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Clif Droke

Clif Droke

Clif Droke is the editor of the two times weekly Momentum Strategies Report newsletter, published since 1997, which covers U.S. equity markets and various stock…

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Where Are We Along the Inflation/Deflation Curve?

Where are we now along the long-term inflation/deflation curve? Are we heading, as many commentators now assert, into a period of hyper-inflation similar to that of the 1970s? Or is the country moving the opposite direction into spiraling deflation (as Bob Prechter, et al, contend)? Is it possible that both sides in the debate are wrong and that the answer lies somewhere in the middle? I believe this is a distinct possibility (nay, a probability) and I'll outline my position in the paragraphs that follow.

I first brought up the possibility of the coming years being marked by deflation mixed with inflation in an article about three years ago and dubbed it (with special thanks to one of my readers) "retroflation." This term was coined to describe the aspects of living in K-wave deflation while the Fed attempts to keep the economy liquid by priming the liquidity pump. Have we not seen the realities of retroflation in the past two years as certain retail segments of the economy remain low, while other areas have inflated (most notably oil and gasoline)? This amply demonstrates the dual forces of inflation and deflation at work.

I would like to suggest that, for the next few years at least, this mixture of inflation and deflation will present the best of all possible worlds, economically speaking. K-wave deflation will keep the overall consumer price level at relatively low levels while financial asset values and select commodities will continue to rise. We've looked previously at the conditions that are now in place to bring this scenario about, namely, massive levels of debt on the personal, corporate, and federal levels that allow the Fed to pump money with reckless abandon...and get away with it! This is what I mean by "the best of all possible worlds" from a Keynesian's point of view.

Another thing the money masters of the U.S. economy have going for them is that we're about to enter the historically buoyant 05-09 portion of the decade (i.e., 2005-2009) which is historically bullish. In fact, there has never been an exception to this bullish pattern in the last 100 years of U.S. history. The 10-year cycle bottoms at the end of every fourth year (2004) and the subsequent lifting effect spills over into the fifth year of the decade, with intermittent pullbacks in even numbered years (e.g., 06, 08) and typically "up" years in the 07 and 09 years. Thus, 2005-2009 should be overall positive from an economic standpoint.

Let's assume the inflationist position for the next few years is the correct view point. Can we expect steeply rising prices year after year for the rest of the decade? Not likely. During the 1970s, the U.S. suffered through excess money creation which had the effect of overwhelming the country's productive capacity at that time (minuscule in comparison to today's productive capacity). Simply put, too much money was chasing too few goods, hence rising prices.

But let's take the deflationist point of view for a moment. Even if we argue that the real long-term problem is deflation, this still plays into the bullish economic scenario for the next few years. In fact, we can even grant the bears as being correct when they warn over the deflationary threat of China and India. Both of these countries threaten the world with a super-abundance of supply of goods and services. Yet there is more than enough liquidity to answer this supply. In the years to come, prices will remain low because of the supply coming out of Asia, while the accelerating economy will become a job creation machine.

In short, both inflation and deflation alone are impossible at this point along the economic curve. As Donald Rowe, editor of the Wall Street Digest, observes:

"As we move into [the years ahead], excess global manufacturing capacity will prevent a shortage of supply, and hence, will prevent inflationary price increases. Japan's economy, the second largest after the U.S., is growing for the first time since 1989 and will help accelerate global economic growth....add three billion new workers (consumers) to the global free market economy from Eastern Europe (one billion), China (1.3 billion) and India (900 million). Add the wireless/nano-technology revolution as the catalyst for the next great boom, then add the Internet...All of the ingredients necessary for [a] Great Boom are in place..."

Whether or not it will be a "Great Boom" is debatable. But the remaining part of this decade should be sufficiently strong to carry through the long-term forces of deflation and the intermittent pockets of inflation that are likely to be encountered along the way.

Let's discuss for a moment the philosophical aspects of the resurgent bull market. It is a regrettable aspect of American culture that the average American is apathetic when it comes to the character and ruling policy of their leaders. Most Americans couldn't care less when it comes to political or economic policy and the long-term consequences thereof. As long as there is money in the purse, that's all that matters to most.

This is where the engineered, M3-driven bull market will come greatly into play. It is absolutely indispensable for the ruling class that the Fed continues to liquify the economy at a breakneck rate in the next few years. For this is the critical time frame they have been waiting for. We have reached the final step in the age-old dream of a global economy and it's nearing completion. The powers-that-be cannot afford a step backward at this point, hence they've no desire to awake the sleeping giant of the U.S. public. That's why I believe an all-out, two-fisted assault will be waged to keep Americans entranced with money, money, and more money in the remaining years of this decade as the globalist dream is realized by the Elites.

By keeping the average American preoccupied with SUVs, DVDs, second homes, and rising stock portfolios, there almost assuredly will be no protest from Americans when they gradually discover that the "old world economy" is giving way to a global economy with a new set of rules. This, I believe, accounts for the Fed's incessant efforts at keeping the U.S. economy afloat for as long as possible. And so for now, the party continues.

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