Market Review: Debt Deflation

All "this talk of deflation/inflation is confusing," writes a reader from Australia, "it is as if we are going to get one or the other in spades depending which way we fall off the cliff.

"Here is my thought – could this happen?

"Prices of large asset like houses, businesses, etc. fall heavily (deflate) as demand dries up – for various reasons – like no credit availability, lack of employment needed to meet repayments, lack of cash-flow to service existing debt.

"At the same time we get hyperinflation due to collapse of the US dollar, as it is dumped by foreign holders, resulting in prices of life staples – for which demand is rather fixed – ratcheting up steeply oil, gas, food, etc."

The short answer is: yes.

On my recent sojourn to the States, I had the good fortune to meet up with Bob Prechter, author of the recent best-seller, Conquer The Crash, at his offices in Gainsville Georgia.

Bob, who was kind enough to give us a critique of a book we’ve written ("Financial Reckoning Day" John Wiley & Sons due in bookstores in September), is one of the foremost experts on the subject of deflation writing today. During our discussion Bob suggested, while it’s hard to get your head around, the prospect of deflation on big ticket items in the face of hyperinflation in commodities and "life staples" is very real.

The problem is how you define your terms.

On the one hand, as Lew Rockwell points out this week on the site, "price deflation" brought on by competition or innovation is good for consumers and businesses. If you’re in the market for a new car, a new house or you’re about to get whacked with a tuition bill for your children’s college education – "price deflation" will come as a "glorious" surprise.

Likewise, if you’re a producer of finished goods, price deflation is a welcome development in the marketplace. "You are a manufacturer and your main expense is steel parts," suggests Rockwell, "After many years, even decades, of rising prices for ball bearings and other machine parts, your costs suddenly decline. That leaves more money for investment, marketing, paying employees and enticing investors with dividends. It’s a win-win situation for everyone."

"What deflation does," writes Rockwell, "is provide a disincentive to borrow and an incentive to use current savings for purposes of investment. It means a reward for well-capitalized companies and individuals."

Therein lies the problem.

Looking for insight in "the lessons of Japan" over the past decade (an activity we’re rather fond of ourselves), Morgan Stanley’s Stephen Roach pointed out on Friday that while Japan’s banks are perceived to be the speed bump on the road to recovery there… historic levels of debt in America play a similar obstructive role here at home.

"America," writes Roach, "has record debt loads, especially the household sector, where debt-to-GDP currently stands at 80% — fully 15 percentage points above the ratio prevailing in the recession of the 1990s."

American consumers are not of the "well-capitalized" variety that Rockwell suggests will fare well in a deflationary environment. "Should deflationary risks get to the point where Corporate America needs to slash labor costs more aggressively — both headcount and compensation," warns Roach, "that would severely impair the household sector’s debt-servicing capacity. The result would be a sharp increase in non-performing loans and a concomitant outbreak of distress in the American banking system."

In other words, a banking crisis of Godzilla-like proportions – and credit contraction across the board despite the best intentions of Greenspan and his merry band of printers. The Fed has indicated they intend to do everything in their power to stave of the "remote" threat of deflation; including destroying the currency they had been chartered to protect.

"Since 1913 and the founding of the Fed," Rockwell writes, the dollar has lost 95 percent of its value. It is far more likely that this robbery will continue rather than for our lost purchasing power to be restored to its rightful owners: you and me."

Of course, we’re only guessing, but chances seem high that we’re facing a drying up demand for high-ticket items that require financing… and a continuing destruction of the nation’s paper; resulting ultimately in a rapidly declining standard of living for those bearing it.


Addison Wiggin,
The Daily Reckoning
May 31- June 1, 2003

P.S. With interest rates at 40 year lows, you already know your bank is paying nothing… and now, with the dollar falling, even if your money is sitting in the bank – you actually risk losing a great deal of your wealth.

And we are talking about all your money. not just your actual spendable wealth – cash in the bank – but the underlying value of all the U.S. dollar denominated assets you own – including your house, securities – everything.

But you know what? You don’t have to lose it, just because the dollar is falling. In fact, if you play your cards right, you could even make a buck or two. There are many countries where you can find higher interest rates AND see the value of the currency rise against the falling U.S. dollar.

On Wednesday, I wrote to tell you about Everbank, a bank we work with in the US, offers FDIC insured foreign currency CDs – in all of the major currencies.

With Everbank’s foreign currency CDs, you can take advantage of both the higher INTEREST available on many overseas currencies. and any RISE of that currency against the US dollar. For example, if you earned 5% interest and the currency you purchased goes up against the U.S. dollar by 10% you would make a 15%+ return in a year – on money sitting in the bank.

Everbank, which has over 25,000 clients distributed across all 50 states, has been offering its World Currency accounts since 2000, and the team that manages their currency division were pioneers in this area, starting together with Mark Twain Bank over a decade ago.

While the stock market has been falling out of bed and bond investors scraping for pennies, Everbank’s currency accounts and certificates of deposit have been hitting home run after home run. The following returns are calculated by adding together the interest earned and the currency appreciation:

Currency YTD ’03 Past 12 mos*
Australian $ 19% 22%
British Pound 3.25% 16%
Canadian $ 18% 16.25%
Danish Krone 12.5% 29.5%
Euro 12.25% 29%
New Zealand $ 13.5% 30%
Norwegian Krone 5.5% 27%
South African 15.5% 41.5%
Swedish Krona 12% 30.25%
Swiss Franc 7.25% 22.5%

How’s that for money sitting in the bank?

Contact Chuck Butler or one of the other specialists at Everbank World Markets right now by calling 800.926.4922. Mention that you heard about Everbank from Addison and they’ll be happy to send you a copy of the comprehensive "Decline of the Dollar" research report Chuck wrote earlier this year.

(Everbank is the nationwide division of First Alliance Bank, ranked "superior" by IDC Financial Publishing, and it’s FDIC insured, just like your local bank.)

P.P.S. You’ll find this week in the Daily Reckoning below… If you’ve got some time today, you might find the two part series The Good The Bad, The Ugly might particularly useful in understanding the relationship between gold, the US dollar and the Fed’s position.

PLEASE NOTE: The price of gold and short-term investment opportunities in the face of a falling dollar will be the subject of many a discussion when the Agora crew get together this August in San Francisco. If you haven’t made your reservations yet, you may want to do so right away.

The Agora Wealth Symposium 2003
The Fairmont Hotel
San Francisco
August 13-17, 2003

*** You may also want to make a vacation out of it… immediately following the Symposium the Oxford Club sets sail on an investment cruise to Alaska…


SNOW JOB, II (05/30/03)
by Bill Bonner

"…In addition to bankruptcies and unemployment, business profits as a percentage of GDP have fallen to their lowest level in about 40 years. No mention of this has been made by either the Treasury secretary or the Fed chief. And yet, without profits, why would people invest in new machinery, new ventures, new employees? How could the economy grow? Why would stocks go up?…"

by Eric Fry

"…We will not quarrel with the possible merit of deferring pension plan contributions. But we will point out that deferring the Day of Reckoning does not eliminate it. The pension-plan funding crisis will likely weigh on corporate earnings for years. Likewise, the national savings shortfall will probably stunt economic growth for years to come…"

by Frank Giustra

"…Regardless how it plays out, there is one thing for sure. The world is dangerously awash with U.S. dollars. The downward trend began two years ago and is very much intact. Although it has fallen approximately 25% against the U.S. dollar index, it is still over valued and will most likely fall a further 15% in the next two years alone. In the long run it may go down a lot further…"

by Frank Giustra

There is no doubt that currently America is the most dominant economic and military power on earth. Although the world has seen many great powers come and go, including the Spaniards, the French and the British, America’s influence in all global matters, whether economic, military, technological or cultural, is a phenomenon the world hasn’t seen since the Roman Empire. Sadly, the mistakes that brought about the economic demise of all the past global powers are being repeated with impunity by America’s government and citizens alike…."

by The Mogambo Guru

"….In the usual meaning of the term Big Bang, it means that the universe has collapsed onto itself, and squeezed everything into one tiny, dimensionless dot, and then there was an explosion outward, with glowing bits of burning stuff being hurled willy-nilly into the cosmos, and the sound it makes is a really loud BANG! The primordial matter goes shooting out, cools, gets transformed into planets and people and factories and intangible assets, creating the universe. In the reverse, which I call the "Gnab Gib," because it literally IS the reverse of Big Bang, prices of stuff, say, oh, over-valued assets, disappear FROM around the cosmos into a single point…"


HEADLINE, NEWS And INSIGHT: Eastern Europe and Asia

We, The Traitors
by Adam Michnik

"…What, then, is our betrayal? Today we reject the notion of equality between a regime that belongs to the democratic world – even if it is conservative and disagreeable – and a totalitarian dictatorship, whether its colors are black, red, or green. This is why we will never again say that Chamberlain is no better than Hitler, Roosevelt no better than Stalin, and Nixon no better than Mao Zedong, even if we do condemn Roosevelt for Yalta, Chamberlain for Munich, and Nixon for Watergate…"

The New Currency Paradigm
by William Thomson

"…The appreciating dollar has come at a huge price. The current account deficit has expanded as imports grew and export growth was slashed. Since 1995 the deficit has grown from three to five percent GDP and this year is expected to be 6-7 percent GDP. The US has been trying to dump the strong dollar policy for about a year without saying they favoured a weak one. But since the end of the Iraqi war things have changed. There is a smell of fear and panic in the air…"

The Daily Reckoning