Every time I’ve written about the imminent disaster that awaits U.S. stock markets, and subsequently global markets, the response has been overwhelmingly negative. In 2007, when I warned of steep declines in U.S. markets that were on the way in 2008, I was called everything from unpatriotic, to un-American, to even unholy. When steep declines indeed hit the markets to begin 2008 and gold soared to $850, (fulfilling my September 2007 prediction of $850 gold by January 1, 2008), the name-callers merely disappeared.
It’s not that I revel in markets struggling and the still very real possibility of it shedding great value. In fact, I’d be ecstatic if the U.S. markets looked healthy and an imminent rise to a 16,000 Dow was realistic, with an upward surge taking all global markets along for the ride. Good money can be made in great markets or terrible markets so it doesn’t really matter either way. It’s amazing that people think I have an agenda for wanting markets to crash, oddly connecting my market sentiments to arguments about patriotism or religion. It’s just that I feel obliged to report what I see, because so few nuggets of reality trickle through the mainstream information filters and reach larger audiences.
People seem to forget one central and critical point. Most people seem to believe that they have to lose a great deal of money when crises materialize and forget that it is absolutely possible to prosper during crises as well. Thus, because they feel they must suffer during a crisis, the “shoot the messenger of bad news” syndrome commences. That said, I’m still going to state my utter lack of faith in this mini-rally that the U.S. markets are currently experiencing. Due to the huge levels of unaddressed and unsolved risk that still simmers quite potently beneath the surface, with the current “solutions” being implemented today, I honestly can only see two outcomes. Crash now or crash later.
Should an extended rally of the Dow above 13,000 occur, it will serve no purpose other than to create the illusion of wealth, as opposed to the creation of real tangible wealth. The higher U.S. markets rise in today’s environment, the more likely it is that they will fall even harder in the future. Here’s why. Currently, the U.S. Federal Reserve is playing the same shell game that it has for decades, one in which they alternately inflate stock markets and real estate markets. If stock markets are crashing, then they inflate real estate markets, and vice versa. It’s a vicious circle that eventually will collapse under the weight of its own foolishness. In in the late 1920s, in very simple terms, the U.S. Federal Reserve’s solution to forestall a mild U.S. economic contraction and to stop England’s gold losses was to print more money.
This loose fiscal policy directly contributed to an unsustainable speculative run higher in the U.S. stock market, its subsequent crash in 1929, and the onset of the worldwide Great Depression. When the dot com market collapsed in March, 2000 and Nasdaq plummeted 78%, the U.S. Federal Reserve once again decided to run the printing presses overtime. They cut the Fed Funds rate an unprecedented 12 times in a row, expanded money supply enormously with their free money policy, and created a huge speculative, unreasonably inflated housing bubble that is now bursting today. Now that the housing market is deflating, again the U.S. Federal Reserve has once again slashed interest rates like a demon, this time in an attempt to artificially inflate the stock market. However, these solutions only create problems in the future. With repeated applications of this harmful cycle, and significantly more money chasing fewer assets now, this is why we stand at the brink of disaster today. And this is also why all of these smoke and mirror games are ultimately harmful to you if you are heavily invested in U.S. stock markets (for whatever inexplicable reasons) AND U.S. markets continue to feed this current rally.
The holder of a government bond or of a bank deposit created by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of tangible assets in the economy, prices must eventually rise. Thus the earnings saved by the productive members of the society lose value in terms of goods.
If I didn’t reveal the above paragraph was not one that I scripted, I have absolutely no doubt that there would be a million people out there to deconstruct that as the most stupid thing they ever heard. However, that statement was made by former U.S. Federal Reserve chairman Alan Greenspan in 1966. So consider this. Since President Nixon took the world off the gold standard in 1971, there basically has been no constraining factor as to how much money the U.S. Federal Reserve can print besides the supply of cotton, linen, and ink.
Consequently, U.S. dollar supply is growing by an estimated 16% to 18% a year now, and true inflation (as measured by the formula the U.S. government employed back in 1980) now hovers around 12% in the United States. If Alan Greenspan made that comment in 1966, with an additional 40+ years of dollar debasement, how much more relevant and pressingly urgent is that statement today? Now let’s substitute “stocks” for the words “bond “ and “bank deposit” in the same paragraph above, because it will shed some light on what exactly is causing the rally in U.S. markets today.
The holder of a U.S. stock backed by paper reserves believes that he has a valid claim on a real asset. But the fact is that there are now more claims outstanding than real assets. The law of supply and demand is not to be conned. As the supply of money (of claims) increases relative to the supply of stocks in the economy, prices must eventually rise. Thus the paper stocks saved by the productive members of the society lose value in terms of goods.
And voila, like magic, this is how short-term rallies in stock markets in dire financial conditions are manufactured by the U.S. Federal Reserve. Highly inflated, cheaper dollars also means that foreigners who don’t understand this equation can be conned into buying more U.S. stocks because compared to five years ago, their prices once F/X exchange rates are taken into consideration, are cheap, cheap, cheap. But once foreigner investors in U.S. markets grasp the above explanation, watch out. (For a discussion of historical crises created by similar conditions, please watch the Investment Matrix and Dollar Crisis videos here). Assets valued in fiat currencies during periods of great inflation can actually increase (numerically speaking) while simultaneously greatly eroding your purchasing power parity. In other words, you can become richer in paper reserves but poorer in real wealth at the same time. That is why there will be no real winners (except for the Central Bankers) if this short term rally in stock markets continues and why the longer this manufactured rally lasts, the harder the fall.
One final piece of food for thought. If gold is so speculative and risky and the dollar will rebound significantly as the masses are led to believe, why does the U.S., according to the most recent statistics released by the World Gold Council (March, 2008) hold nearly 80% of its reserves in the form of gold and so little (on a percentage basis) of its very own currency? In terms of tonnage, the U.S. holds more than 2.4 times more gold than any other country in the world and more than 13.5 times more gold than China. Position yourself in hard assets, and if you have the understanding to ride out periods of great volatility, I believe your rewards will be stunning over the next several years.