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Bubbles Bring Troubles

As the title of this work highlights, financial bubbles bring troubles of varying degree and scope in the end, where investor confidence in markets is normally suspended for at least a generation, affecting everything from the larger economy to politics. Is there a comparable situation in history from which we can learn about today's excesses? Our readers know from previous discussions that we firmly believe at a minimum, the globe is on the cusp of topping economically in what Elliott Wave Theory (EWT) practitioners term a 'Grand Super Cycle', with the last crescendo of comparable stature being found at the time of England's South Sea Bubble. Just like today, the South Sea Bubble was a global phenomenon, characterized by multiple and interrelated bubble markets, both debt and equity alike, and all built on the desire of greedy businessmen and politicos to extend economies that were already taxed to their limits.

Of course, technological innovation eventually came along to save the day, which is why the current situation may be far more important than that found back in the 1700's, because it's difficult to envision the human race topping what has already been accomplished from a growth / innovation perspective any time soon. This is perhaps why the current top may be better characterized as a Millennium Cycle Top, and better compared to that of the Roman Empire. These are not new thoughts for us here at Treasure Chests, with the following quote taken from the attached above providing all with a good dose of reality, as follows:

"Or "panem et cirsenses" ("give us bread and games") - the way the last Roman emperors ruled their morally corrupt citizens. Until eventually the bread ran out, and the games turned into rebellions, which destroyed their pot-bellied empire.

The same trends are at work in modern-day America. The Wall Street casino is the Coliseum stage. The Big Business financial elite, the "Princes of the 20th Century," are the pot-bellied Roman aristocrats. The Baby Boomers are the "middle class Romans," comfortably seated as spectators at the Coliseum. The rest of the Main Street Americans are the "extras;" the pool from which the gladiators are chosen."

Many self-indulgent practitioners will argue such grandiose thoughts are fiddle fuddle in today's 'new era', and that any comparisons of this proportion are preposterous. Although not centered on this issue as a matter of focus, Jim Puplava's most recent paper attached above actually takes one through a step-by-step analysis of why such thoughts could not be more germane as it applies to the current maturing of 'grand cycle' forces. Indeed, he touches on everything from how the 'new era' in technology during the 1990's was promoted as a guarantee to a prosperous future for Americans as far as the eye could see; to how today, conditions have eroded into a nightmare of corruption and deceit. Below is a diagram that brings dates and degrees of the concurrent cycle tops into perspective, where without a doubt, the top in the NASDAQ (tech stocks) in 2000 was a significant event within the full scheme of things. (See Figure 1)

Figure 1

Source: Elliott Wave International

One does not have to study much to realize that after a bubble bursts, it takes a very long time for a market subjected to this condition to bounce back, if ever. This has many stock market observers confused at present, because if technological innovation was the generational innovation craze of our time, with the tech stock laden NASDAQ (topped in 2000) a reflection of crescendo within modern day markets, both debts and equities of all varieties should have been crumbling long ago, not other markets making new and even more profound bubbles. Why have grander bubbles now inflated after the year 2000 tech wreck wiped out trillions of wealth worldwide?

A clue to the answer is in the word 'inflated', and of course has much to do with our friendly bankers; always there to lend you that extra dollar to make your current interest payments in the rather large Ponzi scheme they have fostered. Not surprisingly, and consistent with the self-serving statistical wizardry that goes on in government as a matter course every day now, if one were to look at growth rates in monetary aggregates on a domestic basis, nothing would appear to be out of kilter at present over at the Fed. Steady as she goes unless a financial disaster is looming, like in 2001. (See Figure 2)

Figure 2

Source: Bull & Bear Wise

What is not included in the growth rates of domestic monetary aggregates shown above however, is the growth in foreign holdings, which combined with the Fed's own $840 billion balance sheet, plus the roughly $1.4 trillion of USD denominated reserves it holds in custody for foreign central banks, means monetary aggregates have been rising at almost 12% over the past year. So you see, the US is hyper-inflating its economy / money supply through stealth accounting methods, which is why new bubbles are blowing up all over the place from the housing markets to commodities. Further to this, it is through such accounting shenanigans market participants are deluded into thinking the US Dollar (USD) has greater value than it actually does, and why it has not broken down worse already.

With the Fed attempting to stage a meaningful rising rate campaign in the States right now however, and technical conditions in the charts suggesting the USD is preparing to mount a fairly substantial rally against most major currencies around the world at present, it appears the USD will have a relatively short lived reprieve. One should realize this does not change anything for the US banking system however, the real bubble (i.e. and bubble maker), as the group appears to have finally topped against the broader market. This means there is a very good chance that in spite of lower rates coming down the pike, which we would surely see if conditions warranted such a drastic policy change (think deflation scare), domestic money supply growth measures may recover in spike fashion, but will likely not remain buoyant on a sustained basis, just as has been the case since 2001 concerning Money At Zero Maturity (MZM).  (See Figure 3)

Figure 3

Source: Bull & Bear Wise

This advent is likely to have far reaching implications for the global economy because if US banks are not able to grow as fast, and worse if equities turn south, a signal that money supply growth rates, both in terms of stealth and conventional measures will likely suffer, possibly turning negative for a period of time. (i.e. the formal definition of deflation.) Some may think such thoughts fanciful considering the Fed can create fiat digits by simply pressing a few buttons on their computers, just as easily as you are viewing this report. There is only one problem with this thought process however, and that is there is no doubt unlimited supplies of freshly digitized USD's are readily available at all times, but if the demand is not there (think demographics combined with maximized debt service ratios), what good is never ending supply?

And doesn't over supply of any commodity mean the price should go down, where the USD is currently 70 percent of foreign currency reserves held by Central banks. Not if you ask Alan Greenspan, as according to him the Fed is not able to identify bubbles until after they have burst, and they do not target managing these sorts of things. Whether he is telling the truth or not is unimportant as long as one is maintaining a vigilant watch over monetary conditions, and acting accordingly. For instance, did you know that in spite of the Fed purchasing increasing quantities of Treasuries since last year, as foreign Central banks have cut back for various reasons, the effect of this stealth money supply inducing mechanism is decreasing on a percentage basis. (See Figure 4)

Figure 4

Source: Bull & Bear Wise

What implications does such a condition have? First its important to understand that what we are talking about is the dampening of yet another stealth Central authority inflating mechanism, which in the end means both asset prices in the States, and the Dollar, will likely suffer in coming years when viewed in isolation. Why is this? As alluded to in Figure 3, when the threat of deflation becomes a reality, and the Fed has run out of covert inflating methodologies designed to keep the USD from crashing, it will flood domestic money supply measures at increasing velocities to show the world it prefers an uptown trajectory in the economy as opposed to a downtown address. In other words, the Fed will not care if the Dollar suffers due to an accelerated debasement reflected in domestic inflation measures (M1, M2, M3, MZM), because asset prices will likely be under pressure, and with so much of Americas wealth tied up in equities (think stocks and real estate), Central authorities will be forced to pay deference to the fact deflation would be inevitable if too many bubbles started popping at once.

Yes ladies and gentlemen, the Fed will panic once again, making it obvious to the world they are inflating the money supply, which of course will send commodity prices soaring. A lower USD and higher commodity prices won't hurt the prospects for gold any, especially if stocks come under increasing pressure. This should do the Dow / Gold Ratio a world of good in terms of breaking it out the well defined trading range in which it currently resides. One would expect to see gold, with a move in its related equities first to signal a sector progression, anticipate an accelerated monetary expansion. But, it could be the Dow / Gold Ratio falls because of plunging stock prices initially, as there are growing signs throughout the financial landscape that if the paddles are not applied soon, its going to be increasingly difficult to revive the patient. (See Figure 5)

Figure 5

If the Dow / Gold Ratio gets down to the approximate unity area, does this mean that it should turn around and head right back up to a new high over the subsequent twenty years? In order to answer this question, we must first take a look at the bigger picture in order to ensure our basic understanding of where the larger degree cycles stand is correct. And while it's impossible to label the current top anything more than Cycle Degree (think EWT), having fully expended the larger cycle forces set in motion during the 19th century, if the Dow had been around longer, we are quite confident it would be evident this current top (think process) is 'Grand' in scale. (See Figure 6)

Figure 6

Source: CyclePro

That being said, and for whatever this little bit of interpretation is worth (unfortunately something of this order appears to be the case), after such a grand scale sequence has transpired, and evidenced in typical post bubble market behavior, a corrective sequence of proportional magnitude will most likely be in the cards. This means that since the full three-stage sinusoidal sequence of the Dow / Gold Ratio over the past 100 plus years has defined an inflationary time, there is a greater likelihood than not the next phase will define a deflation once a bottom (defining an inflationary top) is established. The absolute price levels are we talking about along with timing is anybody's guess at this point. One thing is for sure however, if the Dow were to suffer 'fifth wave failure' at this juncture, considering it represents the cream of the crop in US commerce, any subsequent inflation attempts could prove quite feeble, meaning the inflation cycle could be truncated. (See Figure 7)

Figure 7

Normal commodity cycles (which are the best measure of successful inflation agendas) last approximately 10 years. So assuming this one started in 2001 with the bottom in the Commodities Research Bureau (CRB) Index, it would be reasonable to conclude current trends will reach the beginnings of the next decade. Again however, if inflation attempts continue to exhibit accelerating decay characteristics, as portrayed above in Figure 4, there is no guarantee this will be the case. One must remain vigilant in terms of monitoring this situation, as we have been doing here at Treasure Chests since our inception.

Good investing all.

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