economic contraction" but he warns that sooner or later money growth will need to be curtailed. Otherwise, "it will ensure that inflation rears its ugly head once again."


Neither Friedman's monetary school or Keynesian economics pay attention to the lethal effects of debt, which is the raw material from which money is manufactured in a fractional reserve system. Not even the Austrians, who are free market orientated in every respect, including monetary policy, factor in the lethal effects of debt on an economy, though they do understand that fiat money results in mal investment, economic instability and inflation.

With none of the major economic schools talking about this issue, it is little wonder that 90% or 95% of all gold bugs believe the current bubble will end in inflation rather than deflation.

One intellectual giant who understood debt to be deflationary and how the monetary system would ultimately be destroyed by a debt deflation was former commercial bankers (Citibank) and central banker, John Exter. Though John is still alive, he is not well and thus not available to contribute to this discussion today. As a result, we plan to interview a student of his, stock broker and investment analyst, Ron Gilchrist in our February newsletter to further develop an understanding of the lethal dynamics of debt in a fractional reserve banking system.

In a 1982 speech given at the New Orleans Conference, following a speech given by Milton Friedman, Mr. Exter noted then the same views expressed above about how printing money could always allow a country to escape a depression. John Exter refuted that assertion, using the arguments we have been making, namely that a combination of mal investment and accelerating growth of money and debt will eventually strangle the economy. In 1982, total U.S. debt was about $10 TRILLION. At the end of 2001, it was $30 TRILLION!

In predicting an imminent deflationary collapse back in 1982, John Exter was obviously ahead of his time. In fact, inflationists will argue that given a tripling of debt since 1982 with no resulting deflation, disproves the thesis that debt is deflationary. But because a deflationary depression has not yet developed in the U.S., does that mean it won't happen? I believe Ian Gordon has discovered the road map that John Exter was missing in 1982 and that if he had it, he may have held off on predicting an imminent depression then.

That road map I am speaking of is of course the Kondratieff cycle which provides "mile stones" or inflection points for the beginning and ending of the four seasons of the 60+ year Kondratieff cycle outlined by Ian Gordon. Having put an enormous amount of research into this long wave, Ian has noted that over the past four cycles (since the American Revolution) the Kondratieff winter (the deflationary depression) ALWAYS commences following a once in a century stock market bubble. Back in October of 1982 when Mr. Exter made his speech in New Orleans the Dow was slightly under 1,000, which represented a ceiling the market had bumped up against for sixteen years. The kind of market top Ian is talking about are those obvious bubble blow off points such as in 1835, 1872, 1929 and 2000. The 1982 equity market hardly represented a top but looked more like a base. Moreover, in 1982 equity valuations were akin to those that have historically been seen at bear market bottoms.

Moreover, as Ian has astutely observed, a blow off in commodity prices and inflation, such as was experienced in 1980, is the mark of a protracted period of disinflation, rather than deflation. When commodity bubbles burst, that marks the start of the "feel good" autumn. Autumn is when by far the greatest amount of debt is built up in the system. It is a time when everything about the economy feels perfect so people borrow and spend with complete lack of concern about economic reality. It is characterized by enormous amounts of debt, which is used to create money that is then spent or invested in the most foolish ways imaginable. (dot com companies, Enron, LTCM, etc.). The result? Huge amounts of debt but no cash flow with which to service it.

By combing the insights of Exter and Ian Gordon, and those of Exter's student, Ron Gilchrist, we have some advocates of the deflation argument who provide a framework for advancing the deflation argument. In any event, whether your are an inflationist or deflationist, you must agree that we are quite possibly now at the end of the road for the dollar and the monetary system as we know it. A major sea change in the financial markets seem to be in the offing.


During the 1980's and 1990's, but especially during the second half of the 1990's, two significant dynamics have become increasingly important in the U.S. I believe those dynamics will very soon prove Mr. Freiedman's contention that the U.S. can inflate its way out of a depression wrong.

As the chart on the first page of our January issues illustrates, debt (from which money is manufactured) is growing exponentially while income (GDP) continues to grow at a steady clip. Income grows moderately unlike debt because a nation's income is constrained by natural optimal physical forces that politicians and bankers cannot alter by printing money or any other actions. Any actions by the politicians can only decrease those natural parameters.

Politicians and bankers can print mountains of money without limit such that we find ourselves in our current state with the rate of money and debt growing exponentially. But income (in real terms) from which that debt can be serviced (principal + Interest payments) can grow only as fast as the natural physical barriers permit.

So what happens when Mr. Greenspan manufactures more money at the Fed by creating more debt? Debt growth siphons off income form the demand side of the economy. And don't forget, it is being siphoned off much more quickly than GDP (national income) is growing so that increasingly citizens do not have sufficient income to buy even the most basic needs in life. The combination of mal investment and debt loads, which are increasing exponentially, leads to increasing income and debt servicing requirements that then siphon off still more income from the demand side of the economy. At some point, we will have reached the "threshold of lethality" when the economic patient will no longer have sufficient nutrition (income) to sustain economic life. Ian Gordon's work suggests the threshold has already been crossed when the market topped in March of 2000. In any event, we feel the ultimate outcome cannot be in doubt. The massive amounts of debt (now more than $30 trillion in the U.S.) cannot be repaid. Massive debt repudiation through bankruptcy is the only possible outcome.

Enron and K-Mart are but two giant examples that reflect this reality on a micro scale. But as more and more companies - big and small - begin the suffer the same fate caused by an overexpansion of money and debt, the winds of the Kondratieff winter become more real. When debt cannot be repaid, companies go out of business or significantly contract their operations. Unemployment grows, which further weakens the demand side of the economy. What we are seeing with these two major companies is quite likely only the tip of the iceberg.

So, whether it recognizes it or not, the Fed in fact is caught in a dilemma. We suspect the "real Greenspan" may know what is happening. But most of his fellow board members follow Friedman and Keynes which is why we are in such deep trouble. The Fed can print more money in an attempt to create more liquidity. But as we have seen with a record number of rate cuts over the past year, it now has to do so ever more frequently, because each new drop in interest rates results in more toxic debt. But rather than turning things around, that additional debt ensure the economic patient is that much closer to death. For a while, especially in the early stages of the long Kondratieff winter, printing more money (creating more debt) appears to be very beneficial. But in the late stages of the cycle the opposite is true. As with a heroin patient, adding another does of the drug only ensures a more certain and earlier date with death.

So, the U.S. and indeed the global economy is now caught in a DEBT spiral that will soon take us down like the Titanic. Under these circumstances, deflation, not inflation is the major threat. Then, when you add China and other populous countries to the international trading mix, you force an ever decreasing profit margin on American business. That means that more and more businesses will close their doors. More and more unemployment will follow, thus resulting in less income from which consumers and businesses can service debt, never mind buy the essentials in life. These are the dynamics of DEFLATION. These are the dynamics I fear America now faces.


Gold closed in New York at $278.90. The XAU was strong again this week. I am becoming increasingly convinced that gold may have bottomed and that it may indeed have entered the very early stages of a major multi-year bull market.

Thanks to the excellent work of GATA, there can be absolutely no doubt now that the Executive branch of our government in collusion with the Federal Reserve is manipulating the gold price downward. It has done so in earnest since 1994 when the bail out of Mexico made doing that necessary, if that bailout were to be a success on Clinton's watch. But for all the gold that is being dishorded by one means or another from the U.S. and Britain, someone is buying it.

We have noted recently that Russia has begun monetizing gold. India has been a major buyer at these very low prices. Rumors that China is a buyer has also surfaced from time to time. What we do know is that China has said it is beginning to buy the Euro, which currency has in effect a 15% to 20% gold backing compared to less than 1% for the U.S. dollar. We have also noted in recent weeks that Japan has become a major buyer of gold. That news hit the headlines on the front page of the second section of Friday's "Financial Times." Seems as though with their currency evaporating and with the government reducing insurance protection on yen accounts in Japan and with growing fears of international insolvency related to the likes of Enron and Argentina, Japanese citizens are now becoming massive buyers of gold. And since they hold such a major share of the world's savings, this is really big news. In fact, Ron Gilchrist, the deflationist whom we expect to interview in February has suggested Japan is the reason gold will rise above $300 this year.

If you believe that things will settle down internationally, then perhaps you can make the case that gold is not a good investment at this time. But for reasons outlined above, we think international chaos in the global financial markets has, unfortunately just begun. That being our belief, we think the Japanese investors are way ahead of Americans in protecting themselves against a systemic collapse.


The following report on the gold panel discussion at the Cambridge House Investment Conference this past Monday, was written and then emailed by Jeffrey Dahl, President of SAMEX, a Vancouver based junior mining company which we are recommending purchase of in this week's hotline message.


"I enjoyed a brief reprieve from the office schedule yesterday to share breakfast with Jay Taylor, who writes the "Gold and Technology Stock Report" newsletter. It was a pleasure to meet him and compare notes on all things golden. Jay knows his market history well and is a storehouse of "sound ideas," he has also studied geology a bit so it was fun to touch on a few subjects close to my heart as well. From what I can discern he is a real man of integrity and if you haven't reviewed his newsletter before you can check it out at;

"Following that, I sat through the "GOLD Discussion" at the small investment conference held in Vancouver. The panel consisted of six members; Jay Taylor, David Tice (Prudent Bear Fund), Robert McEwen (Chairman, CEO Goldcorp), Bob Bishop (Goldmining Stock Report), Robert Chapman (International Forecaster) and Ian Gordon (Canaccord broker).

"Jay M-C'd the discussion and opened up with the question of GATA's contention that the gold market is manipulated! Well what a love fest we had! Every panelist concurred with varying enthusiasm that "Wild Bill Murphy", Reggie Howe and Chris Powell have refined the evidence to the point that its .9999 fine! Much credit was given to Bill of for his tireless, selfless and sometimes in-your-face (neededly so) efforts to mine out the TRUTH! Kudos Bill.

"Jay also pointed out that at last years convention panel discussion (I don't know who was on it), GATA's claims were mocked as being a few bricks short of a load. What a difference a year makes! I've got to admit that having all these esteemed fellows agreeing with GATA made my day! The panelists each made a prediction of gold's price at the end of the year, and needless to say they all agreed that it would be higher ($500 was the highest guess I think).

"Anyhow, back to work.


I would also like to note that the panel agreed that the acquisition of Normandy Mining by Newmont was also very bullish for gold given that the acquisition by Newmont not only means that Anglo Gold will not now be able to sell that company's future production short, but that Newmont is likely to unwind hedges put in place by Normandy.

In addition, Bob Chapman suggested that the collapse of Enron and the scandal surrounding that case may increase the odds that Reginald Howe's suit against the Fed, the Treasury, the BIS, and major bullion banks will go to trial. Lets hope Bob is right because the sooner the truth about the rigged gold markets comes to light, the sooner international markets can be restored to equilibrium. A return to equilibrium would of course sharply reduce international market risks. Of course getting back to that stage will be result in great pain, given the enormous economic dislocations that have resulted from the ESF and Fed's intervention in the gold and other markets. But a return to the natural market forces is inevitable. The sooner it happens the better, at least for people who see this disaster unfolding and who have prepared for it.

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