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Can You Spell Deflation?

As I have maintained for some time we are in a massive deflationary cycle that is nowhere close to ending. In fact, it is just about to cripple the global economy if you ask me. Here is an excerpt of what I wrote on Feb 4:

“What people need to realize is that we are in a deflationary spiral until there is evidence otherwise. Printing money and government spending are inflationary in normal economic environments, but this is far from a normal economic environment. Anyone that thinks this is an inflationary environment is just not willing to look at reality. There is ZERO wage inflation, asset prices continue to fall, and the debt situation is getting worse not better making asset prices fall further. The central governments can keep interest rates this low forever because banks ARE NOT lending and if they raise rates asset prices will collapse because no one will be able to service their debt.

Without a meaningful debt solution I do not see how it is possible for us to have inflation. The central governments around the world can continue to print money at an alarming rate without inflation because the amount of money evaporating and going to money heaven is greater the amount being created. Short term interest rates and commodities are the best leading indicators of inflation. Short term rates are making new highs in price and lows in yield almost every day. The 6-month libor rate has dropped in yield for 24 straight months and shows no sign of an uptick anytime soon.

Are some prices rising like health care? Yes, but that hardly means there is inflation. Agricultural commodities like corn, wheat, and soybeans are very close to their lows for the past few years. Energy commodities such as crude oil, natural gas, and unleaded gas are still more than 50% below their 2008 highs, no inflation there either. While industrial metals and precious metals have had huge moves in the past year the CRB index is still more than 40% below its 2008 high, hardly inflationary. Commodities and interest rates will tell us when there is inflation and we are not anywhere close to it, yet.

The bursting of bubbles is massively deflationary and the deflation can last for decades. How long will this last? I have no idea but until evidence shows otherwise I wouldn’t bet on it changing anytime soon. In my view we are headed for a double dip and our troubles are far from over. Lastly, while the equity markets have had a V shaped recovery the economy hasn’t. Unless this changes in a hurry the equity markets are going to reflect the real economy sooner rather than later. I just don’t see it happening, so consider yourself warned.”

Here is another excerpt of what I wrote on February 6th”

“The other problem with us heading into massive inflation is that we are not acting in isolation. Many other central banks around the world are acting just as irresponsible as we are here in the US. Where is this inflation going to come from? My point is what currency is going to be the safe haven? We are too connected globally today that many of the old economic models do not work the same as they once did before globalization. If the whole world is acting as one and we are all in the same predicament I just don’t see how we go inflationary…”

Greece Jitters

I can’t see the Greek situation having much any impact on company earnings but it could hit market sentiment. I think it’s still interest rates that will determine the market even though they have little real consistent historic patterns over recent decades.

From 2003 to 2007 rates went up nine times and peaked exactly when the markets peaked so the lesson was that there can be many rises before a recession.

From 1991 to 2000 rates peaked in June 1998 eighteen months & seven rate cuts before the markets topped. Rates continued falling until June 2003, four months after the market bottom. No lesson to be learnt.

Between May 1988 and Oct 1989 there were 11 rate rises in less than eighteen months prior to the 1990 recession. Lesson to be learnt is that we could get many rate rises in a short time frame.

That’s three different recessions* with no similarity at all with rate behaviour regarding time frames or rate direction. From the current perspective the next rate rise or two is very unlikely to signal doom but could cause increased volatility.

I think the risks are that rates will be rising with little slack in the labour market, falling unemployment and after a long bull market. The risk imo is that recession could come upon us faster than may appreciate if wages continue rising faster than CPI & RPI inflation. The number of self employed fell last year, suggesting wages are now more reliable and better on PAYE.

* 2001 was a US recession only.

I think the market is being too optimistic, too soon on Greece. Their red lines are still no pension cuts, no budget cuts and no rise in electricity prices. All things Germany says they must do. I’m still cautious until proven wrong.

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