Issue No. 13. August 1998
posted 30.VIII.98
Inflation, deflation ... or stable prices: revisited
In the April
1998 Issue [LINK] I asked the question of what
to expect in the USA: Inflation, deflation ... or stable prices? I
admitted approaching this crucially important matter for all investors
with trepidation, and emphasized that I did not have any definite answer
to offer, but here is what I concluded then:-
" The trend in the USA suggests a continuation of the current mild inflation or further disinflation. In the absence of a major economic shock (such as a stock market crash and/or a global recession) there is little chance of actual deflation: the money supply can always be pumped up to head that off. (But) I see no reason in the short-term to expect the CPI and/or the PPI to begin to reveal any actual resurgence of inflation either."
and ...
"In my opinion the potential consequences of the events in Asia and the Stock Market Bubble are both of much greater concern than the possibility of a surge in inflation occurring first ... Both a global depression triggered in Asia and a market crash in the USA are potentially strongly deflationary events."
What I was saying is that there are powerful things going on in the US economy that based on recent (post-1945) historical experience ought to produce inflation. The most important is the surging money supply. But there are factors which have been delaying the emergence that general increase in the level of prices which is what we mean by inflation. I explained what I think these factors are. So the question became one of timing - which will happen first, the emergence of inflation or a big overriding event [global depression and/or a Wall Street Crash] that will swamp the incipient inflation before it appears, and possibly create unstoppable deflation. No honest analyst could claim to know the answer to this for sure: it could only be a judgment call.
It remains a judgment call. But, I am now ready to make it. My call is for the global deflationary forces and collapsing US stock markets to arrive before there is any significant inflation in America, and a deflationary slump will follow. Don't forget though - this is Issue Number unlucky thirteen!
My reasoning follows:-
Essentially, the case is this. There is still no sign of general price inflation in America. And the leading indicators still show almost no early warning signs (in fact, on balance, they signal deflation). So, even if there are inflationary forces working their way through the US economy, there is still time to spare. But on the other side of the issue, the global economic problems have accelerated, spread and are bearing down on the USA like an express train. Events are now moving very rapidly indeed and are directly affecting every major economy and region of the world outside the USA. At the same time the US economy is slowing and the stock market is looking decidedly shaky. I think it is now very likely that these forces will strike America soon.
The specifics and details of events in all these places can be read about
elsewhere. I do not want to waste space and my, and your, time reiterating
them here. My job is to try to interpret: to highlight "the big picture".
And, as I said above, after all is said and done this will not take all
that many words:-
There is no-one anywhere now making any plausible, credible case that
the global economy is not heading into a deflationary spiral.
There are of course still plenty of people who say it isn't, or it
is extremely unlikely, or things like "Some time
in the next six months, there will come a time when Asian stocks will be
the best bargains in the world" (Michael Wilson, Investment International,
August 1998). But when you look for the reasoning behind such optimism,
there is nothing of substance there anymore.
Up until now, this has not been the case. Since the global economy began
to unwind visibly last year, there have always been reasonably plausible
cases that could be made that the problem could be contained: IMF
bailouts, massive action by the Government of Japan to stimulate their
economy, and so on. None of these things were silly or trivial. I said
that they would not work, and they have not worked, but this outcome was
never obvious or certain. It has never been easy to spot the flaws in what
were mostly bona fide efforts by the international community to "do
something."
Now though, I simply do not see any plans out there. There is no case for
me to answer anymore. Mere optimism that the crisis will bottom out soon
is all that is left. That and plaintive pleas for someone else to "do
something . . . please.":-
"The White House urged Russia to take swift action to salvage the
rouble and its economy." (Reuters, August 26th). (Like what, exactly?)
"Prime Minister Jean Chretien" (of Canada) "reiterated that its not his
job to rescue the plunging" Canadian dollar. "Its his job" he said,
referring to Gordon Thiessen, the governor of the Bank of Canada.
(quotations from Reuters, August 25th).(unbelievable, but this really
is what he said!).
Michael Camdessus of the International Monetary Fund has been having
emergency meetings with the Russians. So what? Does anyone expect that the
IMF can stop what is happening now?
As an observation, I think that it was, as expected, Japan that was the
key. Once it became obvious that their new Prime Minister could not (or
would not*) stop that nation's slide into a deflationary slump, then many
realised that there may be no more lines of defence, anywhere.
It may not be apparent to readers, but believe me, I am constantly
looking for evidence of a bottoming out of the crisis. I do not wish for
a global Depression! And I would be
delighted to be able to start bottom-fishing for stocks in the Far East
and elsewhere again. But I see no such evidence. If I do I will
report it here with great delight.
(* It doesn't really matter anymore. But as I have opined several times, I
believe that Japan has no options left - with the Nikkei now below 14,000
virtually the entire Japanese banking system is insolvent).
The direct measures - the CPI and the PPI - still do not reveal any. And
taken together the
Leading
Indicators [LINK] (except for money supply) have become sharply more
deflationary since I wrote my earlier assessment in April this year. Look
at the yields on US Treasuries. And at the CRB Index - at 195 it is at a
two decade low. And at the price of gold.
In April, I was still worried about the US money supply. It is still
surging, and it is still something that I am keeping a very wary eye on.
But, on balance, I no longer believe that it will trigger an inflationary
cycle in the US. Under "normal" economic conditions it certainly would.
But once you enter a true deflation the destruction of credit (which is
what the deflation is all about) simply wipes it out. This is what has
been happening in Japan. In other words a surging money supply within
a context where all other indicators are pointing to deflation is not
necessarily at odds with them.
Following such a Crash, I expect to hear many analysts compare it with
1987 and call for a recovery after a few months. Many, many investors will
agree and buy in at what they think is the bottom expecting to make huge
profits. But this is not 1987 - if this time we are indeed in a global
contraction then the economy will NOT recover after the Crash. It will
continue to wind down. In which case those investors buying in at the
"bottom" will find only a Suckers' Rally.
How bad could it get? It might be worse than your worst nightmare. In 1929
the US government finances were quite sound. Today they are not. In 1929
the average US corporation had a clean balance sheet and sound finances.
Today typical financial statements hide more than they reveal. America is
in no state to weather a major economic crisis.
The worst case scenario is a total collapse of the worldwide currency
system. I merely mention this in order to point out that those few
"gold bugs" and other lonely voices predicting total collapse are NOT
lunatics - though sometimes they are called that. I think they are wrong,
and things will not get that far out of hand, but what they see is merely
highly improbable, not crazy and impossible.
I am positioning myself for a deflationary slump, not for a total
collapse. As a cautious,
patient investor I consider the best strategy to be to preserve ones
liquid wealth with the expectation that in due course it will be possible
to buy up sound, productive assets at bargain-basement prices. That is not
a get-rich-quick strategy, but it is the way that many fortunes have been
made in the past:-
"Quiet contemplation is the best speed." (Chinese proverb)
I am not planning to buy up gold, head for the hills, bury it under a
rock, and await financial Armageddon. If, in the very unlikely event that
things are going to get that bad, I expect that there will be warning
signs and that I will be alert enough to see them. After all, there have
been plenty of warning signs for more than a year of the current global
financial and economic problems: the signs are always there but have to be
looked for. There will be time ...
Time for you and time for me,
(T. S. Eliot, 1917)
The global economy
Let's look at this one first. There is a lot going on, but the conclusions
can
be stated in a few words. The reason that this Issue of The Skeptical
Investor has taken longer than usual to write is the tremendous amount of
research that had to be undertaken. For several months I was able to
concentrate my efforts on understanding events in Asia and North America,
merely keeping a weather eye on other regions. But now it is necessary to
monitor unfolding events in Asia and Japan, Latin America, Eastern
Europe (and Russia especially), the UK, the EC, Canada, the USA , and
anywhere else that signs of problems appear.Inflation ahead?
Turning then to the other side of the question - is there evidence of
impending inflation in the USA?So what is in store for the USA?
In my opinion, the most likely outcome is a nasty slump, possibly
rivalling that of the 1930s. Sometime this year now, I expect the
stock market to crash, as it did in 1929, and then to wind down in a
long grinding bear market for some years.
And time yet for a hundred indecisions,
And for a hundred visions and revisions,
Before the taking of a toast and tea.