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Will Deflationary Forces Overwhelm Global Fiscal Stimulus?

Posted by Larry Doyle on September 28, 2009 3:12 PM |

While Uncle Sam and his international brethren are doing everything they can to reflate the global economy, will the deflationary forces deeply embedded in the deleveraging process carry the day and the future? In doing so, will these deflationary forces usher in an economic dynamic not seen since the 1930s?

The analysis and review by market savants, media mavens, and government pundits is ultimately mere noise relative to the denouement of the question proffered above. Jeff Gundlach, of Trust Company of the West, has spoken his mind and believes deflation will ultimately weigh upon our economy and markets. Today I share with you Deflation Rising: Making the Case for a Lasting Deflationary Environment recently produced by Black Swan Trading. High five to loyal Sense on Cents reader Ben for sharing this report.

The professionals at Black Swan produce a thoroughly superb and comprehensive review of this critically important topic. I strongly encourage you to put this post in your “Save” box for further review as we navigate the economic landscape. The report is launched as follows:

“If Americans ever allow banks to control the issue of their currency, first by inflation and then by deflation, the banks will deprive the people of all property until their children will wake up homeless”
Thomas Jefferson

Uncle Sam, whom we’ve dubbed the “stimulator of last resort”, is doing all it can to create some inflation. Inflation creation, through the debasement of money, is one thing governments have proven historically they do quite well.

Inflation bails out creditors because it allows them to repay debt more cheaply in the future, paying back the nominal value of debt with currency that loses a substantial amount of real value.

There is no bigger creditor than government.

But that said, at the moment it seems governments are losing the battle of inflation, to deflation, despite pumping money into the market around the clock.

This report makes the case for deflation. In it we examine the powerful deflationary headwinds that could lock the US and global economy into years of deflationary pressures that are reminiscent of the lost years in Japan when they became locked in a deflationary bear hug.

The report puts forth a wealth of compelling evidence for the deflationary case. The evidence covers the following topics, complete with numerous graphs and analytics:

1. Relationship between gold and the U.S. Dollar
2. Growth in money supply
3. Review of decline in the Consumer Price Index
4. Lack of Velocity of Money
5. Increase in bank reserves
6. Decline in outstanding consumer credit
7. Decline in nonfinancial corporate business credit
8. Discretionary spending reaches 50-year low >>>the writers posit that consumption will be much more dependent on income than credit
9. Decline in personal income
10. Structural headwinds in global economy including:
— U.S. economic policies
— likelihood of asset bubble in China
— dynamics in the oil and food markets

After an exhaustive, but not exhausting, 22-page review, the writers make a compelling case that the lessons of The Lost Decade in Japan will now very likely be played out here in the United States. What plagued Japan during that decade and to a great extent even today….deflation.

Additionally, the buildup of leverage within our economy took place over a 20 year time frame with a few significant hiccups. To think that our economy will be able to delever and recover within a year or two is beyond naive. I would project this delevering, adaptation, and recovery process will take at least five years if not longer.

Whether you place yourself in the deflationary camp, the hyperinflationary camp, or somewhere in between, do yourself the favor of reviewing this report. In the process, you will be more educated and qualified to navigate the global economic landscape.

LD

  • whoisjohngalt

    Larry, about 4 months ago it became clear to me that deflation was in the cards for the same reasons your & Black Swan mention. I was not hurt too badly by the crash a year ago because I had a 50% in money market funds & 20+ T-bill funds. At the worst I was down 20%. When I figured out deflation was the rule, I put MM funds into 20+ Tbills when the 30 year bond was at 4.55%, bought utilities & RDSA when it was 44. I am now ahead of where I was a year ago.

    I sent you a few comments over the last few months promoting deflation when you were mentioning stagflation. I remember stagflation in the 70s & it was cause by the OPEC spike in oil. I knew this was not the case this time.

    I still believe my investment changes were solid. The one I feel best about now is utilities. They pay good dividends & will not be hurt badly even if the economy stumbles along. I also feel good about Ford.

    The investments I would run from are banks & gold. I have my reasons on those two. I will share the gold theory if your like. I think everyone knows why banks should be avoided. I would like to hear your comments. Thanks

  • Larry Doyle

    Whoisjohngalt…I commend you for your discipline and foresight.

    I was very much in the inflation and potentially hyperinflation camp a few months back. I am now hedging those opinions. Why? The deleveraging pressure that continues to run the course only seems to be exaggerated by the fact that government programs are not allowing markets to clear.

    It strikes me more and more as Japan of The Lost Decade. I do think that our friends in Washington may very well have been backed into a corner by our creditors, especially China, to not allow more failures.

    I also think very highly of Jeff Gundlach specifically and his insights on the markets and global economy.

    I do believe this entire process is going to be proacted.

    I will write more on this in the future as there will be no lack of material.

    Thanks for your insights as well.






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