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August 27, 1998
Copyright Princeton Economic Institute
The collapse of Russia is having a profound impact upon the
entire global financial markets from stocks, commodities and
gold to currencies and bonds. Of all the great financial panics
in history, this one looks like, sounds like and moves like none
other than 1929 all over again. The similarities are not to be
found in chart patterns, percentage movements or one-day
greatest point declines in history. The similarities of what we
are living through have more in common with the fundamentals
behind the Great Depression than at any other point in time.
The truth behind the Great Depression is far from the greed of
speculators that the socialists have characterized. Stocks DID
NOT TRADE ON 10% MARGINS as Galbraith wrote in his book. ONLY
new issues traded at such low margins. The NYSE big board was as
it is today – 50% marginable. The OTC market, which the bank
stocks traded in those days, was NOT marginable at all! The
truth behind the damaging effects of the Great Depression were
left out of the papers of socialists who wrote about that point
in history in order to support their case for big government.
ALL of Europe defaulted on its debt with the exception of
Switzerland. Great Britain suspended payments on its debt for 6
months. Russia defaulted, China and Latin America. In total,
nearly $90 billion in sovereign debt disappeared from the face
of the financial world.
Another similarity is none other than the devastation taking
place in the metals and commodities. While the goldbugs have
been relishing in the demise of the Dow with a "I told you so
attitude" they too have been hit with the XAU making new
historic lows today under that of 1986 as well as gold closing
on a new low for the past 20 years. In fact, commodities peaked
in general during 1920 and began a 12-year bear market right
into 1932 bottoming WITH stocks. No commodity, including silver,
offered any hedge whatsoever against the Great Depression and
the asset deflation that unfolded. The current collapse in the
commodities ALONG with stocks on a side-by-side basis is a
direct parallel with that of the events of the Great Depression.
The one striking difference today from that of the 1930s remains
none other than the economy mix itself. During the Great
Depression, 40% of the civil work force was employed within the
commodity sector. Because commodities collapsed, jobs vanished
causing unemployment to rise to 25% in the United States – hence
the term Great Depression. Today, that same type of devastation
is NOT taking place and is UNLIKELY to take place within the
United States. The bulk of the economy in the US is a domestic
oriented service economy. Services include everything from
retail sales, lawyers, doctors, government, politicians and of
course the financial industry. We have seen such a major
depression taking place in Japan. However we also do NOT see
unemployment in Japan anywhere close to 25% even after a 10-year
decline. Therefore, we do NOT see any risk of a major depression
that is identical to that of 1929.
Nonetheless, there is also no way that the low is in place for
either commodities or the stock markets. Further declines are
now likely with perhaps a 23% correction in the S&P 500 by the
end of September in the US. The Nikkei is likely to drop to at
least the 12,882 and a move below that area will raise the
potential of a sharp decline still to 9,700 for 1999. Gold is at
least a $50 decline in it perhaps even short-term while silver
might yet collapse back to $4. Certainly, a penetration below
$4.50 will then lead to the overall target of $2.75.
The greatest danger that we face is that the US government will
fail to understand the seriousness of what is taking place
globally. If this develops, we must be diligent in pointing out
that the US should NOT attempt to put up trade sanctions in
order to protect American jobs from the global deflationary
atmosphere. That would have the same effect as Smoot-Halley
during the Great Depression.
For now, foreign investors seeking US dollars and US yields
should be quick to move. The likelihood that US interest rates
will decline in the months ahead is now very high. Short-term
rates next year might collapse to the 3-3.5% level. Initially,
long-term rates will decline faster as capital pours into US
government bonds. This will most likely create an inverted yield
curve within the US until the Fed is forced to respond to the
global trends. Thus far, the decline in the US share market
basis the S&P 500 has been only 14%. This is not enough to make
the Fed panic. However, a 23% drop by October could have an
impact upon Fed policy.
Emerging markets are now collapsing everywhere. Even within the
ERM, the fixed exchange rates are under attack, which brings
into question the viability of the ECB (European Central Bank)
come next year. Under the current system, the ECB will be forced
by law to bailout and defend any member currency within the Euro
at all costs much in the same manner as Hong Kong or the IMF
have acted in recent times. Under the current global conditions,
trying to create a single currency right now may prove to be the
worst mistake ever made.
Russia’s impact upon gold and silver are clearly monumental.
While inventories in Switzerland have jumped from 5 to 70 tons
in part thanks to Russian sales, the collapse in Russian debt is
also have a major impact upon the banks that have now recalled
all gold on consignment or which has not been paid. Suddenly,
credit to none major countries such as Turkey and India has been
reduced or eliminated. All gold is being recalled back to the
vaults where selling into the open market is now taking place. A
collapse in metals prices at this time maybe unstoppable going
into next week.
For now, the events that are unfolding are very serious. We are
most likely going to face a second wave of credit problems from
the Eastern European nations that depend upon Russia as their
primary trading partner. The Russian fallout is spreading to
Latin America where the credit markets have another $300 billion
to worry about from the banking sectors. These problems are only
magnified by the inability of Japan to deal with its problems
while its ministers are trying to talk the yen up without fixing
the problems that are causing its weakness. Hong Kong continues
to intervene in both shares as share futures in a futile attempt
to hold its currency. We now must be concerned that Hong Kong
just does blow-up itself by taking huge losses due to its
intervention like the IMF and other Asian nations. A blow-up in
Honk Kong will undoubtedly cause a devaluation in China as well.
And of course there is Canada. After raising its rates in a last
ditch effort to support its currency, the C$ fell to new lows
within a matter of hours. Canada again appears to be ready to
commit suicide rather than cut taxes. In the end, not only is
the world economy going nuts, we have far too many politicians
who seem to be taking us down a road of sheer financial chaos
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