Signs Of Deflation

The Daily Reckoning
Weekend Edition
July 13-14, 2002
Paris, France
By Addison Wiggin

“It cannot be repeated often enough,” repeats Dr. Richebacher, “that the causes and pattern of the current U.S. economic downturn are radically different from the garden-variety type of the postwar period.”

For the first time ever, the economy has sharply slowed in the absence of any monetary tightening. And it doesn’t look like it’s going to let up any time soon.

Mr. Market – doing his part in this charade – wrapped up his worst week since the aftermath of the Sept. 11 attacks. In fact, during Wall Street’s eighth straight losing week – and the Dow’s fourth biggest weekly decline ever – the Dow discharged 695, or 7%, to 8,684. The Nasdaq lost 5.2% and the S&P 500 slipped nearly 7%.

Of course, we don’t want to forget the basic reason behind the market’s decline: equities achieved unrealistic heights during the bubble mania of the late 1990s. They’re now trading back at levels last seen when Monica Lewinsky became the first women in history to become famous for decisions made while sorting laundry.

But historically speaking – we ain’t seen nothing yet. During the last great bear market – lasting from January 1973 to December of 1974 – the Dow fell 45% and the Standard & Poor’s 500 lost 48%.

“If stocks were to suffer a similar decline now,” an analyst pontificates in USAToday, “the Dow could fall to 6448, or another 27%, and the S&P to 794, or 14%.” The question for the fabled ‘rebound’ in the US economy is this: “while recessions typically lead to bear markets, can a bear market create a recession?”

“The deflationists argue ‘yes’,” says John Myers. “The destruction of wealth on Wall Street will force consumers to cut spending – which accounts for two- thirds of the GDP – plunging the United States into a stock market-induced recession.”

Of course, “there would have to be a significant trigger,” writes John Mauldin, “for the economy to lurch back into recession this year. Trouble is, there are plenty of potential triggers in the world today: terrorism, Brazil possibly collapsing, consumers starting to pay down debt instead of spending, etc.

While it’s true, argues Mauldin, that at some point in our economic life, we are going to have to deal with the debt this nation has built up… these triggers have been here all along. What would cause the Fed to lower rates?

“Deflation is the one thing that comes to my mind.” More on the threat of deflationary spiral (than you probably ever wanted to know)… below.

Bon weekend,

Addison Wiggin,
The Daily Reckoning
July 13, 2002

P.S. Tomorrow is France’s answer to the 4th of July. This year the French government has invited a couple hundred American troops to parade down the Champs Elysee alongside the elite French corps.

Walking to the office this morning I passed by the Hotel de Ville. The square in front of the Hotel was empty and serene. American flags were draped all over the building and lamposts there, next to there French counterparts. The scene echoed the words of one colleague from the Paris office on the morning of September 12th: “Today, Addison,” she said, “we are all Americans.”

P.P.S. While most of the market has be plummeting in the great bear market of ’00 – ?, John Myers’ Outstanding Investments portfolio has been enjoying a very fortunate up cycle. For the first half of this year, the Dow was down 7.8%… the NASDAQ was down even more… an embarrassing 24.9%. But OI stocks are looking at an average gain of 29.6% for the first half.

In fact, the turnaround in commodity prices we’ve been following with some interest here in The Daily Reckoning, is powering Myers’ picks to unbelievable highs. His gold picks, as you might imagine, have been some among the biggest winners this year – led by Francisco Gold up 238%… and Harmony Gold – up 105%.

But our gains haven’t been limited to the Midas metal. Even though oil has been in a bit of a rut, our Canadian gas pick Niko Resources is up 102% for the first half. Another pick, KeyWest Energy, is up 41%.

THIS WEEK in THE DAILY RECKONING
by Bill Bonner

07/12/02 OVERESTIMATION

“…Who ever underestimated the American economy, we wonder? Au contraire, it seems to have been over- estimated in every detail and by everymeasure…”

07/11/02 THE GREAT WAL-MART OF CHINA
Guest Essay by Sean Corrigan

“…By attempting to make mere money substitute for capital, by pursuing what is known as a mercantilist “development” program – valuing useful imported goods less than sterile monetary reserves and sheltering favored exporters to earn them – and by preventing the free market from working its invigorating magic on the masses yearning for self-improvement, the Chinese authorities are actually impoverishing theirnation…”

07/10/02 DEFLATION

“…Since WWII, the Fed’s mood swings do seem to correspond with the ups and downs in the economy. But sometimes things happen even if America’s central bankers are not particularly in the mood for them…”

07/09/02 DOOMSDAY FOR WALL STREET?
Guest Essay by Martin Weiss

“…I wish I could tell you that even one, single, solitary brokerage firm would have the courage to step up to the plate and say, ‘You’re right. We lied, cheated, and stole billions of dollars from unsuspecting investors. We all did it. Now let’s throw the guilty behind bars.’ But nobody’s talking – even when they’ve been caughtred-handed…”

07/08/02 CONTRARIANISM FOR EVERYBODY!

“…We tossed and turned Saturday night and banged our head on the roof rafters while pondering the subject again on Sunday. How can we remain contrarians now that everyone agrees withus?…”

* * * * * * * * * * * * * * * * * * * * * * * * * * * *

HEADLINE, NEWS And INSIGHT: OHHH So Easy Money, Time To Sell Dollars?… ‘The Economy’ Appears To Have A Will All Its Own… Should The Fed Cut Rates (Again?)… Would It Do Any Good?

Profit from America’s Easy Money Addiction
by John Myers

“…As the U.S. money supply grows at double-digit rates and America’s total debt burden surges to astronomical heights – $32 trillion and counting…Individual investors will not hesitate to sell dollars or investments denominated in dollars. They’ve done itbefore…”

The Profitless New Economy
by Dr. Kurt Richebacher

“…It cannot be repeated often enough that the causes and pattern of the current U.S. economic downturn are radically different from the garden-variety type of the postwar period. For the first time ever, the economy has sharply slowed in the absence of any monetarytightening…”

FLOTSAM AND JETSAM: Cutting rates now probably wouldn’t help the stock market… and would send a signal the Fed was panicking.

WHOSE HAND IS ON THE TRIGGER?
– John Mauldin

“…there would have to be a significant trigger for the economy to lurch back into recession this year.

Trouble is, there are plenty of potential triggers in the world today: terrorism, Brazil possibly collapsing, consumers starting to pay down debt instead of spending, etc. But these types of triggers have been there all along. At some point in our economic life, we are going to have to deal with the debt this nation has built up, but I can’t see that trigger getting pulled this year.

So, what could cause the Fed to lower rates? Deflation is the one thing that comes to my mind. One of the basic rules of central banking as espoused by Paul Volker is “Don’t do anything you can’t fix.” If the Fed creates a little inflation they can fix that.

But if they allow deflation, it is not altogether clear they can fix that problem. We only have to look at Japan to see how difficult it is for a major capitalist market economy to pull itself out of the doldrums of deflation.

I believe Greenspan is far more concerned about deflation than he is inflation. If inflation was the concern, he would not have pumped the money supply almost 50% in just five years. In any other environment or country, that would be sending inflation and interest rates through the roof.

I get asked all the time, “Won’t the dollar dropping bring inflation back?” My answer is that is usually the case, but not likely this time. The world has a massive problem of too much production capacity. The dollar has dropped 10% or more against most currencies, and yet prices of imported goods are now 3.9% lower than in June 2001. They were lower again last month.

How can prices be lower if the dollar is dropping, you ask?

In a theme oft repeated here, manufacturers have no pricing power. Period. In this type of environment, inflation has a hard time getting any traction.

Foreign producers will do what they have to do to get American consumers to buy. If that means taking less money to keep their factories going, it appears they are willing to do so, at least for now.

Further, as Greg Weldon says, “Paper is Burning” around the world. As companies file bankruptcy, this reduces the supply of money. Debt deflation is the one trigger that could start a second and more severe recession. If you thought Argentina was a problem, Brazil could be a far more serious issue, as many banks would have to write off massive amounts of debt if Brazil defaults, which is a real possibility.

If the Fed cuts rates this year, I think it will be likely because they are worried about deflation, and it would indicate the feel that simply printing money is not doing enough to stave off deflation. For me, this would be a huge warning flag…”

Editor’s Note: John Mauldin is an investment advisor in Texas and an authority on hedge funds. His latest book, “Absolute Returns,” on hedge funds and alternative investments, will be out this fall. He also writes The Accredited Investor E-letter, which teaches qualified investors how to find and invest in private offerings.