One of the most fascinating aspects of market/economic behavior is how the majority MUST be wrong in order to fuel the movement. There are loads of articles and forecasts questioning the recovery and how the world will collapse into a black hole. But if everyone is short dollars/long gold it will never happen. Tons of questions all claim the same points – WHERE IS THE RECOVERY?
The fascinating aspect of market movement is watching how the majority create the opposite trend that they expect. Between 1980 and 1985, the number one question I was always confronted with at seminars in Europe was – Would the US move to a two-tier monetary system to default on its debt? The US National Debt hit $1 trillion in 1980. It kept rising as gold then declined for 19 years. The Eurodollar market contained about $1 trillion in deposits. Europeans were convinced gold would rise, the dollar would collapse, and the USA would escape its debt by moving to a two-tier currency, green dollars for domestic use and red ones for international like South Africa maintained at the time. I explained I may have been the only American who even understood the question. I assured clients, that concept was NEVER even thought of inside the USA no less in Washington.
Nevertheless, the more BEARISH Europeans became on the US debt, the higher the dollar rallied. How was that even possible? The Eurodollar deposits dropped by about 50% and they shifted the money to domestic dollar deposits. This is exactly how capital has been moving inside of Europe buying German and Swiss assuming that is a hedge against the collapse of the Euro. A green dollar would be worth more than and red one so they moved into the USA driving the dollar ever so higher. The more BEARISH they became, the higher the dollar moved. Absolutely fascinating. In Europe, the more bearish they became on the Euro, the more stable it emerged because they were merely buying German bonds in Euros and the Swiss pegged their currency to the Euro to stop the capital inflows – another trap for the future ensuring the Swiss peg will break and they will tale a huge loss on their Euros.
The high dollar then prompted the Plaza Accord in 1985 and the formation of the G5. Princeton Economics was the FIRST to ever develop a computer model. So in 1985, I wrote to the White House warning that the attempt to manipulate the dollar lower would send a shock-wave of escalating volatility that would culminate in a Panic by 1987. The White House response was just that nobody else had one of these models so they did not believe they could listen to just one computer. Ever since, firms have hired quants trying to mimic what we achieved without any sustainable success. The computer design of building a fully functioning Artificial Intelligence system that was self-aware, explored the world and revealed fascinating interworkings was more than blending physics, economics, and trading. Nonetheless, they tried whereas models they designed on short-term databases with hard-wired assumptions have consistently failed ever since.
All I can say is that the MAJORITY absolutely must always be wrong. This has led to many accusing me of manipulating the world economy as if some plot in a James Bond movie. So just because the majority of articles are asking WHERE IS THE RECOVERY proves the point. Why have stocks NOT collapsed with a sharp rise in long-term rates already? June exports from China dropped sharply so that implies the USA consumer is buying less. Where will a recovery come from?
We are not dealing with a recovery that is rooted in economic expansion. We are dealing with a shift in assets from PUBLIC to PRIVATE and that does NOT require economic GDP growth. It is a move to safety. One reader asked:
Great articles, I still need you to fill in some areas. How exactly will the bond collapse proceed? Also will rising interest rates attract capital away from equities and other areas and cause those markets to decline with rising rates?
During the early stages, stocks rise with rising interest rates. The stocks are impacted by rising rates only when the expectation of future capital gains is overshadowed by the interest rate. Hence, no two rallies in equities have ever peaked with the same level of interest rates as show here by the call money rate.
The equities will not crash and burn as bonds decline. Forget the talking heads. They have never bothered to look at the markets for if they ever did, they would see they are propagating nonsense. The arrows mark the rise in stocks and the decline in bonds. Clearly, rising rates do not cause the stock market to decline for they generally peak together.
So this has got nothing to do with economic growth. So forget the nonsense about a recovery. This is a capital preservation shift. There is about $2 trillion in hedge funds alone. Many will lose their shirt because they too are often clueless. It takes tens of millions of dollars to create a worthwhile database capable of even providing a glimpse of how capital moves under all conditions. These funds are too cheap to spend what it really takes to do the job without guessing. The majority of funds must lose their shirt. Goldman Sachs had to testify before Congress for their Investment Trust went bust.
The “investment trust” was sort of the domestic “hedge fund” of its day. Everyone was jumping into the game. Waddill Catchings (1879-1967) was a Harvard economist who nearly bankrupted Goldman Sachs in 1931. He created a new entity the name: Goldman Sachs Trading Corporation. The deal was that Goldman Sachs would be paid 20% of the profits earned in this investment trust scheme. The shares were initially offered at $104 and they jumped to $226 per share trading at twice its book value. Just three months into the fund, Goldman Sachs arranged for a merger of the trust fund with Financial & Industrial Corporation that controlled Manufacturers Trust Company that was a giant group of insurance companies. This doubled the assets of Goldman Sachs Trading Corporation taking it up to a staggering near $245 million. This was huge money in those days. The trust now ,exploded and the assets under control are said to have exceeded $1 billion back then.
Goldman Sachs expanded the leverage going right into the eye of the storm that was about to hit starting on September 3rd, 1929. In the summer of 1929, Goldman Sachs launched two more trusts Shenandoah and the memorable Blue Ridge. The shares were over-subscribed and Shenandoah was offered at just $17.80 and it closed on the first trading day at $36 per share. Blue Ridge was even more leveraged and the partners at Goldman Sachs put pressure on everyone to buy as a sign of support. The leverage was astonishing for with just about $25 million in capital, now there was more than $500 million at stake.
The disaster was monumental to say the least. Goldman Sachs Trading Company, whose shares had stood at $326 at their peak, fell during the Great Depression to $1.75. They fell to less than 1% of their high. The loss suffered at Goldman Sachs on a percentage basis was far worse than at any other trust. In fact, of the top trusts, Goldman Sachs had lost about 70% of everyone combined.
Thus, there is no safety in the majority.