Adrian Van Eck's Hotline on Money and the Economy (1 800 219...

Adrian Van Eck's Hotline on Money and the Economy (1 800 219 1333).
For: Thursday, May 6, 2004

I WANT YOU TO PROMISE ME THAT YOU WILL KEEP A COPY OF THIS HOTLINE IN A SAFE PLACE. I THINK YOU WILL WANT TO REFER TO IT IN THE WEEKS AHEAD. I ALSO RELEASE YOU FROM ANY CONCERNS ABOUT OUR NORMAL COPYRIGHT PROTECTION CLAUSE. YOU ARE FREE TO FORWARD THIS HOTLINE TO AS MANY PEOPLE YOU KNOW WHOM YOU BELIEVE WOULD GRASP ITS IMPORTANCE AND COULD BENEFIT FROM IT.

THIS WILL BE AT BEST AN EARLY-WARNING MESSAGE. IN A COUPLE OF WEEKS I WILL SEND MY MONEY-FORECAST LETTER SUBSCRIBERS A MUCH DEEPER FORECAST THAT YOU SHOULD ALSO TREASURE! I BELIEVE YOU WILL NEED BOTH AS ANTIDOTES TO THE HUNDREDS OF ARTICLES, COLUMNS, LETTERS AND REPORTS THAT YOU WILL SEE FROM WALL STREET BROKERAGE FIRMS, INVESTMENT BANKS, GOVERNMENT BUREAUS, THE FEDERAL RESERVE AND THE KIND OF BANKS OFTEN REFERRED TO AS “TOO BIG TO FAIL”.

They have already begun to spin this story into a clever pattern of deception, hoping to avert your eyes from the simple facts I will now call to your attention. I can say the above with confidence because I have lived through a nearly identical situation before, back in September and October of 1979. That was the time when I was the first writer in America to predict that new Fed Chairman Paul Volcker was to abandon the failed concept of trying to control inflation - then raging at a near 20% rate - by raising interest rates. Borrowers did not care what the rates were I said, because some of them assumed their firms might not survive to pay the loans off, and others were sure they would earn a profit bigger than the interest charge.

Years later, Volcker’s secretary would ask me how I knew he was going to make such a switch. “I didn’t know,” she said. “And neither did his wife. No one else was closer to him that we were. So how could you, way up there in Boston, know that he was going to shock the World of Finance and turn it on its head?” My answer was so simple it surprised her, but she instantly nodded in agreement and understanding. “I knew what he was reading,” I said. “It was an enormously profound essay on money by one of the great minds of our Age. It so happened that I had just read it myself. I knew the moment I read it that this penetrating, scholarly piece was going to change the world, if only one other person - Paul Volcker - would wrap his awesome mind around it. And then someone I knew at the Fed casually mentioned to me that Volcker was alone in his office, deep into this essay that no one else at the Fed was taking seriously.”

I realized at once what was coming. And I hastened to inform my subscribers - who were far fewer in number than is the case today. Some of them thought I had gone off the deep end. Everyone knew then, just as everyone knows today, that the only way to control the economy was by manipulating interest rates. They call that tightening money. How silly. If you want to really tighten money you must close the spigot that is pouring money supply forth rapidly.

But the Fed had been trying rate hikes for years. And Volcker had just come back from a meeting in Switzerland of an organization that few in America had ever heard of. It is sort of a Central Bank for the various National Central Banks. These are the Big Boys of Money… towering over even the biggest of private bankers. At that little-noticed meeting, Volcker had gotten an earful from angry foreign Central Bankers who wanted to know when America was going to get its act together and DO SOMETHING about our massive and growing inflation problem.

Then early in October, one month after my Money-Forecast Letter warning that the world was about to turn upside down, Paul Volcker called the first emergency Saturday meeting of the Fed’s Open Market Committee since the Great Depression. He assembled in Washington the other members of the Federal Reserve Board plus all the Presidents of the far-flung independent Federal Reserve Banks. Before the meeting ended, he convinced them to abandon interest rates and to switch to controlling Money Supply Growth.

Of course I knew what would happen next. Having recommended the purchase of Gold at $140 a few years earlier, I put out a quick sell advice at $420, cashing in a “Triple.” Wall Street did not believe me - or Volcker. In their denial, they bulled the price of Gold up another 100% to $840 in the next 90 days. Then Gold collapsed to well below our sell price. Finally the markets saw evidence that controlling money was biting deeply into inflation. Our readers told their friends how right we were and our major growth began.

WELL, NOW FAST-FORWARD TO 2004. THE PROBLEM HAS NOT BEEN INFLATION THESE PAST THREE YEARS. IN FACT, NO ONE EVEN BELIEVES INFLATION IS POSSIBLE THESE DAYS. FED CHAIRMAN ALAN GREENSPAN HAS PERSUADED ALL WHO WILL LISTEN TO HIM THAT HE HAS SPRINKLED A MAGIC POTION OVER THE ECONOMY AND HAS GENERATED PRODUCTIVITY INCREASES GREATER THAN HAVE EVER BEEN SEEN BEFORE IN THE WORLD. COMBINE THAT WITH A POPULAR BELIEF THAT COMMUNIST CHINA IS GOING TO GROW SO BIG AND SO FAST THAT IT WILL FLOOD THE WHOLE WORLD WITH CHEAP PRODUCTS, CAUSING INFLATION TO BE RELEGATED TO THE MUSEUM OF ECONOMICS. IT IS AN UPDATING OF THE SOVIET PREMIER - WHO ONCE TOLD US THAT HIS PLANNED ECONOMY WOULD BURY US! YOU KNOW HOW THAT TURNED OUT.

For well over a year now I have watched as Wall Street has created the myth of a communist China converting to capitalism. There were large fees to be gained as rewards for pushing this make-believe story. The REAL Red China was sucking into its vortex every bit of American money and technology it could muster, whether by lying, cheating or where necessary by stealing. It had chosen 35 giant state-owned corporations as its vehicles for a planned takeover of all the world’s industrial production.

Some foreign corporations were invited in to partner with these companies, the better to gain from the foreigners precious know-how in management and marketing. It was seen by them as prudent to follow the same path trod earlier by Japan and then South Korea. First they would perform the most menial assembly tasks, gradually demanding and getting more and more complex duties and the high-tech know-how and equipment that went with them. When they were ready they would brush aside the U.S. brands and promote world wide their own brand names. You are already seeing the start of that with the one million Chinese-brand computers being sold through their favorite Chinese “factory-outlet”, WAL-MART.

In order to push its program, China had cut the value of its money in half against the U.S. dollar and then locked it in tightly to the dollar. They did this ten years ago. A few years after they carried out this plan, much of Asia collapsed financially. They had tried to compete with Chinese prices and had lost so much money doing so that they went broke. Indonesia in particular saw 30 years of patient construction of a middle-class wiped out in a few years, and once affluent people fell into the ranks of the poor. The Philippines also suffered mightily. Japan fell into a recession from which it has yet to fully emerge. South Korea also fell victim. For some reason, America praised China because they alone did not then cut the value of their money. It was not recognized that they had done so before everyone else and had triggered all the other nations’ problems and that their plague brought on the Russian and Latin America defaults.

American big business, in its greed and ignorance of the fundamental principles of capitalism, fell in love with China’s planned economy and assumed that its workers would put up with slave labor wages and working conditions for two more generations. So dozens and then hundreds of American manufacturing plants moved there. The American Purchasing Managers Association changed its name to the Institute of Supply Management. They began putting out glowing reports on American productivity, production, new orders and employment. Their numbers have grown further and further away not only from the harsh realties of life in America (nine million unemployed, worst since the Great Depression of the Thirties) but even from the Federal Government’s own numbers - which all too often (as in the case of the alleged GDP growth, the CPI and recently the number of new jobs created) have begun to resemble only the vivid imagination of bureaucrats being pressured to come up with the “correct” numbers.

Through it all I have watched the way China was absorbing $120 billion in trade surplus and another $50 billion in direct corporate and Wall Street investment per year. For an economy that totals only one and a quarter trillion dollars a year (about one-tenth the size of ours) that was a way-out-of-line sum of money. That money largely went into China’s four big government-owned banks and then was distributed via a constant series of make-believe “loans” (really subsidies) to Chinese corporations, especially the state’s BIG 35. The result was that the banks were increasingly holding worthless loans equal to two-thirds of their deposits, a number no civilized nation can tolerate. Once, twice, three times China announced “reforms” that consisted of gigantic government cash infusions into their banks, to help them get solvent. But bad loans have been building faster than the bailouts. They were getting cash transfusions while bleeding out 1000 holes.

Then came the climax. China has few raw materials. To build new factories for Americans and themselves, they purchased iron ore, copper, aluminum cake and a host of other commodities - plus advanced machinery and more recently food to feed the millions of farmers who had flocked to cities and had given up growing foods. The volume of imports grew so high that Japan, Asia, Europe and Latin America were living off China, taking from China the money flowing in from America. I knew it could not last and in a recent Forecast I said so. I predicted that one day soon the bankers would call their biggest borrowers into their office and say: “The party cannot afford these huge subsidies we call loans. You will have to raise your prices to cover at least most of your costs.” That is exactly what happened a week ago. Wall Street is desperate to hide the fact that its investments are at risk and that it peddled worthless junk to pension funds and mutual funds. They are using a pile of lies and are claiming all is well in China.

I say they are lying. And the proof I have waited for appeared in Barron’s this past weekend. China has been buying U.S. Treasuries to fund a portion of our debt. That alone kept the Treasury from blowing the whistle on them and their big American CEO friends, who have shipped three million jobs to China and falsely called it productivity increases. (The ISM does not ask members where new orders are being produced.) But guess what: American banks have stripped their loan portfolio dry, cutting back every category except purchase of Government securities, which rose a shocking $15.7 billion. Over at the Fed, foreign holdings of U.S. Treasuries (which had been rising by $6 billion a week for a year actually fell by $1.86 billion). And Fed credit, which had only increased by $23 billion in the previous 51 weeks, jumped an astounding $5.7 billion in one week. In addition, the Fed bought outright $753 million worth of Treasury securities.

We had been warned over a year ago they could and would do this when it was necessary. Greenspan had flown to Asia and told them he had a bottomless checkbook and a bushel basket and would buy any T-debt they wanted to sell. And Governor Ben Bernanke - a genuine scholar of both the Depression and the decade-long period ending in 1951 when the Fed had printed money and brought as much Treasury Debt as needed to keep both long and short Treasury rates very low, had pledged to send helicopters aloft all over America and dump cash out to the public, the way ranchers drop bales of hay to cattle caught in the fields after a snow storm.

SO BRACE YOURSELF. If this is the beginning of the move that I think it is, America will experience a new round of inflation. It will be denied on all sides, as it is being denied now. (I know of no one who believes the government’s inflation numbers. If the real inflation data were subtracted from nominal GDP, it would be seen that both growth and productivity are well below what they claim today.)

Nevertheless, while denying there is inflation, the government and the ISM are boasting that prices paid and received by businesses are climbing at the steepest rate in years, and they say this new pricing power has come just in time to save many businesses that were starved for funds before. So forget whether the Fed dropped the word “patient” from its new announcement. And don’t worry about a quarter-point “tightening” at the end of June or the middle of August. You are seeing the first bales of money dropping from Bernanke’s helicopters. Before they are done, true inflation will be up to 8%, although the government will claim it is either 5% or 6%. And everyone in the financial media, especially the Wall Street Journal and Investor’s Business Daily, will brag about how modest and benign inflation is.

During this new period of DENIAL, Gold is acting as if there is no inflation and will be no inflation. Well, along with my son Jonathan Van Eck I believe they will be proven wrong about inflation and the value of Gold again today, as they were in late 1979. But this time the surprise will be to the upside.

By the way, I will deal with this in detail later. But Alan Greenspan’s fourth term (17 years) officially ends in days. He wants to serve another 18 months, to become the longest serving Fed Chairman in history. No one has mentioned another term officially yet. Maybe the President will let Alan hang by his thumbs for the rest of the year. Greenspan will know the whole time that he now serves at the pleasure of the White House, and if he does something to anger them his dream of a record will be smashed. Just thought you’d like to chew on that.