Impacts Of Deflation
The Daily Reckoning Presents: A guest essay in which the
author suggests that – for the first time in more than
half a century – an old but ever-powerful economic foe
is about to pound the American economy with the fury of
a hundred hurricanes. Oh… and predicts the Nasdaq will
see 500 before we’re through.
IMPACTS OF DEFLATION
by Dr. Martin Weiss
Just a few months ago, I went to Brazil to visit my in-
laws. On the drive from the airport, we stopped at a red
light. A woman approached me on the passenger side,
handing me a full-color pamphlet for brand new VWs on
sale. Their cheapest model was under $5,000!
At the next light, another woman gave me still another
pamphlet – luxury condominiums, once worth up to
$150,000, on sale for under $60,000. I sat in the car in
utter amazement. I always remembered Brazil as the
country of inflation. Now, deflation was rampant.
On the other side of the world, in Japan, the deflation
is even more incredible.
The last time I was there, prices were still outrageous,
and the experts said they’d “never” come down. “The
network of wholesalers and retailers is too convoluted,
too deeply ingrained,” they argued. “Deflation in Japan
is impossible,” they insisted.
Now, Japanese consumer prices have been tumbling
virtually nonstop for two years. A hamburger costs half
of what it did a year ago. Cotton polo shirts are 60%
cheaper. Real estate is down 50%, 60%, even 80% in key
You have not seen that kind of deflation here in America
But you will.
The deflation is not only coming here from abroad. It’s
also spreading from within – from the bust in
technology. The going price for registering an Internet
domain name has fallen from $70 to $7.
You can now buy almost-new computer servers made by IBM,
Compaq, or Sun for 30 cents on the dollar. The price of
a 128-megabyte dynamic random access memory chip, or
DRAM, used in virtually all personal computers, has
plunged from $14 in February to under $2 right now. Can
you imagine that? An 86% plunge in just 10 months!?
No wonder companies that make them are losing money hand
In the world commodity markets, prices are also
collapsing. Crude oil plunged 24% in a mere 10 days in
October. Since the beginning of this year, copper is
down over 12%; zinc, down 28%; and nickel down 14%.
Natural gas hit $11 per million BTUs back in December of
last year. Now it lingers a hair above $2.
Until recently, deflation had been mostly overseas or
limited to certain sectors. Now, it’s lapping at our
shores and beginning to spread rapidly.
Like the ups and downs of the stock market, the tide of
deflation does not flow forward in one straight line. It
come in waves that ebb and flow.
You will see massive deflation one month, and then a
temporary flare-up of inflation the next. You will see
the same zig-zag decline in corporate profits, consumer
confidence, the economy, and the psychology of millions
of Americans. But the die has been cast. There is no
turning back to the old era of non-stop growth or nearly
In October, U.S. wholesale prices suffered the sharpest
decline since the government began keeping records in
1947. In just one month, vegetables fell 11.4%,
passenger cars fell 4.7%, and gasoline prices fell a
Yet, there are many sectors that have yet to be touched
by deflation. The housing market is still a bubble
waiting to burst. The cost of furniture is still holding
near its peak. Your electric bills, medical costs, and
other basics have not yet come down.
While at The New Orleans 2001 Investment Conference a
week ago, I picked up the New York Times. Right there on
the front page, it said exactly what I’ve been warning
you about: “As the number of bankruptcy filings by
public companies surges to a record, companies are
increasingly being forced to liquidate instead of
reorganizing…to sell pieces of their business to the
Do you realize how dangerous this is? Already this year,
a record 230 public companies, with more than $182
billion in assets, have filed for bankruptcy – more than
double the assets for all of last year. And that’s
excluding Enron, with an additional $62 billion in
Imagine the kind of price declines that’s causing!
Why? Because more so than ever before, rather than using
bankruptcy as a way to fix their balance sheets, many
companies are simply closing shop and selling off their
inventories, receivables, real estate, equipment,
furniture, technology, customer lists – anything for
almost any price.
Do you see the consequences? This kind of selling
inevitably produces deflation of the meanest variety –
the kind of deflation that spreads with amazing speed
and fury, taking even the savviest of investors by
surprise. Consider just a few of the unstoppable
* We’ve just seen the worst collapse in corporate
profits since the Great Depression. Every penny of the
total profits earned by the 4,000-plus Nasdaq companies
since mid-1994 has been wiped out.
* Just one company, JDS Uniphase, has recorded the
largest single loss in the history of civilization.
* Enron, the seventh largest US company in revenues, has
gone belly-up. Its stock has collapsed from $90 to a low
of 25 cents – wiping out more than $65 billion in
invested capital, almost every single penny invested by
* Junk bond issuers are defaulting in record numbers.
Even excluding Enron, US companies have defaulted on
$75.2 billion in junk bonds – more than 57% above the
record $47.8 billon recorded last year. Examples:
Bethlehem Steel defaulted on $179 million in bonds and
has now filed for bankruptcy, gutting the portfolios of
thousands of investors…Swiss Air defaulted on 1.5
billion, destroying the wealth of thousands more…in
the second week of November, US banana producer Chiquita
defaulted on $700 million in debt…wireless data
provider Metricom defaulted on $300 million in high-
yielding 13% bonds that were due in 2010. (Apparently
13% sounded great to thousands of investors. But what
good is it if they never get paid?)…Comdisco, a
leading information technology leasing and venture
capital company just filed for bankruptcy, leaving
holders of its $2.82 billion in public debt out in the
All of these had been downgraded to junk before they
defaulted. Who’s next?
Rather…you might ask: what’s next?
When the techs wrecked last year, real estate prices in
high-tech areas of the country nose-dived. Austin, New
York City, and other silicon cities felt the shock
waves. The San Francisco Bay area was especially hard
Now, with a recession officially here – and spreading –
real estate deflation is beginning to spill over the
Rockies, across the plains, and into the South.
You may not have felt it yet in your area. But the
national stats don’t lie: The median existing home price
dropped 4.1% in September and another 1.4% in October.
Average home prices in the Midwest, the one region that
had been spared from the tech wreck fallout, suffered
the biggest decline of all – a whopping 4.5% in just one
month. If they continued to decline at that pace, home
values would plunge by more than half in less than a
Homes have been the Rock of Gibraltar of household
wealth in America…the ultimate source of collateral
for more credit…the last bastion of stability in the
Now, housing, too, is beginning to slip into a serious
Deflation has been the nightmare of the tech industry
for nearly two years. Now, it is on the way to becoming
a nightmare for other industries as well.
The same exact deflation-driven profit squeeze you saw
at the computer server company will repeat itself for
autos, appliances, housing, and even services. It’s no
different than the selling frenzies you’ve seen in the
stock market: Prices fall because people are selling …
and people sell more because prices are falling.
They sell for all kinds of reasons – because they’re
driven by their inner psyche, because they’re shoved by
external pressure, or simply because everyone else is
And the irony of our market economy is that almost every
product and service is traded freely.
Electric power. Water. Temporary workers. All this may
be good for a steadily growing economy, but it’s
potentially very painful in deflation. So, stay the
course. Don’t let market rallies or upticks in the
economy distract you from the big trend – down.
Recession, deflation, and a new wave of bankruptcies
will drive the Dow to 5000 and the Nasdaq to 800. In the
meantime, accept the latest stock market rally as a
gift. Use it as your convenient exit door…before that
door slams shut.
Even in this environment, Wall Street pundits will pound
the table, put a positive spin on every tidbit of good
news, and help generate stock market rallies.
Don’t let them fool you,
December 19, 2001
for The Daily Reckoning
P.S. Deflation is flattening foreign economies and
promises to drive credit addicts into painful
withdrawal. For more on these and other deleterious
trends afoot please see:
Deflation Flattening Foreign Economies
Martin D. Weiss, Ph.D., the nation’s leading advocate
for financial safety, has helped millions of Americans
with his ratings of stocks, mutual funds, insurance
companies, banks, brokerage firms and HMOs. Martin has
testified before Congress repeatedly, advocating full
disclosure of risk to investors.
The Wall Street Journal says Weiss runs a “feisty firm,”
and Esquire noted that his is “the only company…that
provides financial grades free of any possible conflict
of interest.” Forbes calls Dr. Weiss “Mr. Independence.”
Is there anyone in America who doubts that a
recovery is coming early next year? Is that person
awake? Compus mentis? Literate? Vertebrate?
As Eric reports below, stocks rallied again
yesterday. Investors expect Congress to leave a present
under the tree before leaving town on Friday – a
“stimulus package” that is supposed to rev up the
economy. This, combined with victory in Afghanistan, 11
rate cuts, and double digit money growth is supposed to
give the economy the vitality it has so recently lacked.
At least, everyone says so.
“As night follows day,” observes Morgan Stanley
economist, Stephen Roach, “recovery follows recessions.”
But when we look out our window at today’s
economy, we see don’t see the pitch of night. As
mentioned in this space yesterday – consumers are still
spending, cars and houses are still selling, stocks are
still at very high prices. If this is as bad as a
recession gets…well, heck, what was all the fuss
Instead of the dark of night, we see tenebrous
skies and a half-light that could be the dawn of a
recovery. Then again, it could be the fading,
crepuscular light of evening. The sun could be going
down as well as up. Here at the Daily Reckoning, we bet
it’s sinking into recession, not rising out of one,
meaning that the dark of night is still ahead of us:
“After the Fed’s most aggressive interest-rate
cutting ever, the news on the U.S. economy and corporate
earnings [is] becoming ever gloomier,” writes Dr.
“The International Monetary Fund warned on
Tuesday,” adds the Financial Times, that “there was a
significant possibility of a worse outcome” than its
central forecast of a recovery in the world economy next
“The IMF said the U.S. current account deficit and
the historically high level of stock markets were the
most serious threats to its prediction that the world
economy would grow by 2.4 per cent next year.
“In the U.S., the IMF said the overhang created by
past over-investment and high levels of consumer debt
might depress demand and lead to growth being even lower
than its 0.7 per cent forecast for next year.”
And Dr. Martin Weiss suggests, “emerging economies
were falling in the wake of the global tech wreck. Now,
add the events of September 11, the fallout from global
deflation, and the plunge in worldwide exports…and you
have a deadly poison with no anecdote.” More from Dr.
Eric, what’s the latest from Wall Street?
Eric Fry in Manhattan…
– The Santa Claus rally continued yesterday as the Dow
gained 106 points to 9,998. The Nasdaq reclaimed 2,000
by advancing 17 points to 2004.
– The stocking-stuffer most delightful to investors was
General Electric’s upbeat earnings forecast. The
industrial conglomerate wowed investors by forecasting
operating earnings growth of at least 13% next year. GE
stock charged ahead 4%.
– An unexpectedly large jump in housing starts added to
the Yuletide mirth. Housing starts rose at an annualized
rate of 8.2% in November, reinforcing the view that the
economy is quickly getting back on track.
– To be sure, a festive mood has returned to Wall
Street. But not everyone is celebrating. “Luxury hotels
have been hit hard by corporate-travel cutbacks,” the
Wall Street Journal reports. “After sharp declines that
began even before Sept. 11th, U.S. hotel occupancy rates
and prices have stabilized…at nearly record low
levels.” Ernst & Young predicts that national hotel
occupancy rates in 2002 will be at the lowest level in
– And then there is Gap Inc., the beleaguered clothing
retailer who ought to be enjoying the fruits of another
Christmas shopping season. But there will be little joy
in “Khaki-ville” this year.
– Last week, the analytical team over at
Grantsinvestor.com called attention to Gap’s falling
profitability and rising debt burden. The financial
website issued a fresh analysis on Monday that seemed to
touch a nerve, both at Gap headquarters and within the
paneled corridors of Wall Street. Daily Reckoning
readers might find it illuminating to see a glimpse of
how public companies and Wall Street firms respond to
(For the record – when I’m not busy writing my part of
the Daily Reckoning or taking out the trash in Agora’s
offices – I pitch in a bit over at Grantsinvestor.com,
helping to guide its investment research effort).
– Last weekend, while Grant’s Investor analyst Robert
Tracy was sifting through Gap’s latest quarterly filing
with the SEC (known as the 10-Q), he found some
troubling disclosures. Tracy writes, “Gap warns in the
10-Q that fiscal fourth-quarter earnings will be worse
than the third quarter’s: ‘Looking at the remainder of
the fourth quarter, it is reasonable to expect that the
negative trends in comparable store sales and gross
margins could continue. On that basis, fourth quarter
earnings per share would be considerably worse than the
six cent loss reported in the third quarter…’
– “Given that [Gap’s] same-store sales in November fell
by 25%, ‘considerably worse’ seems like a strong
possibility,” Tracy warns. “Gap’s balance-sheet
liquidity is clearly deteriorating. While we would not
yet wheel this equity into ICU, the vital signs are not
– Within hours of its release, the report had spread
through the financial press like a computer virus. The
Wall Street Journal jumped on the story first, followed
by CNN, Bloomberg News and the Financial Times. Gap was
not pleased. That was to be expected. Two Wall Street
firms were not pleased. That was also to be expected.
– At first, when queried by Wall Street Journal
reporter, Amy Merrick, the company refused comment. But
then, around about 1:30 AM Eastern Standard Time, Gap
issued a press release asserting that Grant’s Investor
“misestimated” its debt levels. The company provided its
own, more-pleasing estimates.
– However, Gap was mute regarding the most essential
issue raised by Grant’s Investor: that Gap’s cash flow
is falling rapidly. The company said merely, “Gap Inc.
does not confirm or deny any other statements made in
the Grant’s Investor Inc. report.”
– UBS Warburg retail analyst Richard Jaffe rushed to
Gap’s defense. He told CNN.com that a serious debt
problem at the Gap was “a huge stretch of the
imagination.” Jaffe did acknowledge, “There’s no
question things are stinky at Gap…” Nevertheless, he
maintained his “buy” rating on the stock with an $18
– “It seems a new rating has been invented – ‘Stinky
Buy’,” quipped Grant’s Investor writer, Andrew Kashdan.
About midday, a very angry bond analyst from Goldman
Sachs telephoned Robert Tracy directly and voiced his
displeasure with Grant’s Investor’s bearish conclusions.
– More than likely, the analyst’s displeasure stemmed
from the fact that Gap’s publicly traded bonds had
plunged about 5% in response to the Grant’s Investor
– The established Wall Street players don’t like bearish
views, plain and simple – especially when the views are
on target. It makes their jobs a lot harder and costs
them money. Bullish research is far more lucrative for
Wall Street…even when it isn’t true.
Back in Paris…
*** Recently, I had breakfast in London with Martin
Weiss. I discovered, to my delight, that we share
remarkably similar views about the economy, the stock
market, politics, Alan Greenspan, the future, education,
English breakfast, the Chunnel. I asked him to edify us
with his views on deflation.
Leaving no stone unturned, Dr. Weiss comments: “Most
politicians and regulators don’t understand deflation.
They don’t know what’s hitting them – let alone what to
do about it. Even Alan Greenspan will be helpless to
stop the onslaught. Sure, he has the power to pump
billions of dollars into the economy. But unless
businesses and consumers spend or invest those dollars,
it goes dead – like a blood transfusion without a
heartbeat. Right now…
Businesses are hell bent on cutting back – not spending
more. Since October 2000, they’ve fired a jaw-dropping
2.2 million people. They’ve cut down their help wanted
ads to the lowest level since 1982. They’ve slashed
expenditures on new technologies to the bone; outlays on
travel, almost to zero.
Some consumers are spending again – but only if the
prices are slashed or the credit is free. That’s why GM
has extended its zero-interest financing until January 2
…why Best Buy stores placed 75% of their computers on
sale…and why virtually no store in the nation could
avoid massive price-cutting even on the very first day
of the Christmas shopping season.
Now, as soon as these special deals run out, you’re
going to hear the clicking sound of millions of
pocketbooks slamming shut once again. How do I know?
Because consumer confidence has continued to plunge – to
the lowest level since February 1994.
That’s why the Fed’s money pumping will NOT end the
decline. At best, it will only generate temporary lulls
and upticks. At worst, it will just raise expectations
and cause even greater disappointments – and more panic
– for investors.
The Fed can pump in another trillion dollars and drop
the Fed funds rate to zero…and it still wouldn’t be
enough to spark a real recovery in the economy.”
Still more below…