Here we go again; the Dow closes at a new record high of 15,105.12 today, May 8/2013. Some of you must be wondering how I could have got it so wrong. I have been calling for the winter stock bear market since 1999, one which I confidently predicted would at least emulate the predecessor winter bear market that saw the Dow drop by 90% between 1929 and 1932. But here we are, thirteen plus years beyond the initial autumn bear market peak of Dow 11,750 points in January 2000, with the Dow today closing 28% higher than it was then. How could I have got it so wrong?
Well, for a start I didn’t reckon on the huge fiscal and monetary stimulus precipitated by the Federal Reserve. During the 1929 stock market crash, the Federal Reserve was in its teens. It did act, however, in the initial stages of the stock market crash, by rapidly reducing interest rates and injecting huge amounts of money almost all of which was to New York banks; in the last fateful week of October 1929, the Fed expanded the monetary base by almost ten percent.
“By mid-November, the great stock break was over, and the market falsely stimulated by artificial credit, began to move upwards again. ” Murray Rothbard, America’s Great Depression (4th Edition), Richardson and Snyder, New York, 1983. P. 191.
While the great stock market break was over temporarily, the rally only lasted into April 1930. After that the bear market resumed with a vengeance.
At that time the hands of the Fed were tied, because the dollar was linked to gold. Thus the Fed had to tread warily when it came to reducing interest rates or driving money into the banks, because to be overly aggressive in these regards would produce a run on American gold. That was not to happen until late 1932 when confidence in the dollar was diminished both at home and abroad, pending President Roosevelt’s inauguration. At that time, “Foreigners cashed not only their American stocks and bonds, and also their dollars and hauled American gold away by the boatload. Americans converted their paper dollars and bank deposits into gold coins and stashed them in mattresses, hid them in basements or attics or took them away on one way trips to Bermuda or the Bahamas.” The Kondratieff Wave Analyst, January 1986, P. 8.
That was then, the 3rd Long Wave winter, and this is now, the 4th Long Wave winter. In this winter there are no gold constraints to crimp the fiscal and monetary actions of the Federal Reserve. Without the discipline that gold enforces on the dollar, or any currency for that matter, the Federal Reserve has gone berserk not only in its interest rate policy, but also in money printing, where it is currently printing a $ trillion per year and feeding it into the major banks by purchasing treasury bonds and mortgage backed securities from them. To this end the winter bear market has persisted for almost thirteen and a half years as opposed to the less than three years that the previous winter bear market lasted, which nevertheless dropped the value of the Dow Jones Industrial Average by 90% and the Transportation Average by 93%.
When will it all end? I suspect that will occur when confidence in the dollar is destroyed. So let’s explore how this might happen.
The dollar’s demise might well follow a similar course of events that led to the collapse of the world-wide monetary system in the previous Long Wave winter between 1931 and 1933. Before that collapse most currencies were pegged to gold. Following the failure of the Kredit-Anstalt bank in May 1931, Austria was forced-off the Gold-Exchange standard system and was soon followed by Germany. Speculators then turned their attention as to which country might follow and picked on the British pound by exchanging their pounds for British gold. This resulted in Great Britain leaving the monetary system in September 1931. Great Britain’s monetary demise was followed by most of the Empire and subsequently by Japan in December 1931. Eventually the mighty dollar was forced to capitulate in April 1933.
A similar sequence of the demise of currencies might be played out in this Long Wave winter. Perhaps it will start with the failure of the Euro, after which the Yen and Pound would probably collapse and following the demise of these two currencies the dollar would almost certainly succumb. Once set in motion the failure of national currencies would likely occur at a frightening pace.
Another possibility that might lead to the death of the dollar is that it might lose its reserve currency status. China has negotiated with several countries whereby trade between China and these countries is settled in their own currencies and not in dollars. China will continue to seek such agreements with other trading partners. This effectively dilutes the dollar’s importance as the world’s reserve currency.
A third possibility, as I see it, that could spell the end of the dollar is that China announces that she is tying the remimbi to gold. We know that China is accumulating gold at a frantic pace and we doubt that this accumulation is simply being done to stick it in the Chinese central bank’s vault.
Any one of these reasons, or possibly a combination of all three would spell the end of the dollar’s hegemony and, ergo, the end of the Fed induced rally in this winter stock bear market .