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Page added on January 16, 2016
The Deflation Monster Has Arrived
As we’ve been warning for quite a while (too long for my taste): the world’s grand experiment with debt has come to an end. And it’s now unraveling.
Just in the two weeks since the start of 2016, the US equity markets are down almost 10%. Their worst start to the year in history. Many other markets across the world are suffering worse.
If you watched stock prices today, you likely had flashbacks to the financial crisis of 2008. At one point the Dow was down over 500 points, the S&P cracked below key support at 1,900, and the price of oil dropped below $30/barrel. Scared investors are wondering: What the heck is happening? Many are also fearfully asking: Are we re-entering another crisis?
Sadly, we think so. While there may be a market rescue that provide some relief in the near term, looking at the next few years, we will experience this as a time of unprecedented financial market turmoil, political upheaval and social unrest. The losses will be staggering. Markets are going to crash, wealth will be transferred from the unwary to the well-connected, and life for most people will get harder as measured against the recent past.
It’s nothing personal; it’s just math. This is simply the way things go when a prolonged series of very bad decisions have been made. Not by you or me, mind you. Most of the bad decisions that will haunt our future were made by the Federal Reserve in its ridiculous attempts to sustain the unsustainable.
The Cost Of Bad Decisions
In spiritual terms, it is said that everything happens for a reason. When it comes to the Fed, however, I’m afraid that a less inspiring saying applies:
Yes, it’s easy to pick on the Fed now that it’s obvious that they’ve failed to bring prosperity to anyone but their inside coterie of rich friends and big client banks. But I’ve been pointing out the Fed’s grotesque failures for a very long time. Again, too long for my tastes.
I rather pointlessly wish that the central banks of the world had been reined in by the public before the crash of 2008. However the seeds of their folly were sown long before then:
(Source)
Note the pattern in the above monthly chart of the S&P 500. A relatively minor market slump in 1994 was treated by the then Greenspan Fed with an astonishing burst of new money creation — via its ‘sweeps” program response, which effectively eliminated reserve requirements for banks .That misguided policy created the first so-called Tech Bubble, which burst in 2000.
The next move by the Fed was to drop rates to 1%, which gave us the Housing Bubble. That was a much worse and more destructive event than the bubble that preceded it. And it burst in 2008.
Then the Fed (under Bernanke this time) dropped rates to 0%. The rest of the world’s central banks followed in lockstep (some going even further, into negative territory, as in Europe’s case). This has led to a gigantic, interconnected set of bubbles across equities, bonds and real estate — virtually everywhere across the globe.
So the Fed’s pattern here was: fixing a small problem with a bad decision, which lead to an even larger problem addressed by an even worse decision, resulting in an even larger set of problems that are now in the process of deflating/bursting. Three sets of increasingly bad decisions in a row.
The amplitude and frequency of the bubbles and crashes are both increasing. As is the size and scope of the destruction.
The Even Larger Backdrop
The even larger backdrop to all of this is that the developed world, and recently China, have been stoking growth with debt, and have been doing so for a very long time.
Using the US as a proxy for other countries, this is what the lunacy looks like:
As practically everybody can quickly work out, increasing your debts at 2x the rate of your income eventually puts you in the poor house. As I said, it’s nothing personal; it’s just math.
But somehow, this math escaped the Fed’s researchers and policy makers as a problem. Well, turns out it is. And it’s now knocking loudly on the world’s door. The deflation monster has arrived.
The only possible way to rationalize such an increase in debt is to convince oneself that economic growth will come roaring back, and make it all okay. But the world is now ten years into an era of structurally weak GDP and there are no signs that high growth is coming back any time soon, if ever.
So the entire edifice of debt-funded growth is now being called into question — at least by those who are paying attention or who aren’t hopelessly blinkered by a belief system rooted in the high net energy growth paradigms of the past.
At any rate, I started the chart in 1970 because it was in 1971 that the US broke the dollar’s linkage to gold. The rest of the world complained for a bit at the time, but politicians everywhere quickly realized that the loss of the golden tether also allowed them to spend with wild abandon and rack up huge deficits. So it was wildly popular.
As long as everybody played along, this game of borrowing and then borrowing some more was fun. In one of the greatest circular backrubs of all time, the central banks and banking systems of the developed world all bought each other’s debt, pretending as if it all made sense somehow:
(Source)
The above charts show how hopelessly entangled the worldwide web of debt has become. Yes, it’s all made possible by the delusion that somehow being owed money by an insolvent entity will endlessly prevent your own insolvency from being revealed. How much longer can that delusion last?
All of this is really just the terminal sign of a major credit bubble — a credit era, if you will — drawing to a close.
I will once again rely upon this quote by Ludwig Von Mises because apparently its message has not yet sunk in everywhere it should have:
“ There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
~ Ludwig Von Mises
Well, the central banks of the world could not bring themselves to voluntarily end the credit expansion – that would have taken real courage.
So now we are facing something far worse.
Why The Next Crisis Will Be Worse Than 2008
I’m not just calling for another run of the mill bear market for equities, but for the unwinding of the largest and most ill-conceived credit bubble in all of history. Equities are a side story to a larger one.
It’s global and it’s huge. This deflationary monster has no equal in all of history, so there’s not a lot of history to guide us here.
At Peak Prosperity we favor the model that predicts ‘first the deflation, then the inflation’ or the “Ka-Poom! Theory” as Erik Janszen at iTulip described it. While it may seem that we are many years away from runaway inflation (and some are doubting it will or ever could arrive again), here’s how that will probably unfold.
Faced with the prospect of watching the entire financial world burn to the figurative ground (if not literal in some locations), or doing something, the central banks will opt for doing something.
Given that their efforts have not yielded the desired or necessary results, what can they realistically do that they haven’t already?
The next thing is to give money to Main Street.
That is, give money to the people instead of the banks. Obviously puffing up bank balance sheets and income statements has only made the banks richer. Nobody else besides a very tiny and already wealthy minority has really benefited. Believe it or not, the central banks are already considering shifting the money spigot towards the public.
You might receive a credit to your bank account courtesy of the Fed. Or you might receive a tax rebate for last year. Maybe even a tax holiday for this year, with the central bank monetizing the resulting federal deficits.
Either way, money will be printed out of thin air and given to you. That’s what’s coming next. Possibly after a failed attempt at demanding negative interest rates from the banks. But coming it is.
This “helicopter money” spree will juice the system one last time, stoking the flames of inflation. And while the central banks assume they can control what happens next, I think they cannot.
Once people lose faith in their currency all bets are off. The smart people will be those who take their fresh central bank money and spend it before the next guy.
In Part 2: Why This Next Crisis Will Be Worse Than 2008 we look at what is most likely to happen next, how bad things could potentially get, and what steps each of us can and should be taking now — in advance of the approaching rout — to position ourselves for safety (and for prosperity, too)
Click here to read Part 2 of this report (free executive summary, enrollment required for full access)
24 Comments on "The Deflation Monster Has Arrived"
James Tipper on Sat, 16th Jan 2016 7:25 pm
“Once people lose faith in their currency all bets are off. The smart people will be those who take their fresh central bank money and spend it before the next guy.”
I think people aren’t really losing their faith in currency yet. To your average consumer they see declining prices as a godsend, especially oil and other consumer goods.
It’s only when the deflationary crisis gets so bad that stuff isn’t there will be people snap out of it.
James Tipper on Sat, 16th Jan 2016 7:28 pm
And yes I also agree that saving your money is a fucking joke in this economy and future.
Even the idea of saving your money until your in your late 60’s and can’t even do one quarter of what you used to be able to do is stupid. Let alone being able to afford it.
Might as well take that vacation, buy that $200 haircut, and eat out while you still can.
Saving all the pennies of your income for a future where either money will be useless, or the gov’t will seize it is fucking pointless.
As one person put it, the gov’t can always seize your assets, but they can’t take your experiences. Keep that in mind.
HereWeGo on Sat, 16th Jan 2016 10:57 pm
James, thank you for that incredible insight into what spending habits might look like for a lot of the general public in the near and far term. To think that even someone who has stumbled upon this website (and as a result must have done at least some research on economics) can’t even grasp the concept of compound interest and how it can outpace inflation, really shows that the majority of the population is going to be doomed in their retirement years. From this, you can gain a whole lot of insight. Thank you again
Apneaman on Sat, 16th Jan 2016 11:35 pm
James, truth. As the unraveling continues asset forfeiture, fines, fees, etc will become the order of the day. Already happening for the lower classes regularly. Orlov made a good point about flying under the radar and I agree with him on that. Long before we see a full blown zombie collapse the men in uniforms will be taking people’s shit at every turn. Sorry homesteader, under section bla bla bla, we have the “right” to commandeer your solar panels for the town hospital/police station/public service, bla bla bla.
markisha on Sun, 17th Jan 2016 12:54 am
excellent article, not much to add
James Tipper on Sun, 17th Jan 2016 12:58 am
“To think that even someone who has stumbled upon this website (and as a result must have done at least some research on economics) can’t even grasp the concept of compound interest and how it can outpace inflation”
Tell that to the tens of millions of Americans and people worldwide who “saved” and lost it all in 2001 and 2008. Look at the stock market in the past week, it’s taken an incredible dive.
Keeping your money with the stocks is an incredible risk equal to a roulette wheel. Keeping your money with the gov’t, or in their “pension plans” is like begging a robber not to steal your money. Let’s see how well that worked for the asset seizure that rocked many South American and Eastern European countries. Think it can’t happen here? Think again.
The majority will be lost in their retirement years, if they can even make it that long. “Compound interest” is a product of an ever-growing credit system that’s quickly coming to an end. I joke because even though all these years of savings, one crisis can wipe it all out. Hell even seniors now who saved all of their lives are barely scrimping by.
Don’t tell me what I don’t understand, I’ve taken finance and economics. But I also understand the grim reality for the American empire. Savings are a thing of the past, like the American dream, the white picket fence, the 2.1 kids, and the two-car garage in a nice suburban home. An illusion that is vanishing.
Look at everyone around you, they spend like crazy, almost on instinct. Might as well take out debt and go spend crazy, not like anyone’s going to be there to collect it in 10 years.
onlooker on Sun, 17th Jan 2016 1:50 am
“not like anyone’s going to be there to collect it in 10 years.” That is what I am counting on haha.
makati1 on Sun, 17th Jan 2016 7:42 am
Suggested Sunday reading:
“China GDP totaled more than $10 trillion in 2015: Li”
“Analysis: Qatar charts a new diplomatic path to Russia”
“This is a historical moment”: Xi at launch of new China-led Bank”
At: http://thebricspost.com/
“Travails of a Bankrupt Hegemon”
“America’s Military: They Simply Can’t Be Trusted”
“The End of the Middle Class in the United States”
At: http://journal-neo.org/
And, finally:
“…In the US, some 34,000 pesticides are currently registered for use. Drinking water it is often contaminated by pesticides, more babies are being born with preventable birth defects due to pesticide exposure and chemicals are so prevalent that they show up in breast milk. Many illnesses are on the rise too, such as asthma, autism and learning disabilities, birth defects and reproductive dysfunction, diabetes and Parkinson’s and Alzheimer’s diseases along with several types of cancer. The connection to pesticide exposure is clear….”
http://www.globalresearch.ca/restoring-the-link-between-farmer-and-consumer-challenging-the-corporate-hijack-of-global-food-and-agriculture/5501709
Enjoy!
Davy on Sun, 17th Jan 2016 7:51 am
Another whakco gift from our Canadian neighbors:
“Globalresearch”
http://rationalwiki.org/wiki/Globalresearch.ca
Globalresearch (under the domain names globalresearch.ca and globalresearch.org) is the website of the Montreal-based non-profit The Centre for Research on Globalisation (CRG) founded by Michel Chossudovsky,[2][3] a tenured professor at the University of Ottawa.[4] Weep for the future.
While many of Globalresearch’s articles discuss legitimate humanitarian or environmental concerns, the site has a strong undercurrent of reality warping throughout its pages. Its view of science, the economy and geopolitics seems to be broadly conspiracist. It’s no surprise then that the site has long become a magnet for radicals, fringe figures and whacko elements from the left in general.
enjoy
joe on Sun, 17th Jan 2016 9:15 am
Deflation exists when general price of goods falls. Oil is falling and competition in retail is driving prices down, housing is rising in a poor construction environment. The net impact is almost zero inflation, yet the FED raised interest rates. That will damage the economy, thus the collapse of the stock market. Everyone (who matters) knows though that we will live in corporate socialism and all wrongs will be monetized by the FED. They simply can’t allow us to lose faith in the system of fiat currency they built.
People are saving and wages are falling but deflation of consumer goods is no bad thing in that environment but in the long term it’s bad because investments don’t rise.
Davy on Sun, 17th Jan 2016 6:31 pm
WOW, China may be approaching a critical draw down on its reserves. If that day comes it is “Katti bar the door” in the currency markets. This is not the new reserve currency status the Bric lovers were talking about! This is could be a “free for all”.
“Foreign Central Banks Furiously Dump US Treasuries: Record $47 Billion Sold In First Two Weeks Of 2016”
“China is a paper tiger – with very little reserves left to defend their currency. Perhaps as little as three months given their current burn rate.”
http://www.zerohedge.com/news/2016-01-17/foreign-central-banks-furiously-dump-us-treasuries-record-47-billion-sold-first-two-
“His conclusion is that “swap spreads appear to be blowing out because foreign holders of treasuries, namely China, are selling them at a record pace to defend their currencies. Currency levels are under attack in China, Saudi Arabia and now Hong Kong. The specter of 1997-1998 is again haunting the markets.”
As Green frames it, “the key question is “How long can this go on for?” Consensus is clearly that China, in particular, has a deep pool of reserves with which to defend their currency; I am less convinced. Having seen some contrarian work on the subject, my belief is that China is a paper tiger – with very little reserves left to defend their currency. Perhaps as little as three months given their current burn rate.”
“If accurate (and Green’s calculation excludes the hundreds of billions China may need to leave on its books if its NPL credit cycle finally hits as Kyle Bass is currently anticipating) then the coming months could see an unprecedented shock out of China which having spent hundreds of billions to slow a record capital outflow, has no choice but to let its currency finally float freely, leading to the biggest capital exodus in recorded history.”
GregT on Sun, 17th Jan 2016 6:49 pm
“They simply can’t allow us to lose faith in the system of fiat currency they built.”
The creature from Jekyll Island will be kept alive at any cost, up to, and including, the blood of human beings, both foreign and domestic.
Stevo on Sun, 17th Jan 2016 11:09 pm
Uh…greg you o.k up there? Is your wife cutting back on your meds?
Apneaman on Sun, 17th Jan 2016 11:35 pm
Davy, so you believe in the same things the guy at rationalwiki (and that’s all it is is some guy – not an authority)? Why don’t you contact him with your views on the coming collapse and tell him about your doomstead? He’ll probably make a page just for you. He would call you a malthusian fuctard like nony. Desperate Davy will get in bed with anyone if it helps with his “agenda”. The other day it was a libertarian conservatard blog. Two of Davy’s go to sources diametrically opposed. Is that some kind of even odd days thing? rationalwiki is for atheist, progressive, techno utopian reformers who think with just the right (left) people in office and the right (left) policies everything will be awesome. Science is the cure all. Hillary 2016 and all that. Again you contradict yourself and what you say you believe in. Horseshit Davy.
Apneaman on Sun, 17th Jan 2016 11:43 pm
There’s those sub human 1%ers again.
Richest 62 billionaires as wealthy as half the world population combined
Charity says only a crackdown on tax dodging, higher investment in public services and higher wages can halt the wealth divide widening even further and faster
http://www.theguardian.com/business/2016/jan/18/richest-62-billionaires-wealthy-half-world-population-combined
Apneaman on Sun, 17th Jan 2016 11:53 pm
Wealth of richest 1% ‘equal to other 99%’
http://www.bbc.com/news/business-35339475
makati1 on Mon, 18th Jan 2016 12:34 am
They must be hate China as the Chinese government has just slammed the door on taking money out of China.
http://www.chinalawblog.com/2016/01/getting-money-out-of-china-what-the-heck-is-happening.html
Guess that ends the purchase of high end property in the US. There goes the housing bubble.
GregT on Mon, 18th Jan 2016 1:14 am
Yep Stevo, doing fine. Thanks for asking man!
Question for you buddy. Was the US invasion of Iraq that resulted in the brutal slaughter of a couple of hundred thousand Iraqis, and several thousand American servicemen a reaction to:
A: Saddam Hussein was the mastermind behind 9/11?
B: Saddam Hussein was stockpiling weapons of mass destruction?
C: Saddam Hussein was harbouring terrorists?
D: Saddam threatened to undermine the USD by trading Iraqi oil in Euros and/or gold Dinars?
Take your time Stevie boy, and you’re welcome to use whatever references you like.
GregT on Mon, 18th Jan 2016 1:49 am
“Guess that ends the purchase of high end property in the US. There goes the housing bubble.”
Well if that’s true, all of those 1.5 million dollar 60 year old shacks, on 33 foot wide city lots in Hongcouver, will soon be worth what they really should be. Less than 200K.
makati1 on Mon, 18th Jan 2016 3:58 am
GregT, most homes are not worth more than $100 per square foot, the actual cost to construct the average home in America. If you do it all yourself, it can be done for half that cost. Been there. Done that. Land prices, extra.
It is only snob appeal that makes them worth more to some. Like those who buy luxury cars that say “steal me” or wear designer clothes with the labels on the outside. ‘Pretend’ stuff for a fantasy nation. LOL
makati1 on Mon, 18th Jan 2016 4:02 am
GregT, answering correctly will blow the who charade in his mind. But, the answer is the same for Qaddafi in Libya and a few other countries recently. Now Iran is doing the same, as is Russia and China and India and …
Getting interesting isn’t it?
Davy on Mon, 18th Jan 2016 6:42 am
There the Ape Turd goes again putting words in someone’s mouth and labeling. I have never said I believe in anything as per the Turd’s usual label material. I referenced a site that called into question global research extreme stances for people with anti-American and anti-western agendas. Attaching Hillary to me also is more of your embellishment. I am not voting as a matter of fact. I can’t be part of a circus. Basically Ape, what you do is put labels and embellish words of others you don’t like. That is nothing but a familiar tactic of extremist who preach hate discontent. You are a board bully that has no code of conduct or manners. You act like the end justifies the means and all that. You think this gives you the right to be selectively racist with class and nationality. You preach bile and nothing more.
Davy on Mon, 18th Jan 2016 6:59 am
Continued Chinese currency calamity and contagion:
“China Stocks, Credit Risk Worsen Despite “Short-Squeezed” Yuan Strength”
http://www.zerohedge.com/news/2016-01-17/china-stocks-credit-risk-worsen-despite-short-squeezed-yuan-strength
“The expectation of yuan devaluation has led to massive remittance of yuan,” said China Industrial Bank’s chief economist Lu Zhengwei. “Raising the RRR will increase the cost of arbitrage,” Lu said.”Domestic banks conducting exchanges offshore and remitting yuan to China will be further controlled, pushing up the cost of offshore yuan funding.”
“Although it does pose the question how desperate China must be, and how massive the capital outflow, if the PBOC is engaging in new FX manipulations virtually on a daily basis to prevent the ongoing uncontrolled devaluation of its currency. Perhaps related to that, Chinese sovereign default/devaluation risk surges.”
“But analysts are starting to worry: “2016 is a year when we will see systemic risks emerge in China’s credit market,” said Ji Weijie, credit analyst in Beijing at China Securities Co., the top arranger of bond offerings from state-owned and listed firms. “There may be a chain reaction as more companies are likely to fail in a slowing economy and related firms could go down too.”
Apneaman on Tue, 19th Jan 2016 12:50 am
Why are we looking on helplessly as markets crash all over the world?
The imminent collapse of the Chinese Ponzi-scheme economy shows that we need to bring control to the international economy
http://www.theguardian.com/commentisfree/2016/jan/17/china-economic-crisis-world-economy-global-capitalism