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October 20, 2008

Deflation Overload?
by Gary Tanashian

Excerpted from the October 18, 2008 edition of Biiwii.com's Notes From the Rabbit Hole.

Resources from Robert Prechter's Elliottwave International have been presented on Biiwii.com since the site's creation in 2004. This is despite Prechter having become somewhat of a laughing stock in many quarters of the inflation-stoked bull market (RIP 2003-2007) and deflation having been successfully whipped in the previous cycle. Unlike many 'Inflationistas' [see http://biiwii.blogspot.com/2008/07/i-inflationista.html] I kept EWI in mind through the entirety of the bull market where myths of commodity super cycles and the idea that oil was anything other than a bubble were born. I hope readers did as well. Much of EWI's advice has been vital in dealing with the deflationary pressures now outwardly obvious in the system.

But what of my stance; that of 'inflationist'? Here is a quote from the above linked blog post from July, 2008:

The national (and global) front porch is loaded with chickens. Clucking, confused, bloated birds with nowhere else to go. The Fed is 'pushing on a string' and talk of deflation is growing by the week. In a genuine deflation 'scare', this needs to happen. But when you define inflation as increasing money supply - similar to that which Mr. Greenspan promoted earlier this decade, then that 'pushing on a string' can only be inflation, regardless of what prices on most goods and services do. The Fed is inflating and global policy makers stand ready to fight the dreaded forces of deflation (in prices) as well, although many developing regions are still dealing with the effects of the last inflation - booming prices.

Recall that Greenspan's inflation regime took some time to take hold (credit and housing bubbles) and it is far from a sure thing that today's policy makers will be successful in keeping the bubble economy alive. But that does not change the fact that we are in for a whopper of an inflation cycle. It's all in how you define inflation. If the Fed is successful, gold will pick up on it before positively correlated (to the economy) commodities and then under-perform as it did in the middle of this decade. If the policy does not succeed, the collapse predicted by the 'deflationistas' will indeed visit us, in which case there will be a continued mad scramble for liquidity, which means cash and gold. And one of those two will actually have intrinsic value in such a scenario. But the point is that there will be massive inflation (by policy) even as the collapse in credit and general liquidity continues.

...and another post from August 28 (highlighting Steve Saville's article 'The Coming Deflation Scare': http://www.safehaven.com/showarticle.cfm?id=11094. Sometimes it is helpful for me to review these old posts and thoughts that were put to virtual paper well before DEFLATION became a big, red, neon warning sign for all to see. EWI noted several weeks ago, before the acute phase of the panic, that 'deflation' had not yet permeated the mainstream and thus a contrary indicator was intact that implied more downside in all markets but USD. Well, today I believe that claim is no longer applicable and for me personally to abandon my game plan now would be to render all the stuff written in advance of the panic as just words. Today the stance is being put to the test and as Ringo sang, "it don't come easy".

The opening section of this week's letter is inspired by the email of a subscriber who is extremely knowledgeable in precious metals and fiat money creation. In essence his theme is not to deploy capital until he sees 'the whites of inflation's eyes' in the form of all that 'money' created by central banks actually gaining velocity, gaining entry into the marketplace and changing hands instead of sitting in the banks and being used merely as a life preserver. I think his is a good strategy because being 100% in the safest cash equivalents is the surest thing in uncertain deflationary times. It is why I made that very suggestion in the first edition of NFTRH and why I repeatedly post EWI resources like this one on the site and blog: Prechter's FREE 10-Page Market Letter: Be One of the Few the Government Hasn't Fooled. The man is right - now. He was also right in 2002 but Greenspan was pushing on a lever known as the credit bubble. Bernanke's lever thus far has been made of string.

From a contrary point of view we see the clowns in Washington stuffed into a tiny little car in one ring while the second ring in the global money circus presents a daring high wire act by the ECB as the third ring features Asian tigers jumping through flaming hoops. Credit remains frozen, at least to those destinations that even smell like the leveraged offenders in the lead up to the global financial crisis. The money is there. Authorities have created tomorrow's moral hazard, but it is not getting out into economies or even market 'plays'. No doubt the fear overhang from situations like Lehman's CDS derivatives disaster (http://biiwii.blogspot.com/2008/10/fear-of-lehmans-cds-derivatives-haunt.html) is heavily in play here. This can change, especially given that more and more people are coming to believe it won't. I call that a growing counterparty sitting happily in USD.

As for gold, I parrot once again 'the metal is not about price, it is about long run value' as global casino patrons are finding out. People fretting about the nominal 'price' of gold will be flushed if the headline number goes to our potential (potential, an important word) target of 650 http://biiwii.blogspot.com/2008/09/gold-big-picture.html in the hue of that flashing red DEFLATION sign. Gold was flocked into along with USD in the acute phase of the panic. These panickers are now being punished. It is the way this market works. You own it for long term value or you pay the price for short term emotion.

Meanwhile, things are setting up nicely for a contrary play where the entire world is so gripped by credit and economic contraction, and freshly printed funny munny, rather than blasting out full force from monetary policy spigots, just oozes with the viscosity of pre-refined crude oil and the media still work Armageddon '08 into the terrified public's consciousness in a would be run up to the great(est) depression. Funny thing is, a majority of the new depression mongers were just months ago blissfully aboard the great inflation trade. This is the way markets work. Always have, always will I suppose. We may indeed get a depression, but with the pile of 'money' being willed into existence, any reduction in the viscosity of the goop dripping out of the spigot is likely to signal it will be an inflationary one. Watch all sectors closely going forward.

More analysis follows for subscribers in the October 18 edition of Notes From the Rabbit Hole.

Gary Tanashian
http://www.biiwii.com/

Disclaimer: biiwii.com does not recommend that any trading or investment positions be taken based on views expressed on this site. If you speculate or invest it is suggested that you consult a financial advisor qualified in your area of interest.

Copyright © 2005-2009 Gary Tanashian

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