Investment Indicators from
Peter George
 Greenspan's
Ducks take flight
Peter George
Trinity Holdings
posted September 2, 2004
"I will destroy the wisdom
of the wise"
--I Corinthians chapter 1, verse 19
1. IRAQI WAR DUCK - Death knell of US Empire
2. THE OIL DUCK - rampant bull takes hold
3. THE DOW DUCK - heading for the precipice
4. THE DOLLAR DUCK - forced into FIAT folly
5. THE BOND DUCK - heading for the hills in
fright
SUMMARY
Time was when the 'Honourable Fed Chairman' spoke in measured
tones that markets moved. No more. Having recently had his tenure
extended for another term, Greenspan could be forgiven for wishing
he'd turned the offer down. Things are beginning to fall apart.
The centre cannot hold. It used to be that the old man was miraculously
able to keep 'all
his ducks in a row,' even though the promise of food never
materialized. The magic is fading. In rapid succession the ducks
are giving up and taking flight.
First it was the Iraqi War Duck as the situation spiraled out
of control. He was naturally followed by the Oil Duck as the
price accelerated to new highs. Last week the Dow Duck flapped
his wings with increasing consternation as growth prospects faded.
The Dollar Duck bobbed in concert as the July trade deficit hit
an all-time peak of $56billion. Only the Bond Duck looked set
to stay, having scooted to the far end of the lake to hide under
a bush. He's been conned into a false sense of security and will
soon get a wake-up call when he sees the Dollar Duck has dumped
him and fled.
They will all be gone by dawn. Then comes a Golden Sunrise.
1. IRAQI WAR DUCK
- Death knell of US Empire
If the war situation in IRAQ continues to worsen over a protracted
period of time, it could negatively affect US interests across
a broad political and economic front, eventually turning the
Middle East into a no-go area for US business. It could prove
to be the last straw in a dangerous buildup of threatening situations,
triggering a landslide collapse in the dollar and US markets,
and a long term surge in oil and gold prices. If allowed to deteriorate
sufficiently, it could spell the beginning of the end for the
erstwhile dominant position of the US. To date the only dividend
has been the incarceration of Saddam.
Comparisons with Rome
In the early days of Christianity the Apostle Paul instilled
fear in the hearts of his jailors by reminding them of his rights
as a Roman citizen:
"They beat us publicly
without a trialand threw us into prison. Now they want to get
rid of us quietly? No! Let them come themselves and escort us
out.When the officers and magistrates heard that Paul and Silas
were Roman Citizens, they were alarmed. They came to appease
them and escorted them from prison."
Despite holding sway for hundreds
of years, the fall of Rome was relatively swift, once the center
became rotten and the cash ran out. Romans themselves were no
longer prepared to fight and risk their lives for Empire. Employing
men from the tribes they conquered to do the dirty work, they
themselves opted for a life of luxury. Then, as finances began
to crumble, the Roman mint began to debase the currency. Once
Caesar lost control of the outermost reaches of Empire, he was
forced to 'pull back' his troops. The process marked the beginning
of the end. In due course the barbarian hordes overran Rome.
Comparisons with Britain
In the heyday of British Empire, an attack on an Englishman anywhere
in the world was guaranteed to incur the full wrath of the British
Navy. The policy of internationally -enforced protection for
British citizens gave birth to a patriotic song: 'Rule Britannia,
Britannia rules the waves.'
On the rare occasions when they beat the Springboks, some British
rugby fans still sing it today.
But the writer remembers journeying overland in 1962, after a
three year stint at Oxford University in England. He was returning
to South Africa. On the way he and his co-driver diverted for
a day and a half to climb Mount Kilimanjaro in Kenya. Half way
up they met a party of marooned sailors from the British Navy.
All were suffering from altitude sickness. As South Africans
from Johannesburg the writer and his friend were used to living
at 6,000 feet. Like the writer and his friend, the Brits were
returning home. Foreign Secretary Enoch Powell had recently shut
down their navy base in Aden. The country could no longer afford
the trappings of Empire. In this respect all international ventures
always end the same way. They have done so in the past and they
will do so in the future. The cost of policing and 'keeping the
peace' eventually outruns the benefits of exploitation. In this
context the word 'exploitation' is not even used in a pejorative
sense, but returns to it's original meaning: 'to cash in on or
make the most of.'
'Decline and Fall' of US Empire
This brings us to the US and the problems they are experiencing
in IRAQ. Ever since the end of the Second World War, American
power and influence has been in the ascendancy but the foundations
were laid a half century earlier. Wave upon wave of immigration
brought new blood, ideas and energy. More often than not, as
the British withdrew, they were replaced with American troops.
In rapid succession US business began to vie for a slice of the
pie in erstwhile British colonies. As the history books will
confirm, 'trade follows the flag.'
Now 'the flag' is becoming increasingly expensive to carry while
the payoff in trade is diminishing. IRAQ is an excellent case
in point. The writer watched a panel of experts over the weekend.
One was Pat Buchanan. The other was a woman and editor of the
Washington Post. They were discussing the pros and cons of present
policies in IRAQ. Buchanan strenuously defended the IRAQI government
decision to attack the centers of rebellion in the holy Moslem
cities of Faluja and Najaf - the first predominantly Sunni, the
second Shiite. He said unless the uprising was ruthlessly stopped
in its tracks IRAQ would become ungovernable. The lady member
of the panel vociferously protested, predicting Government and
US actions would alienate the entire Moslem world. There is no
easy answer. Whatever the true reasons for American intervention
in IRAQ, the pipeline carrying exports of crude to the West,
is more often closed than open and the price of oil reflects
it.
The cost of war
If war is pursued with total commitment, the financial implications
for the US are downright threatening. They have neither the men
nor materials to finish the job. To date the cost has been in
excess of $130billion - excluding interest on the additional
debt. There are those who are convinced the US could get bogged
down in IRAQ for a decade at an annual cost escalating rapidly
towards $200billion. At this level it will be directly responsible
for up to a third of next year's total projected budget deficit
of $600billion. Having recently announced major troop withdrawals
from other bases world wide, the US military have cast the dice
for the option of intensified war. Without the ability to rotate
troops in the field, even the current level of strength is unsustainable.
The cost of victory
If by some miracle the US wins, their influence in the greater
Middle East will have been irretrievably damaged. A rising groundswell
of hatred amongst Moslems could make it more and more dangerous
for Americans to continue doing business there. In this event
the reliability of the nation's oil supplies will deteriorate
even further than at present. Not surprisingly it is rumored
that, for the next three years, 10% of all US aid to Africa will
go towards building a deep water harbor off the small island
of Sao Tome. The resort lies off the coast of West Africa, opposite
Gabon, and could produce one day produce oil reserves which dwarf
those of most other countries in Africa.
The cost of defeat
If, instead of standing its ground, the US pulls out of IRAQ
with undue haste, it runs the risk of permitting unbridled chaos
and mayhem. The IRAQ adventure would then go down in the history
books as one of America's worst ever foreign policy catastrophes.
US power and influence would suffer an insurmountable reverse,
substantially undermining America's ability to keep the peace
and influence international events. This in turn could lead to
a major sell-off in US bonds as America's long term credibility
fell under serious question.
Justifying IRAQI intervention
Contrary to most commentators, who with the benefit of hindsight
violently condemn US intervention in IRAQ, we support the English
philosopher who penned the following:
"For
Evil to prosper, all that need happen is for Good Men to do nothing."
There are times in history
when the ruling Super Power has an obligation to exercise that
power in the interests of securing peace and justice. These are
the times when evil men need to be stopped in their tracks. Saddam
Hussein was one of those men but this was not one of those times.
The constraint of available finance ruled it out.
"Suppose one of you
wants to build a tower. Would he not first sit down and estimate
the cost to see if he has enough money to complete it? For if
he lays the foundation and is not able to finish it, everyone
who sees it will ridicule him, saying, 'This fellow began to
build and was not able to finish.'" (Luke chapter 14, verses
28 - 30).
Having foolishly decided to
go the war route, clearly the attempt to justify intervention
on the pretext of the supposed existence of 'Weapons of Mass
Destruction' was either a gross error of judgment or a carefully
concocted scheme to deceive. With the benefit of hindsight, having
ignored the risks of a major financial overrun, it would have
been better to have ignored the UN and justified their actions
solely on the basis of the murderous past and continuing policies
of the Dictator Saddam.
A further complication was that through some of his earlier escapades
- particularly those conducted against IRAN - Hussein had secretly
been supported by the US. Once they decided to abandon him and settle accounts,
they should at least have done their sums and counted the likely
cost before going in.
Even their ability to exploit IRAQI oil has been a gross failure.
Far from being able to increase production, rising levels of
sabotage have with increasing frequency literally turned off
the taps. Short of a miracle there seems no way out. This is
one Duck that Greenspan can no longer wish away and the knock-on
effect is becoming intolerable.
2. THE OIL DUCK
- rampant bull takes hold
The US political elite has for many years held substantial direct
and indirect interests in the oil industry, going back to the
days when John D. Rockefeller controlled the Standard Oil Trust
and most of the oil industry. The Sherman Antitrust Act forced
the nominal dissolution of the Standard Oil monopoly in 1911,
but in reality the oil monster simply became hydra-headed, spreading
into banking, financial services and other major industries in
which the same shareholders continued to dominate. Those holding
the reins ensure that the US government keeps a watchful eye
and tight control over oil, particularly the relationship between
international prices and the up and down stream sharing of profits.
In return the powers that be attempt to maintain a delicate balance
between the interests of the oil cartel and US consumers. Despite
regular predictions by successive Presidents, that the US would
accelerate local production, and tame demand with conservation,
the exact opposite has happened.
Since the seventies, US dependence on imported oil has risen
from 25% to 50% and in the next twenty years is forecast to reach
70%. Having failed to develop alternative solutions, the US faces
a crisis. Simply trying to keep the price of oil steady and 'low'
has in itself a key objective for successive US Administrations
seeking to protect the national interest. Unfortunately, any
form of market interference, apart from yielding very temporary
short term benefits, actually distorts the forces of supply and
demand. It skews the equilibrium price and always carries an
ultimate long term cost.
Evidence of interference
The first IRAQ war in 1990 was allegedly caused when the US sought
to protect Kuwait and Saudi Arabia from a Saddam takeover. But
we need to go back a little. What triggered the IRAQI Dictator's
outburst of anger? If one recalls some of the press articles
of those years, the rationale is interesting. Oil prices were
languishing in the mid-twenties. OPEC had agreed to impose a
reduced production quota on its members. The intention was to
squeeze the price back up to $30. Under rumored pressure from
the US, Kuwait deliberately exceeded her quota to sabotage OPEC
objectives. Saddam was furious and decided to teach Kuwait a
lesson. There were also allegations at the time that the Kuwaiti's
were tapping into IRAQI oil fields by drilling 'obliquely' near
their common border. When Saddam proceeded to threaten Saudi
as well, the US panicked and stepped in to defend both kingdoms.
Prior to doing so they needed to insulate the dollar against
speculative attack. The US was in no position to finance a war
on her own. The dollar would have wilted. To protect the currency
- and as a condition of their providing military assistance -
the US instructed the Saudis to dump their gold stocks. At the
same time they rallied the main oil consuming nations and persuaded
them to share the financial costs of paying for US troops. At
the end of the day it is reckoned the US made a tidy profit.
Unfortunately, without similar wide-ranging support today, the
US can no longer afford unilateral action. The man who pays the
piper calls the tune; when he refuses to pay, the music has to
stop.
More evidence of interference
Apart from the need to sever Saddam's links to sponsored terrorism,
there are those who believe the second IRAQ war, started in March
of last year, was largely otherwise motivated. They say it was
driven by US efforts to secure control of the country's vast
untapped oil stocks and increase the rate of pumping in line
with the size of the underground resource. Clearly, if this were
the case, the outcome to date has had exactly the opposite effect
to that intended. Looking back over the last twenty five years,
one wonders whether a less intrusive approach by the US may not
have given normal market forces a better chance to satisfy long
term customer requirements. Higher average prices over the past
two decades could have stimulated new production, encouraged
the timely development of alternative energy sources such as
nuclear, and promoted consistent conservation. Gas-guzzling SUV's
would then have been still-born and a far greater proportion
of electrical energy would today have been sourced from nuclear
stations - if not they at least would have been under construction.
Current oil prices are 'real' cheap
When Nixon abandoned 'gold convertibility' in 1971 he unleashed
a long term collapse of the purchasing power of the dollar and
a ten year boom in commodity prices. Oil rose from $3 a barrel
in 1971 to $40 by 1980, gold from $35 to a peak of $850. When
the press of today therefore issues panic statements to the effect
that oil, in its current range of between $45 and $50, is breaking
multi-year highs, they are nominally correct. But if they suggest
latest prices are going to ruin the world economy, they are mouthing
nonsense. They need to reduce today's prices to their 'real'
level, to make them comparable with previous peaks, or raise
future target prices to adjust for historic inflation from 1980
to 2004. They should do this before hitting the panic button.
For the same reason, to assume that current prices, in themselves,
can dramatically slow the US economy is not necessarily correct.
Real pain will only come when prices enter a far higher range.
In fact,
we believe the US recovery is terminating already, but for totally
different reasons and we will discuss them later when dealing
with the Dow Duck.
What is a 'fair' price for oil?
If we allow for 25 years of erosion of dollar purchasing power,
then the equivalent of the 1980 highs for oil and gold, in today's
'money,' would respectively
be $100 a barrel for oil - up from $40 - and $2125 an ounce for
gold - up from $850. If the current commodity boom extends for
another 7 to 10 years, and inflation sinks to zero, that is where
prices will head. But if central banks continue to insist on
staving off a threatened world debt collapse, by artificially
lowering short term interest rates and printing money, inflation
could spike up rapidly, as FIAT currencies begin to collapse.
Inflation averages of 6% per annum for the next nine years could
respectively drive the long term 'target' prices of oil and gold
to $200 a barrel for oil and over $4000 an ounce for gold. How
reliable are these relationships between oil and gold?
Relationship between oil and gold
Way back in 2000, GATA contributing economist Adam Hamilton,
proclaimed to a skeptical audience that commodity prices were
entering a major new long term bull. In a highly revealing combined
chart, he singled out oil and gold. He showed that over the entire
period from 1965 to 2003 the relationship between the two had
averaged 15,4 to 1. In other words, with oil at $50, gold should
be $770. Between their respective 1980 highs and today, the average
actually increased to 17,5. That would put gold at $875. This
is probably a truer reflection because from 1965 to 1971, gold
was artificially pegged at $35.
But Hamilton pointed out there had also been times when gold
outpaced its 17,5 ratio by a standard deviation of 1. This elevated
the average to 20. Oil at $50 could conceivably then put gold
at $1,000. So with oil at $200 as above, we would get $4,000
for gold.
This is out of the park. If one accepts the US has played games
in the oil market, it is nothing to what they have been doing
in the gold market. There have undoubtedly been identifiable
occasions in the recent past when the US Treasury was using derivative
structures to exert downward pressure on oil prices, but these
interventions amount to chicken feed compared to the lengths
to which they have gone to suppress the price of gold.
Could inflation take off as we assume above? Let's see what the
'bankers' have planned.
Council on Foreign Relations Project - 1998
In a speech delivered on March 21, 2003, respected GATA member
Frank Veneroso referred to efforts he had made to investigate
the lengths to which the Fed would consider going in the future,
in order to stave off deflation:
"We have not been surprised
by recent willingness of Fed governors to openly discuss unconventional
measures. Our first recognition of the willingness of the Fed
to break with central bank orthodoxy to support an overvalued
stock market occurred when we discovered the Council on Foreign
Relations (CFR) exercise on financial war games designed to prevent
a tech led collapse in the U.S. stock market.
This CFR project apparently began in 1998. It involved 70 odd
important persons from the corporate sector, Wall Street and
banking, government, academia, the military and national security,
and the major international institutions. Only half of the participants
were made public. The exercise involved central bankers and Treasury
officials who where not named. Fed Chairman Greenspan presided
over one of their key get togethers. The objective of this project
was to consider policy responses to contain a tech led decline
in the stock market so as to avert a crash in the overall stock
market, the dollar, and perhaps the economy. Such an extensive
exercise at such a high level suggested that the U.S. Fed and
Treasury recognized the potential for a disastrous stock market
collapse. We were most struck by the open discussion of radical
and unconventional measures to contain any stock market decline."
Some time after the CFR's secret
back-door planning exercise in 1998, Veneroso had sight of Fed
staff papers which indicated a willingness to adopt some of these
same 'unconventional measures' it became necessary to contain
damage from the unwinding of any future US stock market bubble
- or any other asset-type bubbles for that matter, such as property.
We now fast-forward to Veneroso's comments on Ben Bernanke's
infamous speech of November 2002.
"In late 2002, the
failure of US consumption to rise strongly, despite massive cuts
in short term interest rates and record re-financing of housing
mortgages at ultra low rates, convinced the Fed that the traditional
mechanism of monetary policy was no longer operative."
He was referring to Fed Governor
Bernanke's speech to the National Economist Club in Washington
on November 21, 2002.
Bernanke began with a statement which brooked no argument:
"The
conclusion that deflation is always reversible under a FIAT money
system follows from basic economic reasoning."
Bernanke failed to point out
the ultimate destruction which would follow if the above FIAT
policies were actually implemented. He then went on to tell a
parable about an alchemist who discovered how to turn base metals
into gold. Trust a purveyor of dishonest money to choose an example
which points to the mythical destruction of the FIAT system's
greatest enemy, gold! In your dreams Ben!
Bernanke concluded with his now infamous statement of future
Fed intent to counter the threat of deflation. May it be a warning
to international investors foolish or naïve enough to harbor
the faintest hope that the long term value of the US dollar can
retain any sort of meaningful buying power, or that current low
yields on long term US government bonds are anywhere near sustainable
in the years ahead. We think yields will treble, but more of
that when we come to discuss why the Bond Duck is set to take
flight. Meantime, here is Ben's recipe for prosperity:
"US dollars have value
only to the extent that they are strictly limited in supply.
But the US government has a technology called a printing press
(or its electronic equivalent), that allows it to produce as
many dollars as it wishes at essentially no cost. By increasing
the number of dollars in circulation, the US government can reduce
the value of the dollar in terms of goods and services, which
is equivalent to raising the prices of those goods and services
in dollars."
To complete the nightmare,
be assured that many consider Ben Bernanke to be Chairman Greenspan's
most likely successor. It is Fed- inspired statements like the
above which virtually guarantee that commodity prices are set
to defy gravity. That is why oil was recently nudging $50 a barrel
and why, despite lagging, gold is set for a catch-up. Just as
the US Administration's schemes to control oil have come to naught,
ultimately, and much sooner than expected, the gold conspiracy
will implode as well. The latest US ploy to crush oil was an
announcement that IRAQI oil was back at full production and that
in addition, the US was planning to release oil from the Strategic
Stockpile. One day later the IRAQI pipeline was attacked again
and, as for the so-called stockpile, who knows how much is there
and whether they dare release it?
Before the gold conspiracy implodes, there are one or two building
blocks which first need to fall in place. We discuss them below.
3. THE DOW DUCK
- heading for the precipice
In his speech to economists at the end of 2002, Governor Bernanke
openly advocated Fed operations to prevent a bursting of future
asset bubbles. He had in mind open-handed monetization. Clearly
something was needed over and above simple monetary policy if
Bernanke and his boss were to realize their shared dream of eliminating
the cycles of boom and bust, both in markets and the economy.
It was King Canute who, in olden times, demonstrated to an adoring
audience the futility of opposing trends. He placed his throne
on the sea shore - just above the water line - as the tide was
turning. He commanded the sea not to wet his feet. His words
went unheard. Bernanke and his ilk are in for a similar experience.
The difference is that Canute was under no illusions whereas
Bernanke is in dreamland.
Fed intervention by way of a drastic reduction in rates did little
to stem the equity slide from early 2000 to late 2002. Instead,
what they did was generate an even bigger bubble in housing. Today Bernanke knows full well that
a collapse here will be an entirely different kettle of fish
and all he has done is jump from the frying pan into the fire.
Here is why: In 1997, in the US economy, equity and housing made
roughly equal contributions to household net worth. Seven years
later, thanks to Greenspan's rate cuts, the real estate component
had grown a huge 80%, massively outstripping equities, themselves
up a mere 15%.
The equity component crashed 41% from $12, 2 trillion at the
end of 1999, to $7,1 trillion by the end of 2002. By March 2004
it had recovered to only $9, 1 trillion. Housing meanwhile went
beserk:
"accelerating real
estate values kept household net worth largely moving forward
during one of the greatest equity bear markets in decades."
(Author unknown).
To sustain the housing bubble
going forward will now require keeping the bond bubble intact.
Both will pop if the dollar bubble deflates further. The dollar
will definitely implode if the Dow sniffs the return of a long
term bear, a slide which takes out previous lows.
Return of the 'bear'
US markets bottomed in October 2002, European markets only in
March 2003. After enjoying major rallies for the past year and
a bit, all spent the first quarter of 2004 topping out. Between
then and now, led by the NASDAQ, all have since given major long
term 'sell signals.' Let
us explain. Market direction is all about trends and moving averages.
When a market breaks below its 200 day moving average, it generally
signals a long term change of trend. If a market stays down long
enough for its 100 day moving average to turn down, and in turn
break below the 200 day, it draws a line in the sand. Very rarely
will a market then rally above the crossover point before beginning
a major new slide which takes out previous lows.
In the past two months, starting with the NASDAQ, but followed
by the Dow, Europe and Japan, all major equity indices have largely
met the above criteria, as a prelude to re-entering the next
phase of continuing long term bear markets. All these markets
will in due course go lower - much lower than the investing public
presently anticipates.
We will focus on the Dow - See chart below.
The initial breach of the 22-year old bull market, what we describe
as Leg 1, took the Dow down from its all-time high of 11,700
on January 17, 2000, to an intra-day low of 7,200, two years
and nine months later, on October 10, 2002. In the following
16 months the Dow enjoyed an extended rally, pushing up 50% to
10,700 by February 20, 2004. It has been working its way down
ever since.
On August 3, (the writer's
62nd birthday, what a present!) the Dow's 100 day moving average
broke below its 200 day, at an intersection point of 10,246.
Thirteen days later, on August 16, the Dow cracked to an intra-day
low of less than 9800 - a level last seen some eight months ago
in December 2003.
The Dow is currently enjoying what could be a final rally back
to the 'intersection point' of 10,246, before slipping off a
precipice. First stop might be a short breather at 9,000, followed
by a re-test
of the October 2002 low of 7,200.
In a recent letter, Jay Taylor's charting friend, Roger Wiegand,
suggested we could revisit this level as early as October. In
retrospect we would simply have had a two year respite from the
bear. After retracing our way to 7,200, it's probably down again
- big time - to the lower channel at 5,500. One would hesitate
to put a time on it, but probably by end 2005, as gold is roaring
up from $400 to $850. What a switch! More of that later.
Why the Dow is so fragile - the 'fundamentals'
The US is a classic case of an economy drowning in debt. Like
an 'energizer bunny' playing a drum - the action slows as the
battery dies. As a frog expires without warning in water brought
slowly to the boil, so a child watching the bunny is surprised
and crestfallen when the toy goes dead. US investors will be
similarly traumatized when their economy unexpectedly lurches
to a halt. It will be in defiance of authoritative prognostications
to the contrary but the reasons will be plain. Consumers are
totally tapped out, increasingly nervous, and wishing they had
saved when they had the opportunity.
'The Privateer' exposed Greenspan's propaganda as follows:
"The global economy
is slowing fastboth the Bush Administration and ...the Fed know
this and are watching it with increasing dread..one more quarter
at the current rate of deceleration and Japan's economy could
also be back in recessionyet in two days of testimony to Congress,
Greenspan assured the world that the June 'soft spot' was temporary
and there was 'nothing to fear'the rise in oil was 'only transitory'He
painted the rosiest of scenarios in the expectation that no one
would dare to refute him."
Since then every financial
statistic has painted him a liar. Investors were stunned when
the July jobs figure crashed from an expected 228,000, to an
actual 32,000. Dr Kurt Richebacher, former Chief Economist of
Dresdner Bank, was not surprised at all. After carefully analyzing
the fabulous job stats put out by the Bureau of Labor he discovered
that of the 1 million new jobs supposedly created in the 3 month
period March-May, virtually two thirds had come from a new statistical computer
model!
Richebacher summarized the US problem in an interview with Philip
Coggan of the London Financial Times:
"Inflating asset prices,
propelled by a limitless supply of credit at Fed-orchestrated
rock-bottom interest rates, created a deceptive recovery through
a protracted borrowing and spending binge."
Coggan says Richebacher believes
that once the stimuli are withdrawn the bubbles will burst -
thanks to a massive
sell-off in bonds.
The withdrawal of the 'job creation' façade is the first
stimulus to fade from the scene.
As evidence of deceptive recovery begins to manifest, it will
be increasingly difficult to justify share prices priced on the
basis of 22 x average earnings. They would compare with long
term averages of as low as 13, falling to beneath single figures
in recession. On the basis of overblown p/e ratios alone, the
Dow can halve. If foreign funds take fright and begin to exit
US markets, the dollar will tank as well. This will eventually
cause investor malaise to spread. It will finally begin to deter
the long suffering offshore buyers of US bonds. Once the debt
bubble starts to burst and Americans are forced to rely on internally-generated
savings, rates will rise dramatically. Corporate earnings will
fall sharply - they could even halve. Then the slide in the Dow
will intensify. An ultimate target of 2,000 and lower would not
be out of the question over the next three years.
We think the Dow crash will precede the crash in the dollar and
US bonds. Official US spokesmen are already attributing slowing
growth to rising oil. Because oil prices are low in real terms,
we consider this to be a distortion of the truth.
4. THE DOLLAR
DUCK - forced into FIAT folly
As we turn attention to prospects for the dollar, we feel like
a traveler in the desert, struggling to distinguish between the
ever-present mirage at the horizon, projected by the Fed, and
the deteriorating reality experienced on the ground. On the rare
occasions when the stats have not been processed through a government
filter, we are subjected to unadulterated 'Fed-speak' such as
below:
"The rest of the world
loves investing and lending money to America and will continue
to do so ad infinitum, regardless of the ballooning size of the
'twin deficits' on budget and trade."
The second tells a picture
of a nation drowning in debt, gutted of manufacturing capacity,
rapidly alienating a hostile world of lenders, driving perilously
close to a sign reading: "End of the Road."
The war in IRAQ and the dollar
On the face of it the IRAQI war duck is demanding an ever bigger
share of an escalating US budget deficit. Both are out of control.
If the economy slows further, prompting the Dow to slide, tax
receipts will shrink as corporate profits sag in face of recession
or worse. Yet the Administration has been determined to prosecute
the war at almost any cost. Are there other considerations which
can affect the dollar even more than a deteriorating budget deficit,
should the war be lost? It would appear so. An extract from Bill
Murphy's Lemetropolecafe Midas column of August 24, referred
to a recent article in the Asian Times by Pepe Escobar, who wrote
the following:
"From an American perspective, the need to control IRAQ's
oil is deeply intertwined with the defense of the dollar. The
strength of the dollar is guaranteed above all by a secret agreement signed
between the US and Saudi Arabia in the 1970's that all OPEC oil
sales be denominated in dollars.
Saddam Hussein started selling IRAQI oil in Euro's (and making
a handsome profit) in November 2000 - and that's another crucial
reason for the IRAQI invasion. Many OPEC countries, not to mention
Russia, have openly flirted with the idea of trading their oil
in Euros. (OPEC is made up of Algeria, Indonesia, Iran, Iraq,
Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab
Emirates, and Venezuela)." It seems the Americans are fighting
a rearguard action to retain oil sales in dollars. It is a practice
which adds considerably to dollar strength because so many nations
are forced to keep their 'working capital' in dollars. That is
why Saddam had to be taught a lesson to prevent others from copying
his example. The problem is the ramifications of intensifying
the war, run the risk of alienating far more nations than just
IRAQ.
As James Turk recently set out in 'Goldmoney:'
"It seems clear that
OPEC and the other oil exporters are already pricing crude oil
in Euros."
The US trade deficit and
the 'strong' dollar policy
In an effort to retain OPEC's policy of trading oil in dollars,
some US Treasury Secretaries have deemed it important to maintain
a 'strong dollar policy.'
Henry Rubin was one such under Clinton. The right to print dollars
at virtually no cost, and have the rest of the world accept them
as 'payment,' has been
such an amazing privilege, that the US has been prepared to go
to extraordinary lengths to protect it. Unfortunately it has
come at a very high cost and a glance at a long term chart of
the trade deficit versus the trade-weighted exchange rate of
the dollar will explain why this has been so. See chart below:
Not since 1977 has the US run
a trade surplus of any size. When the US Fed hiked rates to 20%
plus in 1980 to break the bull market in gold, the dollar took
of. From 1981 to 1986 it rose nearly 40%. This caused the trade
deficit to explode. As rates were cut again and the dollar subsided,
the trade deficit briefly disappeared for a year in 1991, but
the surplus was marginal. Having roundly condemned the market's
'irrational exuberance' in the mid nineties, Greenspan withdrew
all caution and refused to comment as the Dow and NASDAQ surged
into the year 2000. Dollar strength followed. The trade deficit
plunged to new depths and despite a sharp fall in the value of
the dollar, it has not yet been sufficient to turn the tide.
The EURO rose 50% in less than two years, from $.86 in February
2002, to a peak of $1,29 in January 2004, before pulling back
to its current artificially low level of $1,20. Yet, so far it
has had no effect on the trade deficit.
The reason is most likely because years of dollar 'over-valuation'
have gutted US manufacturing industry, much of which has been
exported to China and India.
The ECONOMIST calculated a year ago that it would take a further 50% devaluation of the dollar merely
to swing the trade deficit back into surplus - let alone enable
the US to generate sufficient foreign exchange to pay of years
of accumulated international debts.
There is a second possible reason. Rising oil prices, combined
with falling domestic production, are together ensuring that
oil's contribution to the burgeoning trade deficit is growing
by the month. It is not yet hurting consumers but it is building
somewhat of an insoluble problem for the dollar. Even a further
devaluation cannot help that much. There is simply an absolute
limit to the amount of local oil production at all but stratospheric
prices.
Likely consequences of a major dollar fall
The problem with engineering a hefty devaluation as part of a
strategy to swing the trade deficit back into surplus is that
it would sow panic into the US bond market. A fifty percent devaluation
would require the dollar to fall 15% per annum for three years
in a row. US 30 bonds presently yield only 5%. Imagine a foreign
holder losing 15% of his capital, each year, for three years
in a row. A 5% return on his money would nowhere near compensate.
We will study the outcome we expect when considering the likely
behavior of the BOND DUCK in the next section.
5. THE BOND DUCK
- heading for the hills in fright
Changing the US way of
life
There are two alternative strategies to dollar devaluation. The
first requires effecting a radical change to the US way of life.
The second opens the door to allowing the adoption of Bernanke-type
policies of blatant monetization.
In discussing the path of discipline, we draw on figures appearing
in the latest Privateer but present them a little differently.
The July budget deficit widened from $54 billion to $69 billion.
The June trade deficit jumped to a record $56 billion from May's
$46 billion. The latest figures for each give a combined average
monthly twin deficit of $125 billion. On an annualized basis
that amounts to $1,500 billion. The latest estimate for US Gross
Domestic Product (GDP) is $11,600,000 billion or $11, 6 trillion.
The twin deficits account for 12, 9% of GDP.
That is HALF the problem. The other is that the US is also living
on internal credit to the tune of another 12%. Combining the
three items comes to an enormous 25% of GDP, which is currently
being borrowed into existence.
If one were counseling a spendthrift he would be told to start
living within his means. Cut what he cannot afford. Why should
it be different with nations? If one were dealing with minor
problem countries like Thailand or Argentina, they would simply
be told:
"Sorry boys, there
are no more loans. It's over. Get back into line."
It was the radical but respected
American economist, Dr. Ravi Batra, who in 1998 said:
'The US is just a big
version of Thailand.'
Imagine the extent of the internal
contraction the US would have to suffer if they overnight decided
- or were instructed - to stop the borrowing? It would cause
a 25% contraction of US GDP. The world can no longer afford to
lend the US 12,9% of its living standard, nor can the US itself
continue to pile up internal debts, most of which have come by
way of extracting maximum equity from the housing market.
A surprising African example of budgetary discipline
The writer is based in Cape Town at the southern most tip of
the African continent. Our country, South Africa, is still responsible
for 25% of the world's gold production. Some of our American
friends prematurely write us off and describe our ANC government
as 'pro-communist.' There
is no doubt many of its older members once were avowed communist
supporters when Russia was their main source of military support
and finance. It is hard to blame them. Yet there is also evidence
that Rockefeller gave the ANC R30m in 1985 - to assist them in
their efforts to fight a terrorist war against the White-controlled
'Apartheid' government of the National Party. At the time we
recall the EPG (European Parliamentary Group) visiting South
Africa in an urgent attempt to persuade the whites to accept
an immediate hand over of power to a black-controlled pro-communist
government. Fortunately South Africa's President at the time,
PW Botha, totally rejected their efforts.
Majority Rule by a black-controlled government only came 9 years
later in 1994. Communism had collapsed in 1991 so by the time
the ANC gained power their erstwhile friends had gone and the
entire system had been shown to be a total fraud.
With the demise of communism and the expansion of 'globalism,' countries that refuse to trade and
get efficient will fall off the log and starve. Erstwhile communists
have to learn about capitalism.
It is not just Black Africans who have to make this adjustment.
Americans need to study the past history of some of their own
political leaders. In 1969 as a Rhodes Scholar at Oxford University
in England, ex-President Clinton was violently protesting against
his country's participation in the Vietnam War. A year later
so was the Democrat's latest contender, John Kerry. Both were
well aware that some of their backers were out-and-out Marxists.
They were definitely not 'anti-war,'
they simply wanted North Vietnam to succeed in its takeover of
the South, and thanks to the efforts of men like Clinton and
Kerry the Communists won the war. Fortunately they have lost
the peace and Clinton and Kerry had to grow up. South Africa's
ANC is having to do the same. Talk to the beneficiaries of 'Black
Economic Empowerment' and 'Affirmative Action.' They think capitalism is wonderful - wouldn't
you?
We have taken this political detour in order to find an excuse
to quote from a recent article by the Chief Economist of South
Africa's largest 'parastatal.'
His name is Mandla Maleka and he works for ESKOM - otherwise
known as South Africa's 'Electricity Supply Commission.' He writes a regular column for South
Africa's biggest circulation daily newspaper, part of the ARGUS
Group. His latest article was headed:
"Save more, borrow
less, and grow the economy"
It was an excellent call to
fiscal prudence and financial discipline from one of South Africa's
top black business leaders. He ended with the following injunction
to his countrymen: "A saving nation combined with prudent
fiscal and monetary policy managers should be able to grow the
economy to levels sufficient to attract foreign direct investment
and create employment. So do your bit - slow down the appetite
for CREDIT and increase your SAVINGS."
US will likely choose the coward's way out
We doubt the US will listen to the wisdom of a little nation.
They are too far down the road to financial ruin.
Matching their current trade deficit of $56 billion for last
June was net foreign investment of $72 billion. An imminent crack
in the Dow could frighten off foreign investors, even cause them
to pull out in droves, reversing the inflow into an outflow.
The dollar would crash and the US would be forced to fund its
budget deficit from its own non-existent savings. Other things
being equal, that would tend to push rates up sharply, rapidly
puncturing the housing boom. The Fed would initially try to prevent
it happening. Bernanke would inevitably begin to monetize the
debt. The Fed would have to PRINT the money to buy the bonds
that investors were no longer prepared to subscribe for at current
low rates. Failing that, rates would have to rise very sharply.
As the printing began in earnest, dollar holders would begin
to jump ship and seek alternatives. Japan and China would be
left holding the baby.
Unless private holders harbored a collective death wish, they
would switch their dollars into a safer 'store of value' as quickly
as possible. It could be other currencies or gold and silver.
As the dollar slide accelerated, the pressure on other central
banks would mount. Most might try to slow the rate of collapse
by intervening - printing their own currencies to buy the dollar,
hoping to stem the rate of decline. In the process FIAT currencies
will collapse together. Soon enough, international investors
and savers will switch to gold. For more on this process readers
are encouraged to ask for copies of an earlier report we wrote
entitled: "Currencies in FIAT folly." It is
27 pages long.
Readers may recall that in our 'SUMMARY' we described how the
BOND DUCK had initially: "looked set to stay, having
scooted to the far end of the lake to hide under a bush. He's
been conned into a false sense of security and will soon get
a wake-up call when he sees the Dollar Duck has dumped him and
fled."
That is indeed how US bond rates have been behaving in face of
growing evidence of a slowdown in the US economy. There is little
sense of the dangers facing the dollar if fears of a slowdown
cause a sharp sell-off in the Dow. As we described above, a dollar
crash has serious consequences for off-shore holders of US bonds.
We therefore maintain that the current strength in US bonds is
merely a deceptive rally. We believe that from a technical perspective
the weekly chart contains a 'reverse head and shoulders' pattern.
Furthermore, if we look at a monthly 'arithmetic' chart of the
30 year bond, it will be clear that there is 'a long term
falling wedge formation' which has already broken out and
upwards. It is pointing towards a long term upside target for
the 30 year bond rate of 12% and higher. We therefore concur
with Dr. Kurt Richebacher's prediction that in due course there
will be a 'massive sell-off in bonds.' See chartist, Daan Joubert's long term chart
below.
CONCLUSION
After years of playing the magician, Greenspan has run out of
tricks. Returning to the scene we painted at the outset, the
'ducks he liked to keep in a row' are one by one taking
flight but the BOND DUCK is the most important and will likely
be the last to fly away. We predicted in our 'SUMMARY' at the
beginning:
"They
will all be gone by dawn. Then comes a Golden Sunrise"
Here is what we meant:
As the world's biggest borrower, the US is responsible for managing
the most significant financial instrument available to international
investors. It is the US bond market. In order to sustain its
attractiveness the US needs to ensure that the dollar fulfills
its role as a safe 'store of value.'
It further has to persuade lenders that US ability to service,
and eventually repay, ballooning international debts, is credibly
within the bounds of probability. We believe that a calm, cool,
assessment of the facts does not support such a conclusion. This
leads us to the following. If the world's most widely-used financial
instrument is close to unraveling, and, if in the process, most
other FIAT currencies could be dragged into pit with the dollar,
there is a near certainty that sooner rather than later a growing
proportion of world savers and investors will be struggling to
get through the doors of gold and silver. The days of governments
being able to purvey FIAT currencies and related bonds as honest
repositories of people's savings, is drawing to a close - albeit
not always obvious as the trends unfold.
Central banks have gone to great lengths to persuade the world
to trust in their FIAT currencies. The process has entailed a
simultaneous conspiracy to suppress the price of gold and denigrate
its properties as a 'safe haven.'
This has enabled governments to keep long term interest rates
at artificially low levels because the lower than normal gold
price signaled 'inflation under control - no need to worry -
we can keep printing.'
The extent of suppression of gold bears comparison with an old
Roman war machine called 'the catapult.' Having been pulled back to its maximum point
of compression, release will bring a violent surge.
As we were finishing this letter, John Embry and Andrew Hepburn
of Sprott Asset Management published a brilliant 66 page study
entitled:
"Not free, Not Fair:
The Long Term Manipulation of the Gold Price"
Sprott are well-known Canadian
Fund managers, controlling total funds in excess of $1,6billion,
invested mainly in gold, gold shares, and precious metals. John
Embry used to hold down a high-level position with the Canadian
branch of the Royal Bank of Scotland. The latter were suitably
embarrassed when Embry had the courage to come out and speak
the truth. He and Hepburn summarized their findings as follows:
"The more we investigated
the gold market, the more readily apparent it became that the
gold price appeared, in the POLITEST of terms to be 'managed.'
Despite that they went on to
say:
"We believe gold is
well-launched into a multi-year bull market for a number of strong
fundamental reasons. In fact we would go on to say that the fundamentals
may well be better today than they were in the seventies when
gold experienced a TWENTY-FOLD move in price."
They concluded with the following
forecast:
"The inevitable failure
of the latest attempt to influence the gold market will serve
to AMPLIFY the forthcoming rise in the gold price that is going
to occur anyway for very solid financial and geopolitical reasons."
In the longer term, drawing
a line through Sprott's guidelines, gold could ultimately rise
20-fold again, from last year's $350 to an eventual $8,500 in
9 years time. The Sprott report can be accessed at their website:
www.sprott.com.
Once the price breaks through the 'glass ceiling' of $430
imposed by the world's central banks, it will quickly move back
to $550, then on to its all-time previous high of $850 - last
seen in 1980. If one had to guess timing, one would look to the
metal soaring back to $850 by end - 2005. That is in 16 months
time. $500 could be on the cards by Christmas, or early next
year. Greenspan's ducks will soon be gone. Then the 'hunter'
will become the 'hunted.'
END
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Peter George
will be launching a NEWSLETTER SUBSCRIPTION SERVICE within the
next 2 months.
If you would
like to be kept informed please email pgportfo@trinityholdings.co.za
|
Other articles by Peter George:
- Currencies in 'FIAT Folly'
- face Abyss of Destruction - March 12, 2004
- Strategy for R6/$, Buy Gold
NOT Dollars - July 12, 2004
- SA Gold Shares - Buy when
there's Blood - July 27, 2004
- Energy Unlimited - Aflease
and Uranium - July 27, 2004
Friday, August 27, 2004
Peter George
tel : 021-700-4880
cell: 082-806-3147
e-mail address : pgportfo@trinityholdings.co.za
website: Trinity
Holdings
Peter George turned 62 in August,
2004. Born in Natal, South Africa. Graduated with a BA (PPE)
- Politics, Philosophy, and Economics - at Oxford University,
England, followed by an MBA at the University of Cape Town. He
was a Member of the Johannesburg Stock Exchange from 1969-1981,
Chairman of Wit Nigel gold mine near Johannesburg, from 1983-1987,
and a Member of the South African Bond Exchange from 1993-1997.
He and his associates currently own an option to repurchase and
reopen the Wit Nigel gold mine. Today he writes a regular commentary
on world markets, currencies, and gold. He lives in the lovely
South African city of Cape Town. His reports are available via
e-mail or, by special arrangement, via surface mail - for the
elderly who are not yet 'computer literate.'
His e-mail address is : pgportfo@trinityholdings.co.za
________________
321gold Inc
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