Deflation to the fore

Oil, gold, bonds and global GDP scream deflation

Here we go again. For the umpteenth time since the 2008 financial crisis the rate of global growth has plunged yet again. But this time is different- on two counts.

One is that US stocks are at all-time highs and stocks in most other markets are either near all-time highs or at multi- year highs and this is occurring at a time when global GDP rates are plunging. This is a first since the 2008 financial crisis and such a vast discrepancy is worth noting. The other unique development is just how broad based this latest downturn has been all over the world.

Today even the mighty German and Chinese economies are suffering headwinds not seen since the last crisis. In fact Germany experienced its first decline in growth in the second quarter and most Eurozone countries are now steeped in a recession despite negative interest rates from the ECB, underscoring the folly of their gimmicks. Yet despite their LRTO to commercial banks, negative interest rates and the like the ECB decided at their last meeting this wasn’t enough to spur growth so they finally decided to deploy full scale QE (Ponzi) measures.

In recent weeks commodities, bonds and global GDP rates have plunged together to invoke fresh worries about deflation. Last week the CRB index of all the major commodities plunged below its key trend line as silver joined oil and many other commodities experiencing severe technical breakdowns in their price as global demand continues to wane. Aggregate commodity prices better reflect economic conditions than stocks and bonds because they are not as directly monetized by the global central banks. Thus this recent plunge in commodities can be seen as very indicative of another leg down in global growth.

Another tell implicating deflation is the global bond markets. Yields on US and other sovereign debt refuse to break out higher as they should with stocks at all-time highs. And despite 25% unemployment and negative growth in Spain investors have somehow decided that prices of their bonds should be higher than US bonds. Same deal for Germany, Italy and even Ireland. This suggests two things are in play- sheer insanity on behalf of those who own those bonds and also that these bond markets collectively are also expecting deflation in the near term. And despite the most havoc in the Middle East and elsewhere in decades, oil prices continue to swoon and gold cannot catch a bid. Something is different here -global demand for goods in no doubt waning in this late stage of this long wave economic cycle.

It’s all too evident that global central bankers are now staring into the deflation abyss with seemingly with little to offer other than a hollow promise to never allow rates to rise again. They are now compromised by the overhang of trillions in accrued debt that was supposed to be a remedy and restore growth. But it turns out you can’t restore growth by massive monetary stimulus at the tail end of a major credit super-cycle as advanced by the Kondratieff Wave principles. Too bad the central banks didn’t study the Japanese economy and stock market over the past 25 years for a remedial primer on the importance of long wave cycles.

The perils faced by Japan can hardly be overstated. The capital flight from Japan in recent months is staggering and without precedent and accounts for the dramatic depreciation in the yen against other currencies. In fact this plunge is alarming on many fronts because it’s pace suggests something more ominous could be at hand. For anyone who applauds Abenomics in boosting their stock portfolios there are thousands of Japanese citizens and small business owners who curse them.

Since the fall of 2012 the average Japanese citizen has seen their purchasing power greatly diminished by the rampant inflation caused by a determined effort by PM Abe to devalue their currency. There is just no free lunch with superficial schemes to reflate economies through wholesale currency debasement. Wiser investors in Japan knows this and want no part of owning Japanese assets as they fear their value will continue to erode in real terms as the yen continues it’s epic plunge unabated. I wonder if the infinite wisdom of PM Shinzou Abe ever considered the fallout from seeing trillions in institutional capital flee the country. Same could be asked of PM Putin in Russia. It does matter. Oops.

Currency moves on this order of such a major developed country are quite rare and unsettling to say the least. In 2012 I posted comments titled Japan: Land of the Rising Yields suggesting that one day Japan would become so indebted their currency would plunge and their rates would rise as investors demanded more yield for such risky debt. The sudden and awesome capital flight from Japan in recent weeks may just provide the impetus for those rising yields. Heck, at near zero yield they have nowhere to go but up. Let’s remember that Japan is by a mile the most indebted country on Earth and they also have the second largest and most liquid bond market on Earth, making any disruption in that bond market quite an international event. Investors of paper assets in any market should be very afraid of anything that would trigger a sudden rise in JPY bond yields.

This capital flight from Japan has taken much longer to play out than many expected because for so long Japanese citizens and corps have for years bought Japanese debt like fools at near zero returns. But now the trillions of institutional fund flows have finally gotten the memo and abandoned Japanese debt for much greener pastures in the US and elsewhere forcing the yen to plunge like never before. The soaring inflation coming directly from Abenomics impacts the average citizen in Japan more than other countries because they have to import so many basic raw materials, namely oil, and thus most of their citizens suffer from outsized inflation that destroys their purchasing power. More proof of the colossal failure in their incoherent monetary scheme was delivered with the release of their Q2 GDP numbers which showed an alarming contraction. Oops.

The people of Japan have now for decades suffered from the severe effects of the fool’s errand of a botched monetary policy- near zero return on their savings, a stock market that has lost more than 70% since 1989, and recently a crippling and outsized inflation since 2012 coming from a currency now seen as junk from global investors. Any gains in their stocks are mostly overwhelmed by the very real destruction of their currency. Turns out there there is a price to pay for such a massive and capricious currency printing scheme by Japan and the rest of the world should take note. Turns out you cannot overcome a Kondratieff Winter with pure debt monetization. Mother nature does not take so kindly to that.

Japan has been for decades and is now still paying a very steep price for ignoring K-Wave principles and I suspect many other nations will too in the coming years. Once again, a global Kondratieff Winter is likely to have its roots in the one country most entangled with it’s traits- Japan. Hopefully other nations will come to see the empirical record in Japan since 1989 as one that showcases the sheer absurdity of expecting QE and other central bank gimmicks to effect true and meaningful change that can provide a sound foundation for meaningful growth.

The long anticipated collapse in Chinese property prices has begun to manifest in earnest of late despite last ditch efforts this spring by the Chinese authorities to relax lending standards. It hasn’t worked according to recently released data and many still expect a wave of corporate defaults to soon mushroom there, reflecting a horrendously overbuilt landscape that is a hallmark of any late credit cycle that precedes a Kondratieff Winter. It appears now perhaps closer than ever for the inevitable bursting of the Chinese property bubble.

To thwart this and maintain their target of 7.5% GDP China recently announced another stimulus of almost $1 trillion to their banking system but that is unlikely to remedy such vast over expansion over so many years. And just last week a top official basically confirmed that attaining 7.5% growth in China is most unlikely. When this is confirmed later this year it will further validate the quandary global central banks face in stimulation growth through policy tools that are outdated and increasing ineffective.

One tell that the gig may already be up in China is that the gambling revenue in Macuau has plunged dramatically since late spring. Another tell is the desperate selling of homes by Chinese bureaucrats eager to avoid the wrath of the severe clampdown of corruption by the new ruling regime. China will be hard pressed to achieve their self imposed capricious and arbitrary mandate of 7.5% growth year despite their extensive goosing of the numbers. Yes, the deflationary choo-choo train is still chugging along despite the tens of trillions of fiscal and monetary stimulus from the global central banks. As It turns out the money changers aren’t all that and long wave credit cycles do matter after all. Oops.

This premise of deflation to the fore is further cemented by the moon shot advance seen by the US Dollar Index in the past few month, breaking through all kinds of long term resistance through a combination of global reticence and the growing divergence of economic output between the US and all other nations. We have advanced here on our site time and again since the financial crisis that the US dollar would not crash until most of the global debt deflation had been removed and as of today that is hardly the case. The critical 78.50 USD Index line in the sand held once again this summer which no doubt implies that deflation will reign until the final purge of excess debts are removed.

The dollar surge and such persistent global deflation is very much in line with Kondratieff Wave principles advancing that no sustainable growth can ever be achieved until the preponderance of excesses of existing toxic debt are removed from the global financial system, Given that these excesses are now at historic highs so we can expect this nasty little bitch we call debt deflation to continue unabated despite all those trillions in stimulus. We have advanced for years here that the folly of hyper-inflation wasn’t likely to occur until the full measure of debt deflation had been exorcised and that has proven true. A robust US dollar and a crashing commodity complex shows the battle against deflation is hardly over.

Since the 2008-9 crisis, we deflationists have been too early on forecasting the major corrections in the stock markets as we have underestimated the ability of central banks to pull off their balancing act of promoting some growth without risking the ruin of our financial system. But the hallmark principles of the Kondratieff Wave have clearly been true to form in forecasting so many of the conditions now baffling the experts- the ultra-low growth and high unemployment in global economies, low inflation everywhere and the US Dollar juggernaut that have altogether served ironically to help stocks maintain their elevated levels. These together with unprecedented corporate stock buybacks have sent stocks higher and higher despite a worsening global backdrop.

So the divergence between global economic impotence and global market omnipotence is peaking now before our eyes. The stock markets in the US and many other developed nations are now reflecting some of the traits seen at market tops- near zero bearish zeal, expanding PE multiples, frenetic IPO markets, and more. Our primary count remains that the US amid most global stock markets are now topping and have very limited upside before a sizable pullback occurs this fall into March of 2015 and what began as a needed correction could morph into a bear market If central banks lose their ability to influence the credit markets. No one can predict the true fallout coming from any bona fide change in sentiment among investors to the long overdue reversal in interest rates. If such a reversal was anything less than orderly one could expect a significant pricing of risk along the entire continuum of paper asset securities like stocks and bonds.

More than six years removed from the financial crisis most had expected much better results from global economic performance from ZIRP and the monetary firehose of tens of trillions printing by the Federal Reserve and other central banks around the world. The only inflation to be seen has come from stocks and bonds that can’t help but rise with such tailwinds. Fed policy in the Yellen era has centered on the the promulgation advancing the notion of macroprundential regulation in formulating the monetary policy responsible for allocating credit in the most dynamic and complex financial system ever. It is essentially an overkill in the micro management of an financial ecosystem that is not feasible. These directives coming from the Fed and other central banks are the antithesis of market based solutions and will ultimately prove to be futile. The command economy style championed by the Federal Reserve has no place in our modern and dynamic financial marketplace.