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Financial Markets

Jay Taylor
June 21, 2004

As we go about living our daily lives, the bigger picture is easily lost because what is happening here and now is so much more real in our minds than what happened months and years in the past. And so with recent economic news being positive, we "feel" as though things are good and getting better, even though a view of the past several years reveals a trend that is, at best, lackluster. No doubt the equity bull market is still indelibly imprinted in the psyche of American investors. Since bull market is the only kind of equity market the majority of Americans have known, they naively expect that to continue indefinitely into the future. They have little use for the study of market cycles because they like bull markets, and it is easier to simply project the known past indefinitely into the future.

I know about projecting the past indefinitely into the future. I have been there and done that with gold. I
watched and profited from the gold bull market of the 1970s, and then came the 1980s, and I rather liked future gold price projections made at what turned out to be the end of the 1970s gold bull market. And so I think I kind of understand the mentality of masses of Americans who have built their lives and future expectations around perpetually rising equity prices.

But the chart below shows that equity markets have not perpetually risen. In fact as the chart of the S&P 500 illustrates, equity markets are displaying an unmistakable topping pattern of lower highs and lower lows. And as Richard Russell points out, there are indications that the really big money continues to come out of the market, just as it did prior to the first phase of the current long-term secular bear market. The S&P 500 is lower than it was in 1998. The NASDAQ is still far below its peak of over 5000, and the Dow is still a long way from its peak of over 11700. What is truly remarkable is the fact that these major indexes have failed to even come close to their all time highs, despite the most aggressive monetary and fiscal stimulus in the history of mankind.

What is going on here?

Published with permission from

The inability of the Fed to drive equity prices to new highs was predicted by my good friend Ian Gordon when I first interviewed him in 1999. Ian said then and he says now that the huge and rapidly-growing debt that was created during the Kondratieff autumn would not be equaled or surpassed in his lifetime. (Ian only recently turned 60. And since the Kondratieff peaks occur only every 60 or 70 years, Ian would have to live to be 120 or 130 to see the next peak).

Why is Ian so cocksure in this prediction? Because real data he has collected, some of which dates back to just the Revolutionary War, suggests that with or without a gold standard, policy makers always repeat the errors their grandfathers committed. They inevitably think they are smart enough to overcome the laws of nature as they apply to money and economics, so they invariably set out to create prosperity by increasing the money supply. They push that process as far as they possibly can until the system can no longer be sustained, because at a crucial point into these 60- to 70-year cycles, debt becomes so excessive that no matter how hard they try, policy makers are no longer able to keep the bubble expanding. In other words, when there is no longer sufficient energy to inflate the bubble, it is not possible to maintain its current dimensions. Rather, a very rapid and devastating shrinkage of the economic bubble is mandated by Mother Nature, because insufficient income is available by a sufficient number of market participants to avoid a reversal of the inflationary process into a deflationary process. Defaults beget more defaults until, eventually, wave after wave of bankruptcies end up in a massive repudiation of debt that leads to huge levels of unemployment and a massive decline in income.

This is not a happy event, but as with all corrective measures in nature, it is a necessary one. Yes, I know
everyone these days thinks our current policy makers, who are equipped with modern technology and
derivatives and all manner of financially engineered products, are smart enough to escape laws of nature that have confined mankind since his creation. What would be unique in the early stage of the Kondratieff winter (the impending deflation) would be for policy makers to worry about the excesses. But just as in 1930, our ruling elite are quite convinced they can escape natural consequences of the kind of economic immorality that is at the very heart of "printing press" money.

We are led to believe by our college professors that we have learned from the 1930s. But actually we have not learned anything because our policies are exactly the same as they were following the 1929 stock market crash.

The Fed wasted no time in goosing the money supply back then, and we have done the same this time around. Within four months of the crash, the discount rate was cut in half, according to Murry Rothbard. And President Bush is leading the nation into deficit spending, just like Hoover did. So we tried monetarism and Keynesianism in the 1930s, just as we are trying those policies now. They didn't work then. They won't work now. Yes, we may have more data and more computer power. But all that will allow us to do is delay the correction, with the end result being an even deeper and more devastating Kondratieff winter than if our manipulators were less competent.

As Ian Gordon pointed out, the demarcation point in each Kondratieff cycle is the stock market peaks. So much debt money was created to fuel stock prices to absurd overvalued levels that, ultimately, the system has lost its ability to be inflated to such a level as to drive equity prices to new highs. And debt begins to weigh down the demand side of the economy, too, as an increasing portion of cash flow must be allocated to paying interest and principle on debt rather than to buying goods and services.

But surely Ben Bernanke can fire up his super duper helicopter printing machine and scatter $100-bills by the millions out to America and thus keep the bubble inflated, no? No, he can't, because in a fiat money (liability based) system such as ours, debt is the raw material from which money is manufactured. Every time Mr. Bernanke drops dollars out of airplanes and those dollars are deposited in a bank, a liability is created. So, if debt is THE problem at the terminal stage of the Kondratieff cycle, how can printing more debt provide the answer to the problem? And that becomes an especially daunting problem late in the Kondratieff cycle, when debt is growing so much more rapidly than income.

The relationship shown above is the single most important reason why I unfortunately feel confident in
predicting that we are heading for K-cycle ending deflationary collapse. The only politically viable solution for either Republican or Democratic president is to print, print, print. But to do so means to create debt, debt, and more debt. If income could be created as easily as the illusion of wealth is created via increased monetary aggregates, it would be a different story. But as the chart above illustrates, income is constrained in a linear fashion over time, while fiat money and the debt from which it is manufactured can be increased according to the whim and wishes of politicians, policy makers, and other privileged thieves on the inside of our system. And so, with mathematical certainty, as long as the above-noted relationship between debt and income continues, we will have a deflationary collapse. How soon? I don't know. But the direction of the trajectory of the debt line relative to the income line suggests to me that we are most likely looking at a period of months not years.

June 20, 2004
Jay Taylor

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