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A question
that many are asking right now is what impact the Fed's latest monetary
policy action will have on the projected deflationary scenario for 2013-14.
Specifically, market participants are wondering if the Fed's monetary policy
action will prevent deflation from running its course.
The answer to
the above question holds profound implications for investors in stocks,
commodities and real estate. If the Fed is serious about its commitment to
stopping deflation at any cost, it could potentially put the brakes on the
deleveraging process and hold off a deflationary nightmare for a few more
years. The emphasis here is on the word "potentially," for it's
still very much in doubt that the Fed's efforts will suffice for reasons
we'll discuss here.
The long-term
deflationary cycle of 120 years is just two short years from bottoming, which
means the proverbial finish line is in sight. The bad news is that two years
can seem like an eternity when the deflation cycle is ravaging the global
economy, as it's expected to do in 2013-14. Even the slightest hesitation or
deviation from the central bank's aggressively loose monetary policy would
allow the floodtide of deflation to overwhelm the financial market and
economy.
Next year is
a critical one for the economy as it marks the start of the final "hard
down" phase of the 60-year/120-year economic cycle due to bottom in late
2014. If the Fed and the other major central banks (notably the ECB) take
their foot off the monetary accelerator for even a minute it will allow
deflation to overspread the global economy, potentially reversing the recovery
of the last four years.
It would be
tempting to conclude that the Fed's commitment to stimulating the U.S.
economy through its recent "quantitative easing" (QE3) effort along
with the ECB's pledge to rescue the euro zone economy will keep the global economy
on an even keel through the end of 2014 when deflationary risks are greatest.
If China, Europe and the U.S. all shared the same commitment to fighting
deflation through loose monetary policy it might be possible to engineer a
soft landing for the global economy. Standing in the way of this, however, is
a troubling lack of coordination on the part of the three major central
banks. It's for this reason that the deflationary scenario is still likely to
prevail by 2014.
Take for
instance the stated intention of the European Central Bank (ECB) to stabilize
the euro zone economy through large scale bond purchases. ECB President Mario
Draghi recently announced the ECB would do
"whatever it takes" to end the euro zone debt crisis. That
announcement coincided with the launching of a $650 billion bailout fund
earlier this month. But while the European Stability Mechanism, or
"bazooka," as it has been nicknamed, is meant to help struggling
European countries by extending loans or making bond purchases, its implementation
is a far cry from what has been promised. Since EU member countries have been
slow to provide start-up reserves, the fund will only have about $100 billion
by 2014, according to reports. As one source pointed out, "That suggests
that troubled countries like Spain may not get much help in the
meantime."
Spanish Prime
Minister Mariano Rajoy was elected just under a
year ago on an austerity ticket. His government has signed off on a
belt-tightening program worth over 60 billion euros through to the end 2014
to cut the country's deficit. But as Reuters observed, "the spending
cuts have dented investment while tax rises have hit consumers' pockets and
driven prices higher." Think of austerity as oxygen deprivation for a
hospital patient who's in desperate need of air. By refusing the life giving
oxygen to a dying patient, both Rajoy and Draghi are exposing Spain to the ravages of the 120-year
cycle decline as we head closer to the fateful year 2014. While this may bode
well for the gold price as investors seek out financial safe havens, it won't
bode well for the euro zone economy or the people of those countries.
Shortly after
ECB President Mario Draghi made his "whatever
it takes to save the euro" statement, Sy
Harding of Street Smart Report pointed out that "whatever it
takes" didn't include cutting interest rates to also stimulate the euro
zone economy. "Concerns are already rising that its announced program of
unlimited bond-buying may even worsen the euro zone's recession, since the program
requires governments that request the debt bailout to adopt and adhere to
strict austerity measures in order to qualify for bond-buying, including
reducing government spending and cutting wages, pensions, and services even
further." All of these things are deflationary and will constrict the
euro zone economy instead of expanding it.
The Kress
120-year cycle due to bottom in late 2014 is the nemesis of central banker.
Although bankers like Draghi and Bernanke
instinctively recognized the deflationary undercurrents of the times, their
reactions in trying to stop deflation are becoming increasingly ineffective.
As David Knox Barker put it in a recent issue of his Long Wave Dynamics
Letter, "It is the mandate of the central banks to maintain price
stability and maximum employment. The problem of course is that by pursuing
these mandates with monetary policies, coupled with fiscal policies, the
problems of price instability and unemployment are exacerbated."
Barker also
points out that central bankers are engaged in a potentially lethal balancing
act between private sector deleveraging (i.e. deflation), monetary stimulus
and austerity. An example of consumer deleveraging can be seen in the
following chart. After the 2008 credit crisis, U.S. households cut their debt
down to pre-recession levels as of late 2012. Home mortgages, credit card
debt, and most other consumer liabilities have drifted back to 2006 levels,
according to Moody's. But as Bob Prechter of Elliott
Wave International has said, credit contraction is ultimately the
"kiss of death" for a consumer based economy like the U.S. Barker
also notes that without central bank intervention, private sector
deleveraging would have been much more profound.
 
While many
economists tried to put a positive spin on the reduction of private sector
debt, others are more skeptical. Kenneth Rogoff of
Harvard University Nathan Sheets of Citigroup say the deleveraging process
still has years to run. They note that while debt as a share of income is
down, the second quarter's 113 percent was above the 94 percent average since
1980. Sheets says the ratio will likely fall
"some years" to about 100 percent.
As for the
extensive stimulus measures of the Fed, central bankers are perplexed why
this historic money creation hasn't resulted in inflation. The reason is
simple: the main force of long-term deflation as governed by the 120-year
cycle is still in play and is acting as a massive counterweight to bankers'
attempts at re-inflating the credit balloon.
"In the
U.S. the austerity comes in 2013," writes Barker. "It could tip the
apple cart." The evidence strongly suggests that the crashing wave of
the Kress 120-year cycle in 2013-2014 will do just that.
One more
factor in our analysis of the debt/deflation cycle should be mentioned:
China. Bloomberg Businessweek magazine reported
that Chinese factories are now experiencing wholesale-cost deflation for the
first time since 2009. Bloomberg also reported that Song Guoquig,
an adviser to the Peoples Bank of China, says deflation is a real possibility
for China in 2013.
Writing in
Reuters, Andy Mukherjee recently observed concerning China: "In an
excessively leveraged economy, even small price decreases can cause large
increases in bad loans and financial stress." This assessment can be
equally applied to the U.S. and explains why the Fed is so eager to pump
liquidity in the face of Kress cycle deflationary pressures.
The ultimate
failure of the Fed's response to global deflation will likely be caused by the lack of cohesion and coordination among
the monetary policies of the world's largest central banks. Between Europe's
bank pushing for greater austerity measures and the U.S. hoping to avoid the
same, it's clear that the bankers are no longer on the same page. This
confusing mixture of deflationary and inflationary monetary policies will
only exacerbate the final "hard down" leg of the Kress mega cycle
into 2014.
Clif Droke
2014: America’s Date With Destiny
Take a journey into the future with me as we
discover what the future may unfold in the fateful period leading up to
– and following – the 120-year cycle bottom in late 2014.
Picking up where I left off in my previous
work, The Stock Market Cycles, I expand on the Kress cycle narrative and
explain how the 120-year Mega cycle influences the market, the economy and
other aspects of American life and culture. My latest book, 2014:
America’s Date With Destiny, examines the most vital issues facing
America and the global economy in the 2-3 years ahead.
The new book explains that the credit crisis
of 2008 was merely the prelude in an intensifying global credit storm. If the
basis for my prediction continue true to form – namely the long-term
Kress cycles – the worst part of the crisis lies ahead in the years
2013-2014. The book is now available for sale at:
http://www.clifdroke.com/books/destiny.html
Order today to receive your autographed copy
and a FREE 1-month trial subscription to the Gold & Silver Stock Report
newsletter. Published twice each week, the newsletter uses the method
described in this book for making profitable trades among the actively traded
gold mining shares.
Clif Droke
is the editor of the three times weekly Momentum Strategies Report
newsletter, published since 1997, which covers U.S. equity markets and
various stock sectors, natural resources, money supply and bank credit
trends, the dollar and the U.S. economy. The forecasts are made using a
unique proprietary blend of analytical methods involving cycles, internal
momentum and moving average systems, as well as investor sentiment. He is
also the author of numerous books, including most recently “2014:
America’s Date With Destiny.” For
more information visit www.clifdroke.com
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