people believe rhinoceros horns have medicinal properties.
We might doubt this, and study might prove we are correct
in our doubts. But as long as people believe the horns
are efficacious, the tools used to process the horns will
be capital goods, and will fetch a market price that depends
on the value assigned to the horns. The moment the last
person stopped believing the horns had beneficial properties
the tools would cease being capital goods and would lose
all their value, unless they had alternate uses
-- Gene Callahan
title today has a few undertones... it is actually a boating
term, which the Captain will use when all systems are down
in order to compute the straightest line possible to the
desired destination. For Mr. Greenspan's sake, that line
hopefully leads to higher stock prices. We won't argue with
the supposition that the shortest distance between two points
is a straight line, though a Quantum Physicist might. But
we will argue the expected destination. We will argue that
in this instance, the straight line leads directly to dollar
obliteration. Having said that, it hasn't been a straight
line so far.
Consumer's Capital with a Stable "Marginal" Utility
Gene Callahan, an economics author for Mises.org,
wrote an essay last week titled, The
Structure of Capital, where he showed that the
value of a capital good is defined by its use, rather than
by any visible physical, or intrinsic, characteristic that
it may have. To be sure, he adds:
use is a function of the mind. Indeed, in Human Action,
Mises says capital "is a product of reasoning, and its
place is in the human mind. It is a mode of looking at
the problems of acting, a method of appraising them from
the point of view of a definite plan."
would like to take the liberty to add something to Mr. Callahan's
brilliant analogy. Clearly, since the market price of the
capital good is dependent on the value (price) that the
horns fetch then if by some bizarre sequence of events (outside
of Mr. Callahan's control), the price of the capital good
appreciates beyond the value of the horns then it ceases
to become a capital good. Obviously, that statement is only
true so long as it is not useful for the production of something
with more value. By this very nature, then, the process
of economic evolution is to a great extent potholed
when prices are generally unstable - hypothetically of course
because that just wouldn't happen today.
the more persistent notion crossed my mind that within Mr.
Callahan's paragraph perhaps lay the framework for the Fed's
psychosomatic strategy to bury the gold standard. The idea
that there are three dependent but hierarchical levels in
which capital may be defined is stimulating thought on its
own. To conclude that something with certain physical properties,
for instance, can be defined as capital by virtue of those
same visible properties one has to consider also, their
usefulness in producing something of more value. There are
two distinct levels right there, but Mises demonstrated
that usefulness is also a state of mind. Thus, there is
a mental dimension to capital as well. To us, this is equally
interesting as it is disturbing. For, to think that there
exists such a plan to manipulate the highest order of that
hierarchy, borders on evil. But to know that such a plan
exists. That must be quite the load for anyone with a conscience.
consider first that gold isn't really a capital good. I
am not talking about the factors of production that go into
producing bullion. They are capital. In the case of the
mining business, for instance, this form of capital has
been effectively displaced, unless it has developed alternate
"uses." We are talking about Gold bullion itself.
doesn't have physical properties, save its conductivity,
which make it useful to produce much of anything really,
except jewelry. To that extent it is looked at as a capital
good, because it is too scarce to be generally employed
as a conductive agent. Yet, given a choice between a bar
of gold and a basket of jewelry containing the same weight
in gold - assuming that the other materials in the jewelry
are additional in weight but have no marginal value
- I don't know that I would choose the jewelry. It would
only make sense to take the jewelry if it appealed to my
particular unique set of individual tastes and preferences,
for if it didn't, then it would have no use to me except
for what I could get for it. Thus, the value added by the
jewelry industry is incidental to my decision. The conclusion:
it is arguable whether it is a capital good at all.
is more reasonable to perceive gold as a consumer good rather
than a capital good. In fact, that is probably why the government
has a problem with it… because it is often inconveniently
preferred to their legal tender. But consumer good is not
entirely accurate either, for good implies it is consumed.
So for the sake of clarity, let's just call it a consumer
were the World Gold Council to choose to promote the jewelry
industry, by chance, it might help to manipulate gold's
efficacy in this manner. It doesn't need to alter the metal's
physical characteristics, nor can it do anything about people's
natural preferences for it. But it can try to alter your
state of mind so that you perceive gold as an input, thus
a capital good, rather than a final product of natural consumer
Gold is not just any (consumer) asset but perhaps the ultimate
consumer asset. For, it is a luxury; meaning that there
is not enough of the stuff that anyone wouldn't want more
of it. Sort of like today's money… it is hard to imagine
that anyone wouldn't want an additional dollar (today's
legislated money) in his or her wallet. Get the irony? Gold
is a luxury largely because it is scarce relative to…
gold, unlike most other metals, perhaps due to this relative
scarcity, is able to hold its marginal utility theoretically
indefinitely. Marginal is a word that Chairman Greenspan
seems to favor these days, by the way, and it is in that
word where you will best be able to explain gold's superiority
over time. Time of course meaning decades, and in our case,
perhaps even longer.
that we've established "some things," allow me to conclude
that the conditions, which are precisely what make gold
an important monetary asset, are twofold:
is a consumer luxury, which happens to have a relatively
determined marginal utility.
believe that a regarded economist, Mr. Fekete, has debated
this idea in greater depth in his essay, Whither
Gold. It can be found at the FAME
website -- Foundation for the Advancement of Monetary Education.
me try to explain what I am getting at, it's important I
think. The first question I would have for me is, "when
are you going to rap this nonsense up Bugos?" Just kidding.
But why do these particular conditions make gold valuable
as a monetary asset? Follow me.
Horns, Gold Is Not A Con
reason that inflation is confusing in the first place is
that when looking at commodities such as oil, which is clearly
a capital good of multiple orders, implicit in its value
are many factors which influence price other than simply
an expansion in the money supply. Thus, even if inflation
(read: explosion) of the money supply was the root cause
of "unstable" oil prices, because of the many ways it (the
oil) is of use to us, so many other things may affect its
price simultaneously. This is what makes the oil price a
tough inflation barometer. However, as the economy slows
down, thus reducing oil's value as a capital good - because
it goes into producing so many things whose values must
decline with the economy - yet, oil prices instead stay
firm, or appreciate, perhaps it is really about time to
reconsider the monetary aspect of the price equation.
on the other hand, does not have such a wide array of productive
uses. So that when it does go up, appreciably, everybody
should rightfully perceive an inflation problem. Furthermore,
so long as gold does not appreciate in dollar terms, our
other entire price, credit, and economic instabilities can
legitimately be blamed on other things, rather than the
nation's abusive monetary authority. If, for instance, gold
prices rose along with energy prices last year, it is doubtful
that we would need to listen to statements such as, "the
Fed has got inflation under control," would we?
Gold did not go up. Hmmm. I guess the Fed has inflation
under control. That must be the conclusion, which is confirmed
by the CPI. Triple, Quadruple, and Quintuple balderdash!!
But we've already beaten that one to death in previous reports,
Gold has economic value simply by virtue of its relative
scarcity, something that simply cannot be said for the dollar.
In fact, it is even scarcer than oil, I think.
it also has another value… the personal satisfaction that
it brings to the consumer of jewelry, a high "marginal rate"
of satisfaction, if you will. How many commodities can you
think of where you would want more and more and more of
them, in any shape or form? Diamonds perhaps, but if all
heck broke loose, you may discover that the market is a
little less liquid, owing to the awesome amount of diamonds
actually in supply. The market is not only rigged, but control
of the market is far too concentrated to function as a reliable
unit of account, and thus, store of value. Silver? Sure,
but not likely over gold. Besides, silver is primarily a
of Platinum and/or Palladium? Sure, but then the Russians
and the South Africans will rule the world. Having said
that, both of these metals are also very much a capital
good. Without their value (use) to us in building catalytic
converters or fuel cells, their consumer appeal would pale
in comparison to gold. I can't speak for everyone, but personally
it does not matter to me how much more "valuable" platinum
is today; I like my gold ring better. Maybe I just haven't
made the mental adjustment necessary to value something
according to its dollar price… bah, bah. Which brings me
to another point - no not the Clintonites - that since the
Fed SUPPOSEDLY has the most gold in the official sector
(world), and with the threat of imminent inflation breakdown
(dollar meltdown) looming, perhaps promoting the gold standard
would be in their interest… I better stop there… sorry to
get off on such a bullish tangent.
it is important to be clear about what we mean by a stable
marginal (unit of satisfaction) utility. The reason is that
despite these arguably superior conditions, and with the
abundance of dollars being created every day by the Fed
- more accurately, the American private sector financial
system - gold markets are so quiet. There can be only three
explanations for that:
is no inflation and all of the above is rhetoric
prices are directly manipulated, and
exists a deliberate misinformation campaign (include
financial alchemy in here) aimed at persuading us that
we do not need rhinoceros horns.
four could be both number two and three. In the case of
our current dialogue, number three means that the campaigner's
aim is to persuade you that gold is an ineffective inflation
barometer, or that it is not the great monetary asset it
once was, or whatever. This despite the fact that, publicly,
most banks officially claim that it still is. Just that
it is not as useful sitting around in a safety deposit box
as it is employed as extremely cheap capital for whomever
can write the cheque, in overused overprinted over-owned
and junk credit backed dollars. Mr. Rubin must have been
quite the salesman.
the point of the exercise is to illustrate that unlike rhinoceros
horns, gold has natural values, which go beyond a simple
"con." Thus, the effort to abandon a gold standard can only
be successful in the end, if the monetary authority is a
human(s) of the highest standards, principles, AND power,
which needs no anchor. For otherwise, sooner or later, an
inappropriate abundance of dollars relative to the scarcity
of gold, will unavoidably result in monetary chaos when
the day comes that the marginal utility of the dollar declines.
note that we have argued that this day has arrived in Declining
Dollar Utility, written late last year, at about the
time that the energy crisis in California was just beginning
to escalate I think… yes they are connected.
In his congressional testimony last week, Greenspan argued
that the real problem is that the surplus is going to
wipe out the debt faster than anyone could ever imagine.
Naturally, the next question was opened with the comment
"nice problem to have…" of course, for the record, he is
referring to the "unified" budget surplus.
it. Now I understand why everyone runs around Washington
using the word surplus as if it were real. They have
invented an adjective to act as a disclaimer. Now they
can lie to us with a straight face. For the word "unified,"
includes social security receipts, which are not really
intended to go towards paying down the debt… otherwise we
would be spending our social security fund today, wouldn't
I certainly did come away (from watching the testimony)
with some insight, however, into Greenspan's expectations,
which will undeniably influence the FOMC's actions this
morning. Greenspan made reference to a forthcoming "V" shaped
recession, typically a term used to explain very bullish
stock charts, as he pondered the most likely economic outcome
for the months ahead. The trouble is that he is using the
term in a forward-looking manner… but I suppose that he
has litigation protection for that.
what could he be talking about if he is not talking about
consumption; for it is unlikely that monetary policy can
do anything to stimulate production? So in this case, he
must have some sort of delusion where he envisions manipulating
consumption, so that it stays somewhat stable while the
factors of production have had time to work off their excess
inventories. In other words, while production first contracts
and overshoots, it is then encouraged to rebound ferociously
in order to meet back up with demand. I use the word ferociously
deliberately to describe the use of his bullish body language.
Greenspan sees the tax cuts as not possibly an immediate
solution to our problems, but rather a hedge for a potential
future where he may be wrong about this half-baked V shaped
recession hypothesis… and we instead fall head first into
a ravine, where consumption needs to be subsidized by fiscal
means if it has half a chance at growing... by then, he
expects that the timing of the impact of the tax cuts would
then, our own hypothesis remains intact: The Fed continues
to fuel consumption, despite the heightened risks of inflation
"breakdown." Remember, breakdown means that inflation
don't work for them like it used to.
1985, there have been five periods in which the Fed reduced
rates several times in a row. In four of those periods,
the Standard & Poor's 500 Index began rallying within
a month of the first rate cut and three months later the
index was up an average 8.6 percent. Fed policy-makers
lowered rates by a half-point on Jan. 3 in a surprise
move, and the S&P surged 6 percent over the next three
weeks. The central bankers meet Tuesday and Wednesday,
and all 25 bond dealers that trade directly with the Fed
expect another half-point cut, to 5.5 percent. Strategists
say the market will benefit from such a move. ``You can
feel with some added confidence that we have indeed seen
the bottom'' for the economy and stock prices, said Brian
Belski, chief fundamental market strategist at U.S. Bancorp
Piper Jaffray in Minneapolis.
Deborah Stern, Bloomberg, Jan 29/30.
can the market benefit from something that has already happened?
The interest rate cut, I mean. Contracts on the Fed Funds
rate have already moved to influence the other interest
rate markets, and the money supply aggregates have literally
exploded. The Bulls already got their second interest rate
cut, and anything of bullish significance that might happen
to "equities," as the result of an official move by the
FOMC today, will be anticlimactic.
Term Yield Index
are generally convinced that people will (still) be willing
to pay more for future earnings if interest rates are lower.
This can be true if the inflation environment is relatively
benign. Under such circumstances, people can have confidence
in future private sector earnings power and the efficacy
of monetary policy. Thus, the only question becomes adjusting
the earnings multiple to a given level of interest rates.
But such a benign macroeconomic backdrop simply does not
even if it did, the assumption is that the interest rate
is the only necessary valuation input. And we all should
know that this is not true, especially our readers. But
since we have already established this in Return
of the Risk Premium just a few months ago, we won't
waste much space on it today. Recall:
Equity Risk Premium represents the additional
return demanded by an investor to own equity over and
above what is considered to be a risk free interest rate.
It is used in valuation models as a discount rate to determine
the current (present) value of a future stream of earnings.
Look again, Goldilocks has
Composite Stock Index
Research Bureau Index
a matter of fact, the circumstances today are much different
than they were in say 1997 / 1998 or in the early nineties…
much different. Bullish analysts (i.e. cheerleader types
- as opposed to just analysts) will even conveniently agree,
when they want to tell you why "this time is actually
in the case of the Bloomberg report, they want to point
out the similarities between the past and the present, revealing
a strong bullish sentiment in the process. I suppose that
there is nothing wrong with being an optimist, but the fact
remains, that today, not only are stock prices still dear
in a contracting economy. Not only have the capital markets
already factored in, and spent, the next 50 basis points.
But the changing macro environment has yet to be fully factored
into the blue chip Equity Risk Premium, period.
Jones Industrial Average
Composite Stock Index
besides the less than certain macroeconomic backdrop, which
can only be accurately reflected in a theoretical "natural"
interest rate anyway, there are other inputs, which (should)
go into computing the ERP, and which can affect earnings
predictability… assumptions prejudiced by consensus perceptions
for productivity, or the trade deficit, or technology spending,
or even government surplus projections. The list of potentially
wrong assumptions is so long that it has become boring.
So the relevant question on this argument is, how confident
are investors that the earnings will be there, relative
to say, how confident they were in the first quarter of
Isn't it the truth? Some sectors of the US equity markets
have improved on their poor technical chart conditions…
meaning that they have demonstrated, or printed, some meaningful
will to move higher. Market breadth (of participation) too
has improved, somewhat. This is quite amazing actually,
if you consider the extent of the damage done to the economy
and the more speculative capital markets. The improvement
is certainly making us sweat a little about our market call,
last week, for a 2000 point Dow drop. However, after looking
at Tuesday's action, we remain steadfast…
reason, as we've already mentioned, is that while the market
has fully discounted the next rate cut, it hasn't yet discounted
our inflation hypothesis. Specifically, how a rate cut will
help to "aggravate" that outcome. But it is more than that.
The longs have bid up the wrong sectors… financials, banks,
semiconductors, telecoms, etc. Essentially, over the past
month, investors have expanded the multiples of stocks,
which will clearly benefit from lower interest rates in
a benign economic climate, but which are most likely
to underperform in an inflation breakdown. Thus, we cannot
reasonably expect any extension of this rally to be sustained;
regardless of how low interest rates may go so long as dollar
the past few days, and especially on Tuesday, the bulls
have added a few short-term plays into the fray. Alcoa's
little run (Tuesday) was obviously a speculative welcome
home coming parade of some kind for the inauguration of
Mr. Paul O'Neill to his new role as Treasury Secretary.
But it left the stock far short of a clear primary trend
reversal… meaning that the primary trend is still down,
or neutral at best. Furthermore, while O'Neill will undoubtedly
be a benefit to Alcoa's shareholder's in his new role sometime
in the future, the stock trades at 20 times earnings today
and besides, Mr. O'Neill has other priorities on his agenda.
Such as persuading congress that they should jump all over
Bush's tax cut plan even while dollar inflation is breaking
out all over the place.
the top nine Dow performers in Tuesday's rally turned out
to be the cyclicals and commodity stocks - generally the
issues, which should outperform in an inflationary environment,
and generally the issues we would be bullish on in such
an environment. But their average (unweighted) price earnings
ratio is 20, and arguably at the END of a long economic
expansion when their optimum earnings power ought to be
fully represented in the data. General Electric sports the
healthiest of these at a whopping 36 times earnings. Furthermore,
five of the nine issues are still unquestionably controlled
by a primary bear market trend, while three have challenged
their primary bear controls at best, leaving only one in
a decided primary up market: Minnesota Mining & Manufacturing.
Would you believe it? Maybe we're onto something after all.
if the bulls have already spent their liquidity as well
as their sentiment, the FOMC is going to have to give them
"more" than 50 basis points if a liquidation of blue chips
is to be averted. Else, we remain undeterred in our call
for a 2000-point drop in the Dow Industrials.
than a half point rate cut? I doubt we want to make a call
like that, and additionally, how the equity and bond markets
would react to such a bold move is not clear.
we know what to do
To be sure, this is a silly game for Wall Street, because
if you ask us, the real play is in oil, and other commodities.
What do you think that oil prices will do on a rate cut
like that? Yee-hah!!
Grade Copper; weekly
c'mon, gee... new economy or OIL? What does your gut tell
you? Do not forget to take into account the fact that Phelps
Dodge recently threatened to shut down some production due
to the prohibitively rising cost of power. However, they
are on hold to see how the situation plays out, for the
moment. Wow, suddenly there could be a play on copper too…
how viciously shrewd. Remember how plentiful it seemed that
that commodity was only a few years ago? My, things may
change fast. What about something a little more luxurious;
like a commodity that will surely be scarce as the need
for technology to advance continues?
we had to be in the equities before the rate cut, it would
be on the short side, although if we had a choice we would
be entirely out until after the rate cut… BUT, we would
hedge our trade with a long position in the CRB, and especially
in gold, "prior" to the rate cut.
prices were perky today on a very weak consumer confidence
report... an odd development in its own right. The dollar
is likely to react negatively regardless of whether they
lower by 50 or 100. We are rapidly nearing the point of
recognition for our inflation hypothesis. And finally, the
charts for both Gold and Silver are looking quite interesting…
note the nine-month declining wedge controlling the gold
price: Thus, if I had to put my money anywhere, it would
be on a bet that gold prices are about to break out of this
Prices / weekly chart / COMEX
Prices / weekly chart / COMEX
But, what about the government's
Are we suggesting that investors should bet against the
government's ability to contain the energy crisis in California?
Yeah. Are we suggesting that investors should bet against
the government's ability to hold the stock market economy
together? Absolutely! Especially since they (the government)
are the cause of both problems. Allow us to try and make
the connection between all of that, and what is happening
in California at the moment.
doing our level best, there are forces in play over which
we don't have control now, the form of deregulation that
California passed five years ago," Governor Gray
brother. Those (regulatory forces) are the only forces you
have control of pal. Forgive us, but it is fun picking on
the politicians, because they are a non-stop source of irony
is no point in blaming deregulation when the source of the
problem is a quadrupling of natural gas prices over 12 months.
What is the source of that imbalance? An overheated economy?
But, I thought we were in recession. Suddenly we got a shortage
of gas, hmmm. Sure there is a real estate boom in California,
which has been building natural gas utilities into about
three quarters of the newly built homes on the west coast.
What has fueled the boom though? Productivity and technology
- not likely.
that is why the money went there, but who supplied the money
and how much of it did they supply? It's easy, really: the
Fed, the US banking / financial system, and the various
GSE's (Government Sponsored Enterprises)… truck loads… that's
how much. In fact, we are witnessing the greatest monetary
inflation history has ever seen!
"is" a relationship between gas prices and oil prices. It
is conceivable that if oil prices did not rise to $35, but
rather stayed at $10, there would be a much smaller impact
on the gas markets. By the way, wasn't the economy stronger
from late 1999 to the first quarter of 2000 than it is today?
Yup. Yet gas prices were 1/3 of what they are now. Yes,
it has a lot to do with oil prices, but what caused oil
prices to rise so sharply in the first place? If you cannot
answer that by now, please reread the prior paragraph.
Mr. Greenspan's cowboy Fed policy ought to obviously accelerate
both problems… energy and economic. I would be surprised,
personally, if he were to make such a bold move this week
(bold meaning greater than a half point). But bold he is
going to have to be.
of Mr. Greenspan:
Street Experts... we just throw you off of the plank and
see if you can swim. If you can, or even if you can't
but can keep your head above water for 30 seconds at a
time, we'll promote the heck out of you so that you will
intimidate every other shark in the neighborhood. We will
do this by giving you credit when you don't deserve it,
and the more you jump up and down for our cause the more
credit you'll get. This virtuous credibility cycle will
then escalate our mutual influence and wealth, but when
the going gets a little tough, we'll blame the whole mess
on you because we gave you the opportunity to look like
a clown in the first place. C'mon, don't miss your opportunity…
Uncle Al needs you! Good Luck.
Edmond J. Bugos
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