Sunday, October 5, 2008

The deflation versus inflation debate

Are we going into deflation or inflation? That seems to be a widely debated topic. I thought inflation would win out, but I was wrong. We're going into deflation for at least 1-2 years. The evidence is and was all there but I thought Helicopter Ben could work some more magic for another round. Now I don't think it's gonna happen (why the hell did I rely on a pseudo-bureaucrat to fix markets?!). This is going to be a wicked, deflationary bear market that is probably not more than half-way done. Though an intermediate-term bottom is likely coming within the next month for the major indices, it will be just that.

How can I be sure of the deflation argument? The chart below, which is from from Ned Davis Research, and the credit market events over the past 14 months.

The housing market crash has caused the debt bubble to begin its implosion. Defaults are accelerating (whether voluntary or involuntary and whether personal or corporate), banks are insolvent and hoarding money/tightening lending standards, the "shadow banking system" of derivatives is frozen, and the psychology has shifted to fear. Once a bubble like that shown in the chart above bursts, it ain't coming back. Notice the last time the debt bubble popped was in the early 1930s. In case you're wondering, yes, we are headed for a similar socioeconomic replay.

If you're not familiar already, now is the time to get into Elliott Wave theory via Robert Prechter and the gang at I would recommend reading Prechter's book "Conquer the Crash" immediately if you have not done so. We've started the nasty "C" wave down and it's going to get ugly.

Inflation may certainly rear its ugly head once this deflationary collapse finshes, as our country is ripe for a good old-fashioned currency crisis once the dust settles. The guy at this link says it better than I can, but I envision a similar series of events ahead:(

In any event, the times ahead will not be pretty, and I'm not just talking about the stock market. This is not doom and gloom, this is preparing for a pending reality that has historical precedents in the United States.

Cash, gold and gold stocks, and going short the market are the best investment alternatives. Being a bull on general equities is the equivalent of financial suicide, though nimble traders can play the wicked bear market rallies that will occur. If you don't know what you're doing, SELL ALL YOUR STOCKS TODAY AND GET INTO CASH, preferably using short term government paper equivalents (i.e. 5 years or less duration federal government bonds). Stuffing cash and gold under the mattress for a year or two is a viable option as well. Remember, in a deflation, cash is king!

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