Let’s Not Forget the Big Long-Wave Picture

As we deal with the daily concerns of life, it is very difficult to see the big picture. Out of life-sustaining necessity, we must care about putting food on our tables, paying the rent, keeping warm in the winter, and keeping cool in the summer. Those of us in the financial world hear the question raised dozens of times each day, “What will the Fed do next?” as if that were a life-and-death matter.

One of my best friends is Ian Gordon, a British-Canadian stockbroker, who contacted me back around 1997 to exchange newsletters. I have never asked Ian why or how he has derived his love of history (economic history in particular) but Ian, more than anyone else I know personally, is able to step back in time and put the current into a long-term perspective. Ian believes, as do I, that history repeats itself, though never exactly in the same way as it did previously. The differences from one cycle of history to the next are long and different enough that  when combined with our intense focus of the present, they keep us from getting a good sense of where we are and where we are likely headed, given the ebbs and flows of history.

The chart above, which was constructed by Ian Gordon, is very familiar to long-term subscribers of J Taylor’s Gold & Technology Stocks. It shows four major periods of major credit expansion and contraction, starting with just after the birth of the United States of America in 1776. When you view history from this long-term context, you begin to realize that whether Bernanke pauses, raises, or lowers rates at the next meeting is meaningless, because ultimately, policy makers are just as impotent to stop the forces of economic cycles as the Corps of Army Engineers is to stop hurricanes.

We believe the odds now favor the U.S. heading into a recession in the near term, and given where we are now in the Long Wave or Kondratieff cycle—apparently at the start of the major credit contraction phase as shown on the chart above—we have to be concerned that this next business slowdown could indeed be the beginning of the mother of all bear markets, at least in our lifetime. Throughout history, but especially more recently politicians and bankers have shunned all manner of gold imposed monetary discipline. Attempting to defy the laws of nature they imposed man made laws that would allow them to try to outrun deflation by printing endless quantities of paper money. And as promised by Ben Bernanke, the Fed he leads will almost literally shower the nation with cash from helicopters in order to stave off the next Great Depression. And we are quick to acknowledge policy makers, with modern day information and propaganda technologies, have been able to delay the day of reckoning longer than in the past. But lest you think policy makers from former generations did not also employ exactly the same methods as are being employed now to stave off the next business contraction, you need to read the Murray Rothbard book America’s Great Depression. (By the way, we were treated to a preview of how the Bernanke helicopter will work when the Federal Government began writing out $3,000 checks to alleged victims of Hurricane Katrina.)

If you can set aside the bull crap fed to us daily by the mainstream media (it is the mouthpiece for the ruling elite), what you will learn from Murray’s book is that the current policies are practically the same as they were in the 1930s. True, our current manipulators appear to be more efficient and competent in manipulating the minds and actions of Wall Street and the population in general. But the policies are the same. What the establishment seems not to understand (or perhaps are just ignoring) is that the laws of economics have not changed and that they will ultimately prevail. So, eventually, the cold Kondratieff winds of deflation and depression can no more be overcome by windy politicians and their helicopter money printing machines than can the hot winds of a hurricane.

Exponential Debt Growth/Linear Income Growth Spells Trouble

America’s Founding Fathers understood that, in the long run, everyone would be better off if the markets were left totally free from intervention. They understood that markets are capable of allocating scarce resources much more efficiently that, say, a Russia’s Politburo or a group of rich white men gathered around a humongous Federal Reserve boardroom in Washington.

Unfortunately, current policy makers have forgotten that. They have employed Keynesian and monetarist economic policies that are truly in tune with the central planning mentality of fascist and communist dictatorships.

In fact, that is where I think the current powers behind the throne are taking us. But that is a topic for a different time and place. More immediately, our task is to try to understand the problematic imbalances these policies are creating, and to
profit from them or at least to preserve our capital, as most everyone else—that is the masses who are content to take at face value what Mr. Bernanke, the politicians, and leading corporate executives—tells us.


Ultimately, debt becomes such a burden that it can no longer be serviced. And when that happens systemically through the economy, as it does every 60 or 70 years in the Kondratieff cycle, we get major economic contraction that results in massive bankruptcies, debt repudiation, high levels of unemployment, and plunging prices. If policy makers would not engage in manipulation the markets would self adjust on an ongoing basis in a gradual manner and there would be minimal upheaval. Unfortunately, politicians and their crony banker friends are helpless market manipulation addicts who can’t resists intervention. So, imbalances are pushed to an extreme until they reach a breaking point. The correction and restoration back to equilibrium is enormously painful and disruptive.

Why does the system ultimately break down? Why can’t Mr. Bernanke or his successor simply print enough money to avoid a day of reckoning forever? In very simple terms, there are two factors. First, the more excessive the amount of money, the more artificial is economic growth. That is, resources are allocated in a very inefficient manner. So for example, during the 1990s high-tech stock market bubble, we saw billions upon billions of dollars lost in tech stocks because those enterprises were not viable businesses. Had we been on a gold standard and money had been hard to come by, capital resources would not have been misallocated.

Instead we would have had capital allocated to businesses that would have generated profits. But here is the real problem. Even though money is carelessly thrown into mal investments as a result of the excessive creation of money via the banking system, the debts from which this money was manufactured remain to be repaid. And so you get the relationship pictured in the chart above where debt is growing exponentially while income is constrained by the physical laws of nature. In other words, in a fiat currency system like the one we have now, in which debt is the raw material from which money is manufactured, it is possible—for a time—to create the illusion of wealth via the “printing press.” But it is not possible to create sufficient income from bad investments with which to repay the debt.

Since the last Kondratieff cycle began in 1949, the system has been built up with ever increasing levels of debt relative to income, as politicians deficit spend to win votes and bankers create money out of thin air to enrich themselves at the expense of everyone else. It is an immoral system and ultimately a very unstable system, but it is the one we have. Our belief is that it is better to recognize it for what it is and profit from that knowledge accordingly than it is to pretend it doesn’t exist, as CNBC and most of the mainstream would have you believe.

In fact, it has been this ability to see this big picture that has enabled us to construct a Model Portfolio that has beaten the market, hands down. Hence the name for our soon-to-be-launched new Web site, www.WeBeatTheStreet.com.

Tweaking the Big Picture

Because the Kondratieff cycle is generational, we recognize that there are many countertrends within this longer cycle. In fact, the cycle is about four generations long, so that you will never live through more than one complete cycle though if you live a long life, you can living into a short part of a second cycle.

By right, if you adhere strictly to Ian Gordon’s theory that the Kondratieff winter, which by definition we entered with the peak in the equity markets back in 2000, is a deflationary period of time, there is no room to own the kind of inflation hedges we hold in our portfolio such as energy and base metals. However, thanks to this continued defiance of the natural laws of economics by our policy makers, inflation is still very much with us and in fact as measured by the CPI and PPI has been increasing. We have no doubt that Ian is right in that this “winter” period will ultimately contain a K-winter end and the beginning of the next K-cycle. But to be wrong for a number of years, waiting for the ultimate deflationary crash, can be very expensive. We think it is better to profit from inflation while it lasts, but also to be ready for the tipping point toward deflation when that occurs.

I am in agreement with Paul van Eeden, Marc Faber, and some mainstream economists including Nouriel Roubini, who are suggesting the odds favor the U.S. entering into a recession starting late this year or early next year. My “gut” tells me these guys are right, but the problem with my gut is that it is often wrong. Dr. Roubini is even suggesting that the upcoming recession will be especially nasty and deep. Do I hear K-winter? I am ready, willing, and able to believe an economic contraction—even a very severe one—is in the making, given the opinions of these esteemed gentlemen and my own gut sense.

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J Taylor’s Gold & Technology Stocks is published monthly as a copyright publication of Taylor Hard Money Advisors, Inc. (THMA), Box 770871, Woodside, N.Y. Tel.: (718) 457-1426. Website: www.miningstocks.com. THMA provides investment advice solely on a paid subscription basis. Companies are selected for presentation in this publication strictly on the merits of the company. No fee is charged to the company for inclusion. The currency used in this publication is the U.S. dollar unless otherwise noted. The material contained herein is solely for information purposes. Readers are encouraged to conduct their own research and due diligence, and/or obtain professional advice. The information contained herein is based on sources, which the publisher believes to be reliable, but is not guaranteed to be accurate, and does not purport to be a complete statement or summary of the available information. Any opinions expressed are subject to change without notice. The editor, his family and associates and THMA are not responsible for errors or omissions.

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