The Big Gamble

By: Ed Bugos | Mon, Apr 3, 2000
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Dow Jones 1897-2000

• The Fed.’s gamble on the “New Economy,” and how it unwittingly threw the global monetary system on the poker table.

Total Reserves



Do you remember when everybody thought that the world was flat?Knowledge without money is simply a philosophy, while money without knowledge is lucky enough to have gotten together with the fool in the first place, but knowledge and money is entirely powerful. So let me offer you my philosophy.

Why Gold Will Always Reclaim Its Role as A Currency Reserve and, of course,
A Discourse on the Price Mechanism of the Stock Market
simply cannot be avoided.

Dow Jones 1910-1929 Dow Jones 1980-2000

The stock market, as you know, has obliterated all historical yardsticks ever drawn, and has deviated to the far reaches of extreme by any historically defined statistical distribution of price behaviors. The supporters of this “delusion” point towards the unprecedented nature of technological innovation, and to the fact that the game appears to have a completely new set of rules. However, debatably more exciting, were the techno-implications of the triple effect of a broad application of electricity to industry, the Golden Age of Railroading (1900-1945), and the invention of Henry Ford’s assembly line, on the 1920-29 bull market in the US economy. I’ll bet the rules looked different then too. The only difference is that the Railroad, Utility, and Auto stocks made actual profits for shareholders in the 1920’s, at least before the crash. Nonetheless, it was a glorious period for productivity growth in the US economy. Trading high-risk venture stocks on “The Curb” was the equivalent of trading the stocks of the future on the NASDAQ OTC Bulletin Board today.

1910 to 1929  up 660%  —  1980 to 2000  up  1,319%

In fact, I would be surprised if Internet stocks 10 years from now were any more rewarding than Utility stocks are today. Unfortunately, as sure as technology is here to stay and has always been with us, growing our capacity to enjoy life; the rules of the market have always stayed the same in over 300 years. They go up AND DOWN. The faster and harder they go up…the faster and harder they go down. Maybe we should focus more on history than teaching inevitably obsolete technology to our children. At least their history lesson will remain useful for their whole lives. A comparison to the 1920’s is, however, obsolete. Not because of any sort of “New Economy,” but because we have to look back further to find an historical equivalent to today’s excess. We have gone beyond anything ever seen this century, but you can be sure, the history lessons are there…if you dare to look.

Economic Theory today is based on assumptions first made by Adam Smith, the father of all contemporary economic theory, in his book The Wealth of Nations (1776).

His primary assumption was that an economy consists of rational individuals making rational decisions. From this assumption grew a quasi-scientific understanding of a free market system. Smith acknowledged that such a free market system, under this assumption, somehow was able to function more efficiently en masse when individuals were allowed to pursue their own self-interest, than when they were bound to common interests. He saw it as if an “invisible hand” mysteriously allocated the economy’s resources to their most productive uses this way, through a free market “price mechanism.” He was right, for the most part.

Before and since his teachings however, human financial history is littered with examples of a breakdown of this price mechanism. Speculative manias and hyperinflation showed up in England and France in the 1700’s, the US in the late 1800’s, the entire world in the 1920’s, ‘70’s, and ‘80’s. Even though I am sure that I have missed a few, I’m quite sure that they all ended badly. The Federal Reserve’s emphasis on a “Stable Price Policy,” is largely a recent adjustment to Smith’s economics that accounts for mass psychology, in that it at least acknowledges the distorting affect of unstable goods prices on an economy. Let me explain what I mean.

Inflation becomes a problem when expectations about an imminent shortage of a desired good accelerate, and rapidly rising goods prices force a crowd culture to evolve which hoards these goods out of fear that they will disappear, or at least become prohibitively expensive. No longer do people need these goods for fundamental reasons. The result is further accelerating prices and an equal misallocation of economic resources to the production of this good. Now, go back and substitute “stock” for good(s). So, Although current demand is not representative of the economy’s true needs, it nevertheless stimulates an overproduction of this good and therefore compromises the efficiency of the economy’s invisible hand. The invisible hand is trying to allocate the economy’s scarce resources to meet a self-fulfilled, artificial, and temporary demand. It blows some of its cylinders in the process, and ends up feeling woozy when stuck with the chore of painfully putting all the pieces back together again. The point of the exercise is to deepen your understanding of the role of the Price Mechanism in any free market economy. It is at least at the heart of our entire culture.

Asset markets are also governed by a price mechanism

Now it’s too bad that no one “officially” acknowledges the effects on the economy of unstable prices in asset markets. To some extent, rapidly rising market values for many technology companies is the result of a properly functioning price mechanism. But this breaks down when the only reason to buy them now is because the risk of not owning them outweighs the risk of losing the whole investment. Crowds become maniacal when they threaten to destroy anything that they cannot assimilate, and when participants feel that they cannot afford not to be part of it all. When the sole reason for buying consists of mere expectations that prices may keep on rising, it becomes an inflation problem, and the dangers of economic distortions and imbalances are inevitable because the price mechanism has broken down.

Although it may be argued that a rapidly rising technology sector is beneficial to the economy, we should also not forget to assess the cost of such a program. I think that most of us today live in denial of the fact that the fastest growing sector of the economy today is not technology, it is the stock market. The stock market is not only a part of the economy, but it has historically led the economy. Today, however, it is the economy. Forget about technology for a moment. It is the business of the stock market and all of the businesses it supports that most of the country’s resources have been allocated over the past decade, to the point that stock certificates threaten to take over the US Dollar as a global currency. Think about it. Over the past year alone, public companies have been buying record amounts of each other at record values with inflated stock certificates. They have been using stock to acquire new technologies, more of which are probably lower in quality than usual, and yet demand higher values than usual. They have been paying employees with paper they are allowed to create at virtually their own discretion, and at an increasing pace. Would you like to see the data? Just give me a ring. I wonder just how much of the premium built into the stock market is due to its prevalent value as a commercial currency?

As a matter of fact, the current value of the US stock market has outgrown total money in circulation as measured by M3, the most popular measure of US money supply, years ago. It is now twice the value of M3, and has continued to grow along with credit while the monetary base lays stagnant. This is scary for policy makers at the FED because they do not dictate how much stock is printed, and they don’t interfere with the value of such stock or what it is used for, yet they are unwittingly losing control of the US money supply. Already they have admitted to the obsolete nature of current definitions of the primary money supply data. Perhaps it is time that the FED adopts its policy of stable prices to include asset markets, especially if they outgrow the economy, and for all intents and purposes, are used as currency. Else they risk an overproduction of currency that is not under their mandate, and consequently, risk compromising the credibility of our paper based monetary system with which rests confidence that officials at the Federal Reserve Board actually aren’t human. For if they were, their judgement would not be perfect, and confidence would not be so invincible. Alan Greenspan has not created a stable price environment. Prices are volatile almost everywhere you look. From asset prices to commodity prices, extremes we have rarely seen before, and directly a result of bad management of the nation’s real money supply…I know, they didn’t mean it. While the asset inflation persists, the consequences remain invisible. Problems like this become discernible only when the bubble bursts.

M3 Money Stock


While total bank reserves are only slightly higher than they were in 1980, and real currency (cash + demand deposits) has stalled out six years ago, stock market wealth has ballooned from under $2 Trillion in 1980, to near $15 Trillion plus today. In the same period, M3 has grown from under $2 Trillion to near $7 Trillion today. Likewise, consumer credit has quadrupled over the past twenty years. This level of excess has never been tested before!

The inability to expand the mandate of the now prestigious FOMC policy of stable prices to include all the sectors of an economy has allowed an incredible distortion in many sectors, and will someday be seen as a failure. Unfortunately, the recipient of the negativity is likely Mr. Greenspan who has actually tried to make a parallel argument to his overseers in his acknowledgement of the wealth effect. The fault truly lies with those who set his mandate, whose mandate is in turn set by those who represent our democratic wishes. The fault is indeed ours and the immediate source of the excess is ours. The trouble with greed and fear is that they can consume us. Who said that human nature was simple? Speaking of human nature. I would like to hammer a point home about the importance of Mass Psychology.

In the Shepherd, We Trust

I wonder who was the very last person to buy the very last gold bar twenty years ago at $US800 an ounce, and if he has sold it yet? For I would like to buy it.

I wonder what on earth has changed in only five years that has convinced stock market investors that we cannot fall from these insane heights, precipitously? In 1997 the Dow fell almost 15% in two weeks. In 1998 the Dow fell 20% in August. With severe one day declines in both cases. Now, with even more excess than ever, and 20% to 50% higher, most prognosticators expect some kind of smooth rolling correction, or at worst, a short bear market. Let’s get real about some things here.

I do not know exactly how or why these mass psychological delusions occur, but I do know that they do, and that there is a distinct difference between an individual’s ability to reason on his own, and his ability to reason in a crowd. Most of us act differently in a crowd. In fact, a crowd becomes its own entity, often independent of the participant’s own rational preferences, with moods and logic of its own. Ever wondered why it is that when a looting incident breaks out, most people in the vicinity participate, yet privately, each one of us watches the news of the event shaking our heads in disgust? Why do you think we form clusters of populations throughout the country rather than spread out evenly? Like wolves, sheep, and dogs need to travel in herds and packs, humans get something from banding together for some cause. They need leadership. Just look around. Some analysts go so far as to suggest that people really do not know what they want until they see that others want it. Regardless, the herd tendency is precisely the reason that the system of democratic government has evolved into one of representative government rather than one of demagogue populism, as in ancient Greece. That much I know.

Some in clandestine companies combine; Erect new stocks to trade beyond the line, With air and empty names beguile the town, And raise new credits first, then cry 'em down; Divide the empty nothing into shares, And set the crowd together by the ears.  - Defoe (1660-1731)

I wonder if Mr. Greenspan has considered that today's new economy heroes, his greatest fans, can potentially become his greatest foes some day? They might even convince everyone that the Fed.’s good intentions were at the center of creating an asset bubble that it refused to recognize except in hindsight. At least Greenspan recognizes this danger. In a recent statement, at a hearing before the Senate Banking Committee on monetary policy this week, a senator who vied for the 1 millionth person to tell him he was the greatest thing since the wheel was invented, praised him. Greenspan responded by stating the obvious. "Gentlemen, from the top of the mountain, all roads lead down."

The bullish case for the stock market...

Is that technology is the fastest growing sector of the economy. That its contribution to productivity is driving this expansion, which in turn accelerates the rate of technological innovation, and therefore productivity and earnings. It seems that technology has become a permanent force for containing inflation. In fact, so much so, that certain chief economists on tout TV have questioned the need for a Central Bank at all. All it wants to do anyway is apply ancient economic theory to the new economy. In any case, Mr. Greenspan has finally acknowledged the forces of technology, so it is likely that he will persuade the FED to stop raising interest rates soon. And that is exactly what the decline in long term yields last month suggests. Bond traders are anticipating a peak in interest rates. However, even if interest rates do rise, they can’t compete with the fast growth in the technology sector, which is immune to recession anyway because business and government will have to continue to shell out funds for the best new technology, just to compete. In fact, new money keeps pouring into their treasuries through the stock market anyway. As a matter of fact, technology has, through better communications, decreased the chance that a recession results from a buildup of unwanted inventories. Finally, the wealth effect is just pulp fiction.

That is an awfully convincing argument for owning stocks! However, I cannot even begin to tell you how many things are wrong with that whole argument. If you’re up to the challenge, follow me.

Individuals have always been more comfortable making risky decisions in a crowd than on their own. Every human has a predisposition to this “herd instinct,” which I believe is inversely related to his own self-confidence, objectivity, or perceptive abilities. Nonetheless, herds, or crowds, need a constant flow of new members to feed their strength, survive, and affirm their collective beliefs (the crowd’s ego, as distinct from the participant’s egos). This need for constant reassurance is consistent with the reason a crowd exists in the first place; the human way to eliminate uncertainty in an uncertain world.

The stock market is an important part of the economy. Without it, a free market system cannot flow. It is supposed to direct capital to its most efficient use, which is to acquire no more noble an end than more capital. It is why it is important to contain the integrity of such an economic tool. The Federal Reserve Board uses it as a leading indicator for the rest of the economy. Something in the neighborhood of 55% of households (consumers) are riding this bull. The majority of the ‘new’ budget surplus is due to capital gains tax receipts alone. A growing proportion of public companies is using it to remunerate employees with stock, or stock option plans. Let’s face it, it’s a big part of the economy. It has grown at least tenfold in value over the past twenty years, and easily represents one of the largest cumulative assets of the entire nation. On the other hand, the rest of the economy, the cumulative value of a nation’s annual production of goods and services, has only grown four-fold over the same time period, and that is without adjusting for inflation.

The point is that the stock market is the fastest growing sector of the economy, not the technology sector. Don’t kid yourself. The new economy promoters are just those, promoters. The game of funding technology ventures is many times larger than the cumulative incremental profit that the technology sector adds. Willing venture capital is what is responsible for the technological revolution in the US, not the other way around. Why don’t you think the rest of the world, which has access to the same technology, has seen the same benefits? Because the money has so far been flowing into the US “economy,” FROM everywhere else. Money makes the world go around, at an increasingly dizzying speed. That is the point. That growth in the technology sector is not immune to what happens in financial markets.

NASDAQ Chart GDP Chart

NASDAQ stock market composite vs. US GDP since 1984. Which do you think is the fastest growing sector of the economy?

Twenty-fold rise up less than 200%

You have already heard my arguments about inflation and the delusion about productivity, not the least of which comes from the difficulty in empirically measuring the intangible gem. Through history, we have gone through bursts of productivity surges that ended even though each one looked better than the last. The reasons for that are probably way too complex for anyone to understand, but what does happen each time is that the resultant prosperity and excess create a surge in demand for capital and resources that races beyond an economy’s ability to produce them, and that includes stock certificates. This strain on resources, be it capital, human, goods, or services, creates imbalances that need to be corrected for growth to resume. Today’s delusions meddle with the financial market’s invisible hand in exactly the same way in which general inflation expectations cause a free market system’s price mechanisms to misfire, and thus risk straining an economy’s available resources. In fact, this is exactly what our FED Chairman Alan Greenspan is trying to communicate in his speeches at the same time that we have concluded that he is on our side now that he has acknowledged the “New Economy.”

Apply the KISS principle and the truth becomes clear

The reality is that the best growth stocks on the board are priced for maximum growth without error for the next five to ten years. In fact, the bulls are looking so far beyond the valley that they don’t see the precipice right in front of them. Regardless of the fundamentals across the valley, they are all piling onto the same fragile cliff. Technically, the bear market started last summer. By the end of 1999, more than 50% of listed US stocks were down on the year. Almost 80% were either down or flat on the year. Meanwhile, the averages, which are supposed to represent “the market,” posted double-digit returns. This is no bull market, it’s a statistical illusion! What it describes, is a market where money is being raised by selling off the broader market to pile into the large cap high flyers. What that suggests is that the source of buying power increasingly comes at the expense of the rest of the market rather than new fund inflows into the market.

This divergence has grown for seven years now, but began to deteriorate sharply in the spring of 1998. Before then, every rise (A – C) in the composite at least showed a noticeable improvement in the market’s ability to broaden out. Since then, however, look closely to notice the consecutively diminishing capacity of the market to broaden out at all. In fact, since October (E), the NASDAQ has almost doubled on narrower and narrower leadership. What this means is that it takes bigger and bigger moves to stimulate trading in the larger majority of the composite, and that capital is likely leaving the peripherals to inflate the center of this thing.

The dramatic rise in margin debt underscores the rising gap between the desire to own these flyers now and the scarcity of fresh fund inflows. Remember that a crowd has gone mad when it begins to destroy anything it cannot assimilate, like the “old economy?” Yeah, right. This has been going on clearly for the past year now, but it has become more obvious in that it has shown up in two of the market averages. The Dow and the S&P 500. For most of the past year, the bulls have been hoping that the market broadens out.

That the rest of the market will catch up to the leaders. Now that it is clear this won’t happen, they have come up with lots of reasons why the ridiculous divergence will continue. They tell us not to worry, not to look down, just keep looking over the valley because the sky is clear and you can see a long, long, way out. In the face of rising interest rates, I think that it is time to step back from the precipice people.

Take a look at the chart on the front page. Can you find the 1987 stock market crash? I bet a lot of people were looking well over the valley then too…ouch! Yet, on this chart, it looks like such a little correction.

So What About Gold

Does it have a future? If the stock market crashes the economy, how can Gold prices rise? Who’s going to buy jewelry in a recession? Where will there be any inflation? I can answer these questions, but I implore you to keep an open mind.

Historically, that is beyond the past 30 years, Gold has seen three primary sources of interest. The one that has never been questioned is in jewelry. People like to wear gold, it’s looks good. It is the other two that need to be discussed and where you need to keep an open mind…

As a store of wealth, and in its historic role as a guarantee against a nation’s currency

A store of wealth implies protection against general price inflation. However, since stock market returns have far outpaced inflation over much of the past twenty years, that seems to have been the right place to be anyway. In fact, a look at the 20-year disinflationary trend since the early eighties explains much of the decline in demand for gold by investors for the preservation of their capital against the evils of inflation. However, we buy and sell things, usually, based upon the outlook going forward, not by looking in the rear view mirror. Inflation is a phenomenon that re occurs from time to time. This is not the first 15-year period that it hasn’t existed. It is not the first time that governments believed that they have licked it and killed it permanently. It’s just the most recent example of bullshit. It’s funny that so many people believe that Mr. Greenspan has conquered inflation, while he himself still worries about it! Personally, I don’t know when general price inflation will show up in the economy again, but it will. When it does, stocks will perform badly and gold will perform well. It’s that simple.

Now here is the real twist. Our monetary system has been free of the gold standard ever since Nixon abandoned it. Since that time, the US Dollar has grown to dominate global commerce. Again, this is not the first time that a currency has become globally dominant. However, it will be the first time that a currency has achieved such status without the backing of gold and without ever crashing. It is not the first time that sophisticated economist types thought that they could manage a monetary system using human judgement rather than binding it to some fixed supply of gold that didn’t allow for enough growth. It is also not the first time that people were confident in such paper monetary ideas. History is littered with examples of blind faith in governments.

A client and mentor of mine, James Cook (proprietor of Investment Rarities International) has written a book on “Faith and Credit,” that I cannot wait to buy. The problem with a monetary system like today’s is not that it can’t work. The problem is that its management relies on human judgement. Fallible judgement that doesn’t recognize a stock bubble without the aid of hindsight, judgement that cannot compute the mathematical contribution that technology actually makes to productivity, judgement that cannot even count the bloody money supply! In short, it is difficult for humans to be objective at all times!

This has been the value of gold historically, and why it will retain its magnetic monetary characteristics for the foreseeable future. It is not human, and not subject to delusion. This is the lesson that history has taught many a monetary guru. True, it isn’t a perfect system, but believe me, neither is the one we’ve got. At the moment, the US is the world’s police force and Central Bank. Not by choice, but by popular demand. Americans have taken over the leadership role because of their amazing economic illusion. A performance that has a few real fundamentals, but many poor ones.

1.  The country's total Public and Private Debt has not shrunk, it has grown dramatically over the past ten years alone. Forget about the outright lies you hear about budget surpluses. It’s called creative accounting. Besides, most of the improvement comes from capital gains receipts.

Total Consumer Credit

2.  The National Savings Rate has declined from about 5% four years ago to almost zero today. Which is fine because you don’t need to put new money into a market that just gets narrower and moves higher because it only needs to cannibalize the rest of the market. Did you know that this figure spent most of its time in the 6-12% range from 1959 until about six years ago? Not good!

Personal Savings Rate

3.  Two thirds of recent economic growth has come from consumers spending their new wealth. In fact, many are borrowing future double-digit stock returns by leaving their money in stocks and simply raising their borrowing demands. For proof of this behavior, just refer to the statistical relationship between consumer confidence and the direction of the stock averages that month. What this means is that the economy has become increasingly dependent on stock market wealth.

S&P 500 Chart Trade-Weighted Exchange Index

4.  The meteoric rise in the US Dollar over the past four years has come at the expense of weaker markets and economies oversea, and has been based on capital flows likely destined for the stock market. Note the statistical correlation between the currency and the stock averages, except for the last year and a half. This only reconciles my hypothesis that the stock market is rising at the expense of its own peripheries, rather than fresh capital fund inflows.

5.  The nation’s money supply has grown faster than ever, because it increasingly ignores the rapidly rising use of credit and stock certificates, as currency.

Balance of Payments

6.  The global recovery has come from an easily reversible cycle where record money inflows into US markets have inflated stock prices, stimulated consumption, and propped up the Dollar, making it cheaper for US consumers to pick up the slack in overseas goods. This has created an unbelievable Balance Of Payments Deficit that will wreak havoc on the Dollar when the US ceases to look like the world’s “Island of Prosperity,” and takes on the appearance of the world’s Achilles’ heel.

7.  Excess is excess. The invisible hand is drunk and over allocating the nation’s scarce resources to the perpetual inflation of stock prices. We are in the midst of a popular delusion unlike anything that you have ever witnessed this century. Don’t lose perspective.

Every time that a paper based monetary system has been used to inflate an economy out of its poor credit position, it turned into a catastrophe. Both, the now infamous South Sea Bubble in England and the Mississippi Bubble in France at the turn of the 17th century are notorious examples. Remember that our system is only thirty years old and has moved to similar stock market extremes!

There Once Was a High Roller Named John Law…

As sure as every once in a while, a genius like Edison, Einstein, or Newton comes along, a central banker as good as John Law will also arrive, laying the golden goose that is eventually destroyed by his admirers and by the opposite of fear…greed and hope. In the early 18th century, John Law was considered by most to know the subject of money better than anyone else in Europe. When he finally convinced France that no nation could prosper without paper money, the “Mississippi Bubble” was born. Charles MacKay said, “For a time, while confidence lasted, an impetus was given to trade, which could not fail to be beneficial. In Paris, especially, the good results were felt. Strangers flocked into the capital from every part, bent, not only upon making money, but also on spending it. New houses were built in every direction; an illusory prosperity shone over the land, and so dazzled the eyes of the whole nation that none could see the dark cloud on the horizon, announcing the storm that was too rapidly approaching. The warnings of the Parliament, that too great a creation of paper money would, sooner or later, bring the country to bankruptcy, were disregarded.

The extraordinary avidity of the people kept up the delusion, but the more acute stockjobbers (brokers) imagined justly that prices could not continue to rise forever. Vermalet, a jobber, who sniffed the coming storm, procured gold and silver coin to the amount of nearly a million of livres, and drove his precious load in safety into Belgium.” Near the late stages of the bubble, John Law contrived a number of edicts to depreciate the importance of gold coinage in order to maintain confidence in the paper. The quiet accumulation of the precious metals made them so scarce that Law had decided to prohibit, by law, to buy them beyond a limit. Whoever was discovered to have broken this law was arrested and persecuted. This remedy pushed Law’s system over the edge as a growing distrust for his paper money grew out of such an act. Shares of his empire fell precipitously, until he made a last effort to restore confidence. Fully 6,000 men were conscripted by Law’s Mississippi company for the purpose of mining new gold in New Orleans, USA. Only 1/3rd of them arrived, and half of them just sold their tools and walked. Every attempt to diminish the value of gold coin failed, and its value soared. Within months angry mobs would publicly assail John Law and his family. A committee was established, excluding Law, for a remedy to this evil. The first thing they did was to abolish the laws against restricted ownership of gold and silver coinage. Then they forced everyone who had not paid for their stock, to settle for the worthless paper. People began to seek refuge abroad, but anyone who was caught trying to escape faced a death sentence. Afraid for his life, John Law fled the country. From rags to riches, to rags. That is the lesson of humanity.

The reality is that confidence is fickle, while gold is tangible. Even after the stock market crash of 1929, FDR forced a devaluation of the Dollar by raising the ‘fixed’ price of gold. Gold does have a real value – 8,000 years of public confidence – minus the last twenty years or so.

10 Year Gold Chart

So, again, Alan Greenspan is the world’s hero. He is the world’s central bank by popular vote. A decade ago, George Soros and a few other enlightened financial geniuses proposed that the world should have an official global central bank, which would represent a real lender of last resort. Anyone who has paid their dues in the market has recognized that markets are all about debates. The short term direction of stock markets underscore the evolving characteristics of such debates. Sometimes old debates resurface, and sometimes new ones arrive. At the moment, most investors are busy congratulating Mr. Greenspan rather than questioning him, and the only ones questioning him are those annoyed at his illusory tighter monetary policies over the past 12 months.

If I am right, and I don’t see where my analysis can be completely wrong, a stock market debacle should undermine not only US economic performance in the medium term, but could threaten to collapse the Dollar. This is especially plausible if you consider that daily “investment flows” in and out of the United States economy are many times the size of real trade! Under such circumstances, it is easy to see how a debate about the need for a global central bank will resurface, and it is easy to see how Alan Greenspan will receive the brunt of the blame for mismanaging the nation’s money supply. So what though. What does that mean for Gold? Two things:

Firstly, a debate about whether any human, whether by committee or not, can be infallible enough to manage a paper money system will bring into question a number of options not thought about today. Of course, the discussion about a gold standard will resurface if only because it has such firm historic roots.

Secondly, a political battle for control over a global currency and therefore this global central bank is likely to arise, and debates about the kind of collateral that should be deposited with this bank will likely move towards gold.

The reason for this is quite clear. The largest owners of gold are the US and European central banks, which will likely want the most say in global finance. In this regard, it is interesting to note that the FED has never sold or loaned out any of its gold, and it is interesting to note that Greenspan was at the signing of the European bank deal on gold loans in September of 1999. Based on comments in the past, it seems to me that Mr. Greenspan is aware of the value of gold, though that may change. Nevertheless, if only because of their large positions in the metal, it is likely that they will move this discussion of collateral towards gold, themselves.

If the Europeans and the Americans get their way, how do you think Great Britain, the Canadians, and the Australians will have to react when they realize that they have sold all their gold in celebration of the success of the Great American monetary experiment. Yes, they will be angry, but so what. The Americans won’t care. The Europeans won’t care. Under this scenario it isn’t difficult to imagine a stampede of buying by many countries, but most importantly, the Asian economic block which is in the unfortunate situation of having the most underweight level of gold reserves and the most overweight level of US Dollar reserves in the world. Should such a scenario evolve, the price mechanism for gold will kick into gear to signal the economy to produce more gold reserves to accommodate the size of global finance today.

Did you know that China is set to open its first ever Gold exchange any day now? Don’t worry, it’s probably just a coincidence. However, think about this. What do you think would happen to gold prices if speculators like George Soros and Warren Buffet started chasing the market higher?

How and When

Still, it is not entirely clear exactly how a scenario like this would play out and over how long. It is reasonable to expect that the gold market’s first reaction to a global stock market smash would be down, because the first thing that investors might think about is recession, though that would be the exact debate that would persuade foreigners to repatriate at least their excess investment capital. There is also the chance that American investors pull in their overseas capital first, giving currency players a false sense of security about the Dollar’s resilience, however, this train seems to have already left the station (since January). Furthermore, gold bulls may or may not react with confidence right off the bat.

On the other hand, there is the talk in gold market circles, which runs parallel to my arguments in tone, but exact in action. In other words, over the past few months, noticeable gold buying shows up on the bigger down days in the US stock markets. This is interesting for two reasons: First, because it demonstrates a potential rekindling of the gold market of old, where prices do respond to any kind of crisis on the horizon. Second, because this might hold implications for how fast gold prices come out of the gate after a stock market meltdown. Maybe my arguments are ready to be accepted already, and the market will immediately rally.

Then, of course, how can we forget that the US treasury will need to support the Dollar, which might force a call on the FED to sell US gold for fuel to support Dollars. Notwithstanding the heated exchange, the market would likely bid up gold prices for the same reason that oil prices only rose faster when the Americans threatened to sell off their already tight inventory of oil from their strategic petroleum reserve to hammer oil prices. That immediately gives the market what it wants. It puts the government in an even weaker position because what do they do when they finish selling and prices don’t go down?

Why is it that some are able to keep their perspective, while those all around them are losing theirs? Please reply to me with your opinion as to why you think this is so clear to so few. Maybe I’m missing something.

True Colors

Just as man becomes familiar with the animal, learns from it, and profits from its seemingly predictable gyrations, he becomes one, a disciple. This is the tale of greed and corruption in the fiercest bull market that the world has ever known. The tale of a clever beast, who persuaded man to follow him into the Promised Land. Men who followed became disciples who saw the benefit in taming this wild animal. Men who would eventually agree by covenant to keep feeding his increasingly ravenous appetite. One day he would run so far, fast, and wide that only the greediest would follow, though never quite reaching the promised land, but nevertheless certain of its location at the other end of the rainbow. I can almost visualize a parabolic increase in the rate of speed, but suddenly, food is getting scarcer and the disciples start feeding the weaker among them to their creator. Until, as in a perfectly routine cliche, a disciple notices his invincible mentor stumble, not fall, but stumble just long enough for his greed to overcome him and he leapt forward onto his back, crushed him and led the remaining few to a land he has no idea even exists. This is the story of a stock market that needed so much money to keep rising that it did so at the expense of its own peripherals. Rising from the center upward, until it was exposed in true form, all out there by itself, without any disciples’ left to eat. It was the year of the beast, and the end of his species.” -- Ed Bugos.


Ed Bugos

Author: Ed Bugos

Edmond J. Bugos

Ed Bugos is a former stockbroker, founder of, one of the original contributing editors to and former editor of the Gold & Options Trader. He continues to publish commentary on market and economic trends; and provides gold, economic and mining research to private clients worldwide.

The editor is not a registered advisory and does not give investment advice. Our comments are an expression of opinion only and should not be construed in any manner whatsoever as recommendations to buy or sell a stock, option, future, bond, commodity or any other financial instrument at any time. While we believe our statements to be true, they always depend on the reliability of our own credible sources. We recommend that you consult with a qualified investment advisor, one licensed by appropriate regulatory agencies in your legal jurisdiction, before making any investment decisions, and barring that, we encourage you confirm the facts on your own before making important investment commitments.

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