Deflation Is Here

I’ve been warning that the markets were on the verge of another round of Deflation. By the looks of things, it’s here with the US Dollar breaking out of its massive wedge pattern.

The ultimate target for this pattern is the mid-80s. So consider this latest breakout the first leg up of a much larger move that will affect all other asset classes in a big way.

In order for a move of that caliber to occur in the US Dollar, we’ll need to see a full-scale crisis hit the markets (the last two US Dollar rallies occurred during the 2008 collapse and the 2010 Euro Crisis). So expect greater downside risk in stocks in the near future.

On that note, the S&P 500 has broken out of its bearish flag formation to the downside. The ultimate target for this pattern is at 1,000: 13% DOWN from here. Considering that we’ve already wiped out a year’s worth of gains in one month, this should be a MAJOR warning that we’re not done yet.

Inflation allows you to still buy stuff, just less of it, with a given amount of money. Deflation allows you to buy stuff, and more of it, with the same amount of money.

The trick occurs with your supplier ~ he will have to sell off his existing stock for less than he paid for it. He will suffer losses. He will be unable to pay his creditors. He will go bankrupt.

There's usually so much bankruptcy up and down the supply chain (from raw materials producers to final sandwich makers) that nothing gets done.

Sometimes deflation will be kept localized to a single country ~ then they can use those extra chunks of money leftover and IMPORT what they need (See: Spain 1500s). Othertimes deflation will be more widespread. In that case if impediments to import/export are put in place ~ e.g. with protective tariffs to encourage domestic producers to not go bankrupt, you'll get a general collapse of trade ~ (See: Great Depression 1930s)

Most individuals will perceive that their existing debt loads are too high to sustain with their reduced incomes ~ even though interest rates may go to ZERO.

Sometimes your first indication that you have serious deflation is the drop in your interest rates. The United States and Switzerland (as usual) are already accepting deposits for which no interest is being or will ever be paid.

The 2 year T-bill rate may go to 0.3% today ~ and tomorrow it may bo to 0.0%. We can envision selling T-bills with as much as a 2% carrying charge where the buyers pay the government for the privilege.

Much more of this and banks will go "bankrupt" ~ check out the status of BOA today.

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