Nonconventional Thinker: The Deflation<->Inflation Roller Coaster

Deflationary Depression: Ultimate Status Symbol The Biggest House? No. The Most Expensive Car? Try Again.

By Robert Jay
Fri, 25 Jun 2010 11:45:00 ET

Ostentatious display defined the "Gilded Age" in the latter part of the 19th century. Most of the upper class in that period believed that if you had a big bank account, you should make sure everyone knew it.

A century later -- during the bull market of the 1980s-1990s -- "McMansions" with BMWs in the garage became more common. Pulling out the plastic and enjoying instant gratification became pervasive.

In most decades of the past century, families had to save for big ticket items, perhaps even save all year to ensure holiday presents under the tree. To take the whole family out to eat was a special treat.

"We are at a point where we have to have fiscal discipline and maybe go back to the days where you saved up to buy a washing machine, you saved up three to four years to buy a car. We will probably move in that direction as a nation."

Vanguard founder John Bogle (June 22, TheStreet.com interview)

What kind of financial era are we heading into now? Will it be similar to what followed this?

The 1929 crash began the Great Depression and severe economic deflation. The turn in psychology led to profoundly more frugal habits for millions of people in the years that followed.

The difference between the 1930s and today is that the credit expansion of this generation has been far greater. Does that mean a deflation to come that's even more severe than in the '30s?

". . . I'm convinced that deflation and depression are already underway and about to get much, much worse. You can avoid the impact of both trends if you are prepared, and you can even profit from these trends if you are properly positioned."

Robert Prechter, Elliott Wave Theorist, June 2010

How can you prepare?

One part of the answer points to the Ultimate Status Symbol during a deflationary depression: CASH.

When others are cash-poor and in-debt, when lenders can't collect, when prices are falling -- people with cash and cash equivalents will have what everyone wants. You'll be financially prepared to meet and overcome deflation.
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Q&A: Through the Valley of Deflation, Then What?

By Susan C. Walker
Fri, 25 Jun 2010 18:00:00 ET

When almost everyone believes that the Fed's interest-rate policies will eventually create awe-inspiring inflation, it's difficult for other voices to get heard. Bob Prechter argues that the real effect of the Fed's "extra-credit" policies will be deflation -- and that's what will hamper an economic recovery. He went into the lion's den recently to talk with the managing editor of the Daily Crux, a financial website that mainly focuses on the inflation side of the argument. In this excerpt from the interview, which runs in full in the June 2010 Elliott Wave Theorist, Prechter talks not only about why the Fed's action won't create inflation but also about what might come after we have walked through the valley of deflation.

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Excerpted from The Elliott Wave Theorist by Robert Prechter, published June 18, 2010

The Daily Crux: OK, so you don’t think the Fed will go that far. But what if the government got involved and tried to inflate its way out by issuing massive amounts of Treasury bonds to the Fed? Wouldn’t that create inflation?

Robert Prechter: If the government tried to do that, bond holders would get spooked, and interest rates would go up and stay ahead of the printing. At the same time, other credit prices—municipal, corporate and consumer—would implode. When the supply of credit is far bigger than the supply of money—and it is by a huge margin—the value of old credit can contract faster than new bonds can be printed. The net result would still be deflation.

But this is not the most likely scenario. Have you noticed that even the Fed chairman has been telling Congress it needs to stop spending and borrowing? The Fed doesn’t want this to happen any more than other creditors do.

If the Treasury’s interest rates do soar, it will not likely be due to inflation fears but to fear of government default. If the government is forced to pay higher and higher rates, it will become a black hole for money. Spiraling Treasury rates would suck money from other sources, causing banks, municipalities and companies to fail, ruining all of their debts, which would be deflationary.

Crux: Will hyperinflation ever happen in the U.S.?

Prechter: It certainly might. But it could only happen after the bond market implodes, not before. Then, if politicians get hold of a press, they might decide to print. But this is political conjecture, not monetary analysis. First we have to cross the deflationary valley, and this could take longer than almost anyone thinks.

Crux: So what you’re saying is that inflation is possible, but that it can’t happen until deflation has run its course. What would you be looking for to indicate that deflation was over and that inflation was beginning to become a danger?

Prechter: A banking crisis, in which thousands of banks shut their doors. Thirty-three percent unemployment. A ruined private and municipal bond market. And a panic in government bonds. If all those things happened, then you would have to be on the lookout for legislation allowing the government to take over the printing of money or to force the Fed to monetize new federal debt at a rapid rate. I think we will have to see all these things before hyperinflation will become possible. If all of this happens, trade all your greenbacks immediately for gold and raw land.

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Corkscrew Roller Coaster

As the Deflation-Inflation Roller Coaster continues along its path, there is no way to bring it to a halt and get off. All each of us can really do is to make sure we are securely buckled in and hang on tightly for the ride. Those that invited us on board neglected to prepare us for what lies ahead - rather, we were given promises of a smooth and easy ride, one without sharp turns or sudden drops! In actuality, it is more than likely that after the bubble economy is fully deflated at the end of this mega decline (which has only barely begun), and today's bloated asset values then require a strong magnifying glass to detect, that hyperinflation will propel the next phase of our ride.

Future generations will record in their history of this era that the complete de-linking of currencies worldwide from the gold (or other precious metal) standard - that is, what is usually referred to as fiat money, led to the money spigot being left in the 'full on' position for way too long as states continued to rack up debt in an effort to keep economies afloat. In the end, when the bubble became too big to sustain itself, there was an almighty pop - one that was heard around the world. This 20th-century experiment (1971) was found to have been the main culprit. In time, this funny money will be seen by all to be of no more value than that played with on the Monopoly board.