" What Will Cause Stocks To Crash ": ( Excellent Read )
What Will Cause Stocks to Crash?
Part - I
As the U.S. stock market continues to set new records every week, there is almost universal acceptance of the fact that "you can't lose money long term in stocks." Many people do believe that somehow new laws of the universe have been discovered by our Fed Reserve Chairman that insolate us from recessions and bear markets. Yet, students of history know the laws of the universe have not changed. Indeed every stock market and every fiat currency ever created by man has self destructed. There is that uneasy feeling in the pit of the stomachs of thinking investors (the few that are left) who know the stock market party must, at some point, end. Yet seemingly, nothing is standing it the way of unendingly higher stock prices. What on earth could cause our stock and bond markets to enter a long term bear market? For answers to that question, this month we are reviewing the foundations upon which the current stock market orgy has been built. Without suggesting any target date for the markets demise, we hold firm to our belief that fiat currencies like the U.S. Dollar facilitate rot and corruption that is the shifting sand upon which our prosperity has been built. Accordingly, we think this unsound foundation not only threatens the stock market, but our cherished form of representative democratic government as well.
The origins of the current stock market bubble can be traced all the way back to August 1971, when President Richard Nixon led the U.S. into a default under its international obligations to pay foreign banks one ounce of gold for every $35 of paper money presented to it. Before that, President Johnson began to use the printing press to pay for Vietnam and his Great Society programs, which led to a rapid increase in the global supply of U.S. Dollars. With more and more U.S. Dollars flooding the world's markets against a fixed supply of gold, foreign governments quite naturally began to demand gold in exchange for paper U.S. Dollars.
With the quickening pace of gold flowing out of the U.S. Treasury, President Nixon faced a dilemma. Not unlike our current President, Nixon ran this country by polls rather than conviction of right and wrong. He knew that to gain political support he had to expand Johnson's Great Society program while carrying out the Vietnam war. But if international gold convertibility remained a reality, the only way he could finance both guns and butter was thorough increasing taxes. Recognizing a tax increase to be political suicide, President Nixon took advantage of the super power status of the U.S. to lead the U.S. into a unilateral default of this country's obligations under the Bretton Woods Agreement to exchange gold for Dollars when requested to do so by other nations.
In short, we "stiffed" all the countries around the world by forcing them to accept something of lesser value (U.S. Dollars) than we had promised to give (gold). By refusing to honor our commitment to give our trading partners real money for Federal Reserve Tokens (Also known as paper or fiat currency), the one mechanism that remained in place to keep politicians from enabling the banking system, not just the Fed, to monetize U.S. debt, was removed. And as Chart I illustrates, politicians combined with our banking system printed money (i.e., issued & monetized debt) like there was no tomorrow. As with all counterfeiting schemes, wealth was transferred to the people creating money out of nothing and those who have easy access to it, such as banks, large credit-worthy customers, i.e., large corporations, from those who produce useful goods and services.
As can be seen from Chart I, until about 1981 or 1982 this rapid increase in token money resulted in higher rates of inflation because it stimulated "effective demand." At that time, our nation's economic policy, which grew out of the Great Depression, was focused on stimulating effective aggregate demand by allocating income to the lower and middle classes. This was very important because as economist Lord Keynes observed, almost all income flowing to lower income groups gets spent on goods and services, while a large percentage of income flowing to wealthy people is plowed back into stocks and bonds which build factories or speculative endeavors like real estate. With income distribution intentionally directed toward people with a high propensity to consume rather than buy stocks and bonds, by the time of President Carter, aggregate demand became excessive in relation to the supply of goods and services being produced. As a result, the CPI was rising by double digits and interest rates approached 20% by 1980. (Your editor took out a 17 1/2% mortgage in 1981).
Benefits and Illusions of Supply Side Economics
The popular belief propagated by the media and most economists these days is that the supply side economic policies of President Reagan and astute monetary policy of the Federal Reserve have solved all of our economic woes. Indeed, many of the policies of President Reagan were exactly right for the early 1980's. By cutting taxes for the wealthy, reducing transfer payments to the poor, eliminating middle class jobs with an aggressive foreign trade policy and by smashing the trade unions, he solved the excessive demand problems of the 1970's. Reagan effectively reversed the demand side economics put in place by President Roosevelt by re-allocating income from the poor and middle classes to the wealthy who have an ability to invest a higher percentage of their incomes in stocks and bonds. I have no argument with that policy, at least up to a point. Indeed balance is required between the demand side and supply side of the economy.
Although I agree that redistribution of income toward the wealthy was needed in 1981 in order to increase savings and reduce consumption, it cannot be said that monetary and fiscal policy since Ronald Reagan's Presidency has been managed in a responsible manner. Indeed as Charts I & II illustrate, the U.S. Federal Debt (the largest component being M-3) grew exponentially during the 1980's and into the 1990's. Without the thorn of gold convertibility in its side since 1971, our government has been free to issue debt on a scale never before seen in mankind's history. In turn, that debt has been monetized by our banking system in a legalized counterfeiting scheme on a scale that has fueled the enormous boom in stocks and bonds.
But why then, if our government has acted so irresponsibly in creating money is inflation yesterday's problem? Why should you care about financial promiscuity if inflation, as measured by the CPI is low, especially when the stock market is booming? That question reminds me of the lyrics of a song during the 1960's that questioned "how can it be wrong if it feels so right"?. But is everything all right with our financial system? Is there no cost to be paid for financial promiscuity (i.e. printing money)? In fact, I am sure we will pay for the fun we are having now, which is based on activities that defy the laws of nature. Like sexual promiscuity, financial promiscuity carries with it a hidden cost that may not rear its ugly head for many years. But eventually those costs must be paid. The products of sexual promiscuity are often such unpleasant things as disease, emotional stress, divorce and alienated children. Though everything may appear to be great while illicit acts are being carried out, under the surface a pathology looms that eventually exacts a toll on our lives. I am convinced the same is true with respect to the U.S. economy. What will be the products of? In my view, either Inflation or deflation will be inescapable. Even more important I fear that a destruction of representative democracy may also be an outcome. In fact, a decline in democratic government is NOW taking place in America at a rather rapid pace, though few seem to care or to be aware. After all the Dow's pushing 11,000. Let the good times roll!
Impending Stock Market Debacle
I have spent a considerable amount of space since January 1998 in these pages explaining why inflated stock and bond markets will eventually lead to a deflationary implosion. With excessive amounts of money being channeled into the stock and bond markets (i.e., supply side of the economy), the global economy is now facing a problem of too much supply and not enough demand. This is in fact the opposite problem faced by President Reagan when he took office. And as a direct result of American counterfeiting activities, corporate debt as well as government and personal debt has grown very rapidly. Of course, when supply outstrips demand, prices and ultimately profit margins decline. When supplies of good and services become too great and price declines become excessive, debt ridden corporations become insolvent. A chain reaction of layoffs and other cost - cutting measures begin to reduce aggregate demand still further, thus causing a snowballing effect or an implosion of economic activity. This in fact is what happened during the Great Depression. It is also what happened in 1997 and 1998 is Asia. I think it is likely to happen, perhaps soon in the U.S. and globally. As we saw in 1997 and 1998, volatile currency rates (which are also an outgrowth of Nixon's actions in 1971) can provide the trigger for massive defaults across international borders.
With the U.S. stock markets now valued at levels never before seen (yes, even higher than before the 1929 crash), I am convinced that the seeds of the market's destruction have been sewn. The higher the market rises, the more excessive becomes macro-economic supply. Why so? Because 1% of the wealthiest Americans own more than 50% of the American stock market. Since these very wealthy people have all the creature comforts they need (and then some) almost all of this money is channeled back into stocks and bonds. As the process accelerates, the market frenzy grows. Supply becomes even more out of equilibrium with demand. Eventually the system will break down, as it did in 1929 and into the 1930's. Just as excess demand brought about inflation, excess supply must bring about deflation and an end to the greatest bull market of all times. When that unhappy day arrives, there will be a great deal of "gnashing of teeth" in America. The destruction of our democratic form of government may not survive in any shape or form because our politicians and corporate leaders can be counted on to blame the problem on anything but our dishonest monetary system.
Death & Devastation in Just 10 Minutes.
Over the Easter weekend, my family and I visited the Johnstown Flood Museum in Johnstown Pennsylvania. I could not help but draw a parallel between the terrible tragedy of the 1889 flood and the devastation I believe may be headed our way when the current stock market bubble finally bursts. Prior to 1889, some of America's most prominent families, including the Mellons and Carnegies purchased a property some 14 miles northeast of Johnstown. This large property contained a lake resulting from a dam placed across the South Fork, a tributary of the Conemaugh River that flows into Johnstown. The wealthy socialites of Pittsburgh used this property, known as the Johnstown Hunting and Fishing Lodge, to escape from the common folks who made them rich by working in the Pittsburgh and Johnstown steel mills.
Prior to the flood of 1889, an engineer voiced grave concerns about the structural integrity of the South Fork dam. But the Mellons, Carnegies and other socially prominent members of the club chose to ignore those concerns. Then toward the end of May 1889, when heavy rains fell, the South Fork dam suddenly broke. Within ten minutes, 20 million tons of water rushed through Johnstown at a speed comparable to the speed with which water roars over Niagara Falls. Within a period of just ten minutes, 2,100 people (around 10% of the population) lost their lives. With few exceptions, all of the buildings in Johnstown were instantly destroyed.
Death of Democracy?
Yours truly is not the only person to warn of the impending crisis of the U.S. Stock market. Allen Greenspan himself voiced concerns several thousand Dow points ago and numerous other analysts have continually pointed out stock values must eventually be based on earnings. Yet Wall Street and the socially prominent folks of the 1990's (the 1% of the American population who own more than 50% of the stock market) are perpetuating the myth that there are no fundamental reasons to worry about the market. Just as the wealthy folks at the Johnstown Hunting and Fishing Lodge in 1889 chose to ignore warnings of impending doom, so too are today's elites, ignoring signs that the market's structural integrity may give way to a wash out. The top 1% of wealthy Americans who benefit most in absolute dollars by keeping the party going as long as possible, realize full well, just as Johnstown's socialites did, that when or if a problem arises, they will be capable of walking away unscathed.
I do not expect many people to pay much attention to the ideas I am now expressing. When times are good, people are not inclined to cast aside the enjoyment of the moment. But the financial promiscuity practiced by our politicians and our banking system is eroding away the structural integrity and moral fiber of American democracy just as surely as the structural integrity of the South Fork Dam was being eroded in 1889. To illustrate how the mechanics of fiat currency (counterfeiting) ultimately destroys the structure and prosperity of a nation, I wish to pass along a micro-economic example of the Frigo Brothers from a book I recently read titled Land Lords of the World, by Joseph Adam Gondek.
Dishonest Money Ruins Honest Businesses & People
The Frigo brothers brought their cheese making trade to America after immigrating from Italy to New York during the early 1900's. A typical trade relationship between the Frigo Brothers Corporation (Frigo) and a farmer, whom we will name Farmer Jones (Jones), went something like this. Every morning, Jones sent 625 gallons of milk to Frigo from which 500 lbs. of cheese and other by-products were produced. In payment for the milk, Frigo would issue a credit for 400 lbs. Of cheese to Jones. Obviously, Jones had little use for 400 lbs of cheese per day, so upon request, Frigo issued forty ten-pound Bills of Credit to the farmer. Each Bill of Credit would entitle Jones, or whoever held the Bills of Credit, the right to acquire 10 lbs. of Frigo cheese. Given the wide spread confidence in the underlying value of these Bills of Credit, Jones could easily them as "currency" for other things he wished to purchase. The Frigo bills were widely accepted because, based on experience, no one had any doubt about the willingness and ability of the company to provide value (i.e.,10 lbs. of cheese) for each bill. So far, so good. By issuing Bills of Credit, Frigo created a rudimentary but stable monetary system backed by honest productive labor and business. But the next phase of this story, as told by the author, turns ugly. This story is important because it illustrates exactly the same principle of dishonest money (on a larger scale) that has been practiced in America, especially since Nixon slammed the gold window shut in 1971.
Counterfeiting Carnage & Destruction
" It so happened, as it often does whenever money is involved, that a couple of persons who were less concerned with honesty than with getting rich contrived to find an easier way to cash in on the thriving economy of this community than by starting a productive business. They did not own a cheese factory to compete with the Frigo Brothers, but they were very adept with a printing press. They decided to counterfeit the bills that were in circulation as money. They did such a good job that their receipts could not be distinguished from the original ones. Gradually they put this money into circulation. They did it by lending their "dishonest bills" to people in the community.
'There was now more money in the community, and the economy started to heat up. Money was lent freely because there was plenty of it, so more people borrowed the bills of credit from these "bankers" to start new businesses. Services expanded. Everybody was happy. More and more people were coming to Frigo Brothers with their receipts. Each was a claim on the ten pounds of cheese, as well as on anything else in the exchange economy of the community.
'The company, as an honest operation, honored them all, not knowing that many of these bills were counterfeit, not backed up by production value. They were claims, but they never were receipts. Soon the family realized that something strange was happening. It was rapidly depleting not only its current production of cheese but its inventory as well.
'The company's board of directors was in a predicament, bordering on panic. This had never happened before. The board realized that if the company continued to redeem all the receipts coming in, the business would be ruined and it would have to close the plant. So the board decided to stave off the prospect as best it could. It leveled with the public by explaining that what was happening was an unusual situation that it did not fully understand. The board then announced that in order to save the business, the company must now ask for two bills for each delivery of ten pounds of cheese. This would be in effect until the situation cleared up or a better solution was found. This is inflation, first of all, of the money supply, which was expanded by people who created claims on what somebody else would produce. These people who counterfeited new claims did not bring any milk to be processed by the company into cheese with which to redeem them. Of course this was stealing, depleting the warehouses without putting anything in them. It forced the company to ask for two claims for each ten pounds it tried to deliver.
'This was price Inflation, which soon spread to the reset of the economy. The issue of money unsupported by value is the principle cause of inflation. In a nation's macro-economy, there can be other temporary shortages for other reasons. The people of the community, however did not understand what was happening, and did not accept the company's explanation. Instead, they blamed the company for being greedy and raising prices. Fear took over and people redeemed their bills even at the higher price, making matters worse. So the company had to raise the price again and again. Eventually the business went bankrupt, of course, and the plant had to close.
'Now the farmers had no market for their milk, and there was no one to redeem the remaining certificates. The group that was out for fast and easy money kept out of the public view. In the end, however, even they found their money had no value. The micro-economy of this community was now in a depression."
This story illustrates precisely what has been happening on an enormous scale in the United States since President Nixon slammed the gold window shut in 1971. Counterfeiting by our banking system is legal simply because our government has declared it so. It is no less dishonest or immoral than that same crime committed by the thieves in the Frigo. And although it is more difficult to discern the cause and effect in a macro economic setting than in the simple Frigo story, the effects are nonetheless the same.
The Federal Reserve and the banking system in general act in concert with one another in a massive counterfeiting scheme. This practice effectively allows non productive people (i.e., government officials, bankers, lawyers, stock brokers, etc.) to make claims against supplies of goods and services without contributing to the supply of those items. It is in effect legalized theft. And while it is difficult for the average citizen to perceive what is going on, the effects of rampant money creation has been even more greatly obscured by the aforementioned switch from consumer price inflation to stock and bond market inflation. In one major respect, this behavior by our government is even more pernicious than what took place in the Frigo story because politicians can now finance favors for corporations who fund their election campaigns, simply by creating money. The losers are average Americans who do not have this kind of representation. Moreover, the 30-second sound bite political ads are geared to manipulation of the public to further benefit corporate interests.
(Part - II next week)
JTaylo5203@aol.com
25 June 1999
gold-eagle.com
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