Expect a crisis of confidence when reality finally sinks
in. It's the reason I think the place to be is in currencies that have
lasted 5,000 years, can't be forged or rendered valueless by inflation:
gold and silver.
to share a speech I gave April 26, called "Precious-Metallic Armor for the
Coming Crisis of Confidence," at the Las Vegas Precious-Metals Conference.
This crisis I see is incubating thanks to a constellation of factors now
gathering force. We face a weakening dollar and, more importantly, a sea
change in attitudes, as folks finally realize that our problems stem from
the 1990s stock market mania and that there really is no magic Fed wand to
get us out of them. When confidence shatters, stocks will sink -- and
precious metals will soar.
Here’s the speech:
been in the money management business since 1982. I decided to set up a
short-only fund in 1996 because I thought that things were headed in a
very bad direction, though my timing was a little on the early
side. My goal was to distance myself from the "speculative performance
derby" and greed that was building, so that one day I could return to the
long side of the business with my credibility intact, which I still plan
to do when I feel it's safe to be bullish on stocks. For those of you who
care, I will start a mutual fund that will be open to everyone.
thought I might state my prejudices at the outset. I believe that the
mania for stocks and the revulsion against precious metals that we saw in
the late 1990s were opposite manifestations of the same psychology. I
believe that, while that psychology has been dented, later this year it
will be shattered, and stocks will sink as precious metals soar.
believe that the stock market averages are headed much lower. I believe a
dollar crisis lies in our future. I believe that the move that we will see
for silver will dramatically outpace gold to the upside, though I own
both, and I am a director of and own a sizable position in Pan American
Silver and one gold stock. However, I do not believe that a
so-called plunge protection team actively manipulates the stock market
(for the government) And I do not believe that gold is actively
manipulated, as is suggested by many gold bulls.
Lastly, and most
important, I believe that, in a social democracy with a fiat currency
(like ours), all roads ultimately lead to inflation. And in fact, that is
the story of all paper currency regimes. They all collapse.
biggest bubble in the history of the world that we recently experienced
was powered by the most incompetent and irresponsible Fed in history,
along with the public's willingness to suspend disbelief. It was a
state of mind as much as anything else. Folks believed in the
existence of a "new era," in a Greenspan put, and in retiring early, and
Techs as great investments? Hardly.
Folks believed that the wonders of technology automatically meant
that tech stocks were great investments. They even thought that two small
pieces of paper were more valuable than one larger piece of paper, as they
believed that stock splits meant stocks should go up -- though I don't
suppose they expected to pay more for a pizza that was cut into eight
slices than just four. In short, it was all about confidence and,
ultimately, near-arrogance on the part of those involved.
period when an Internet "incubator" (whatever the hell that is) like
Internet Capital Group could be valued at over $40 billion -- more
valuable at the time than, say, Boeing -- and sported a valuation of
approximately 150% of all the world's gold companies combined, is it any
wonder that no one thought they needed to own gold?
supreme, as people were bursting with confidence. At the peak,
Cisco claimed a valuation of over $500 billion. I saved a description
from February 2000 by an analyst who followed Cisco and thought that
within 18 months, it would be valued at a trillion dollars, never mind
that its revenues were on track to be about $25 billion or $30 billion.
Here was a company doing, in essence, about one-quarter of 1% of GDP that
was deemed soon to be worth 10% of GDP. Those are just a couple of
examples of hundreds that I could pick to illuminate the overconfidence of
the public at that time.
I believe that, as much as the mania for
stocks was an expression of confidence in paper, the metals are just the
opposite. They are an expression of a lack of confidence. I believe that
given the pendulum's extreme swing to the side of confidence, it is now
destined to travel back quite a ways in the other direction.
Inflation is how government cheats us
know that the government will cheat us over time, via inflation. We just
don't know at what rate. While lots of intelligent people believe that
deflation is right around the corner, this is not my belief (nor has it
ever been). I believe that people have come to confuse declining asset
markets with "deflation." Deflation, to me, means that the value of the
dollar appreciates against a basket of goods and services.
recession, coupled with a declining stock market and declining house
prices, would be just typical consequences of what happens after a boom,
much less the biggest speculative mania in history. I do not consider that
to be deflation. So, I believe it's entirely consistent to expect a
declining stock market and declining housing prices in the wake of a
bubble, and higher inflation. That does not mean that inflation rates have
to run at a high level initially. But over time, higher rates of inflation
are what we should expect.
I believe we experienced deflation in
the 1930s because we were still on the gold exchange standard, which was
fairly rigorous, certainly compared to the confetti standard that we're on
right now. As far as people asking, "What about Japan?", I don't believe
Japan is a true social democracy. It may be moving in that direction, but
when politicians there seek re-election, they don't tend to act in quite
the same way as ours do.
still throws a long shadow
And, I believe that the mindset
existing in America is to never relive the Thirties again. I think that
explains the statements we've seen from the central bank, in terms of Fed
Governor Ben Bernanke talking about using the printing press to fight
deflation, and FOMC secretary Vince Reinhart talking about buying
Treasurys if asset markets don't respond in a way that the Fed likes. The
Fed has basically said it will not accept "no inflation," and given
its outstandingly consistent record of destroying the value of the
currency over time, who wants to argue with it about that? However
dangerous you may think the Fed has been historically, the Greenspan Fed
takes that to an entirely different dimension.
Here, it might be
useful to take a moment and review the history of the dollar. What I have
prepared is a chart of the purchasing power of the dollar through
something that we can all appreciate. I created it from data that the
Hershey company gave me, after I asked them what a Hershey bar has
cost at retail since its introduction in 1908.
You have obviously
noticed that, from time to time, the price goes up and the amount of
chocolate per bar changes. So what I have done is to take the price and
turned it into the price of chocolate per ounce of a Hershey bar. What you
can see here is that, surprise, surprise, the price of chocolate per ounce
of a Hershey bar has risen over that period, and in fact is up about
twelve-fold. Measured thusly, the dollar has lost 92% of its purchasing
Interestingly enough, however,
the value of Hershey stock, since it came public in 1927, is up about
295-fold, with one share purchased at $39.58 now worth 180 shares at
roughly $65 each. Even after adjusting for inflation, as I have calculated
it, that's still a gain of 14 to 15 times in after-inflation terms.
Obviously, Hershey has been one of the rare, huge winners.
mania, all stocks were expected to eventually do as well "over time," as
people were blinded by long-term returns of stocks like Hershey's --
though they were more interested in stocks like chocolate.com -- and
completely oblivious to the risks. But folks were also completely
oblivious to the No. 1 financial risk that we all face as
investors/citizens, and that is inflation. In that regard, I consider the
Fed to be Public Enemy No. 1.
bubble: Consumers dig deeper holes
Not only did guys like
Greenspan, McDonough and McTeer help the Fed power the mania by making up
new-era rationalizations for it, since the market peaked in March 2000,
they have fomented another bubble, this one in housing prices. This has
enabled consumers to continue to live beyond their means, thereby making
the ultimate adjustment more protracted. Rather than taking the bubble as
a warning sign and urging folks get their financial house in order, the
Fed has given folks the shovel, via the housing bubble, to dig themselves
deeper and deeper in the hole.
It's sort of like lending money to
somebody who had a margin call, rather than making him meet the margin
call, and then lowering margin requirements as well, so he can buy more.
That is, in essence, what has occurred in the housing market, as many
people have increased their mortgages as housing prices have gone
Further, we have put ourselves in a position of being
completely at the mercy of foreigners. Thanks to our trade deficit, we are
dependent on foreigners to be willing to accumulate an additional $1.5
billion every single day, just to keep the dollar where it
The era of denial
that we have experienced since the market peak has really been a period
about denial, and it's gone on longer than I would have guessed possible.
But it is what it is. Initially, folks were in denial about the fact that
stocks had peaked and that we were in a bear market. Then, all of our
economic and stock-market problems were blindly pinned on the attacks of
Sept. 11, even though that wasn't the market or the economy's problem. And
now, all the problems of the last six months have been pinned on
Thus far, Greenspan and the Fed have basically been issued a
pass after going 0-for-12 on the rate-cut front. Folks still have faith in
the Fed, I believe, because the housing bubble has kept the consumer
feeling more or less OK, even as people lose their jobs or know someone
close to them who has lost his job.
However, I believe that later
this year, people will finally be forced to realize that our problems are
a result of the mania, and are long-lived. That psychological readjustment
will come about when the economy and the stock market don't come back
(excluding some minor postwar relief bounce).
Along with that
realization, folks will start to contemplate what happened in the 1930s,
even though things are different now, especially in terms of our currency
regime. They will contemplate what's gone on in Tokyo for the last 12
years, where now 60% of the stocks on the Tokyo Stock Exchange sell below
book value, contrasted to the three times book value that stocks sell for
The Fed has become
I think that at some point, the exact moment being
unknowable, folks will recognize that the Fed has ruined the financial
system, the Fed is powerless to stop the bear market, and the Fed is
powerless to fix an economic bust precipitated by the misallocation of
capital that occurred in the mania.
That realization, I believe,
will cause folks to lose confidence, and that loss of confidence will set
off an avalanche in stock prices, forcing them to be valued as the
fractional shares of businesses that they are, instead of the conceptual
fantasy lottery tickets that they have become. I believe that this loss of
confidence, both here and worldwide, will also cause the dollar to be
reappraised as the piece of confetti that it has become.
don't say any of this because I want it to happen. I say this because to
me, it was preordained by the policies that precipitated the bubble and
the policies that have gone on since the bubble. I don't root for any of
this to occur, but I fear it will occur. My choice is to be prepared, and
to do the best I can in that environment.
Gold looks good because currencies
Unfortunately, when it comes to looking at other
currencies, the euro and the yen are not a whole lot better than the
dollar. I sort of view each of them versus the dollar as a one-eyed man in
the land of the blind. Not too interesting, just slightly better
alternatives. However, all of this is very bullish for the only currency
that has been in existence for 5,000 years, that cannot be printed, and is
no one else's liability – i.e. gold. I would like to be clear that when I
say gold, I also mean silver in the same breath, as I stated at the
outset. Just as buying stocks until your hands bled was a state of mind of
supreme confidence in the mania, owning precious metals is, to repeat, the
expression of the lack of confidence in the monetary authorities, an
oxymoron if there ever was one.
I believe that investor demand, the
lack of which has been responsible for holding back the metals, will
finally manifest itself as this year unfolds and the problems that I have
articulated become clearer to people. Greenspan, in particular, has
painted himself into a corner, at last, by blaming all of our current
problems on "geopolitical uncertainties" surrounding the Iraq war. This is
why I feel that we have a potential catalyst to cause people to
re-evaluate their thinking. When the alleviation of those geopolitical
concerns fails to ignite the economy and the stock market, the game will
be up, and the race to protect oneself will be on.
I have no clue
as to the precise timing of this scenario, since a lot depends on the
length and potency of the relief rally in stocks and the economy. However,
the relief rally in the dollar has been especially pitiful. Basically, the
euro traded from $1.10 to $1.06 in three days, so we had a mild 5%
correction, after a nearly 25% move in the euro. And of course, the euro
is now back over $1.10.
This suggests to me that the dollar is on
borrowed time, and trouble is coming, sooner rather than later. It also
means to me that the price of gold has seen its lows. And, while the
tsunami of investment demand that I envision may still be months away, I
believe the surprises will now all be on the upside for gold.
would just like to close by leaving you with one of my opening thoughts:
In a social democracy with a fiat currency, all roads ultimately lead to
Fleckenstein is the president of Fleckenstein Capital, which manages a
hedge fund based in Seattle. He also writes a daily Market Rap column for
TheStreet.com's RealMoney. At the time of publication, he owned shares of
Newmont Mining and Pan American Silver. He’s also a director of Pan
American Silver. His investment positions can change at any time. Under no
circumstances does the information in this column represent a
recommendation to buy, sell or hold any security. The views and opinions
expressed in Bill Fleckenstein's columns are his own and not necessarily
those of CNBC on MSN Money.
The above article originally
appeared on CNBC on MSN Money under the Contrarian Chronicles
column on May 5, 2003. To read more articles about the precious
metal and equity markets, visit our Gold in the News