Type: TEXT – Story
Content: GENERAL INTEREST
20 Questions with the World's Leading -- Perhaps Only True -- Deflationist, Robert Prechter
Ray Tennant’s Comments:
This should be posted on the Tennantkids site for anyone that is interested
It answers a lot of questions as to what to expect in social behaviour over the next several years
Some good advice and interesting comments
A good example of how social mood changes can change outcomes is the protests in Toronto
A few 100 people out of a crowd of 10,000 changed the mood of the crowd
As the mood changed the crowd herded like cattle and became even more negative
And as always the police over reacted and made the situation even more tense causing
The situation to spiral out of control
As the following article discusses we are going to see much more negative social behaviour
Before the social mood turns positive again
I found the comments about going to the movies in some of the bigger cities in the United States fascinating
My father worked in the movie theatre in Owen Sound during the Second World War
He loved it as he wore an usher’s uniform jacket and escorted the girls to their seat with a flash light
He thought it was great and talked about it fondly
Today theatres do not have ushers and police cars have to sit outside the theatre to prevent gang violence
How the times have changed since the golden age of theatres
Editor's Note: The following Q&A was adapted from an hour-long conversation between Robert Prechter and Jim Puplava, originally recorded on June 19 2010 for Puplava's Financial Sense Newshour.
Visit www.financialsense.com to listen to the audio version of this interview
Jim Puplava: Stocks roared from the March lows of last year, and now we've seen a nice correction since the April high. Is it just an interim correction as the bulls would argue, or does something worse lie ahead? Joining us on the program is Bob Prechter, author and head of Elliott Wave International. Bob, I want to pick up from last September. Since then we've had several quarters of positive economic growth. Asset classes rose substantially, CPI turned positive, gold has hit a new record, oil is close to $80 a barrel. I guess a lot of our listeners would like to know, have these events altered your views on deflation?
Robert Prechter: No, because we forecasted these events, and we forecasted them at the bottom in March and April of 2009. On February 23 in the Elliott Wave Theorist, I said that we were almost at the bottom; that ideally the S&P should get down in the 600s before turning up; and that the Dow was going to rally from that low up to about 10,000. We put that target out a few days after the low. The main thing we said at the time was that it was going to be only a partial retracement, in other words a bear market rally. By the end of it, we said people would be bullish on the economy, there would be positive economic numbers, investors would think we have made the turn, the Fed would take credit for having saved the financial system, and there would be optimism across the board. All of this has happened. And going into April 2010, few people in the fundamentalist or technical camp were looking for a downturn.
The final thing I said was that Obama's popularity would rise into that peak, and on that one I was wrong. His ratings couldn't even bounce during that period, which I found very surprising. But both Obama and George Bush’s popularity trends followed the real value of stocks, not the inflated dollar price of the stock market, which I find interesting.
As far as inflation and deflation go, we had deflation during the down cycle in 2008. Commodities fell hard, the stock market fell hard and real estate fell hard. But the recovery that we were looking for in the first quarter of 2009 was expected to be a reflationary, and it was. You saw a decline in credit spreads. You saw a rise from the lows in commodity prices and stock prices. All of that is perfectly normal. These are just waves ebbing and flowing. But the long-term trend is still down, and as this cycle matures we are going to see more and more evidence of deflation.
JP: During this time, we've seen private sector credit contract while at the same time government credit expanded, which offset private sector contraction. But overall, credit has grown within the U.S. economy. In your opinion, can government, fiscal and monetary policies combined offset your deflationary scenario?
RP: First of all, I don't think credit has increased in the economy. M3 has got a negative rate of change right now. That means lending is really drying up. The Fed has monetized about 1.4 trillion dollars worth of IOUs. I think that, behind the scenes, about that amount of IOUs is slowly disappearing and losing value. Certainly mortgages are losing value even though they're still marked at the original value. I think true values are falling substantially.
Let's look at a couple of other indicators; and remember, these readings are despite the fact that we have been in a reflationary environment for the past 13-14 months: We've had the dollar rally against other currencies. None of the inflationists predicted that one. We've had a very weak recovery in the CRB commodity index. The high was 474 in 2008, it fell down to 200 in early 2009, and it's sitting in the mid-200s right now. It's still down 50 percent from two years ago, and that's despite massive bailout schemes by the federal government and massive monetization by the Fed.
If the inflationists’ arguments were correct, we should be in a hyperinflationary mode right now, with commodities flying, stocks flying and the money supply zooming. And none of that is going on. When you look at the rates of change in the Producer Price Index and Consumer Price Index of the last couple of years, they've been basically at zero. They went negative and now they're positive, but they're basically oscillating around zero. That's not runaway inflation. And even though gold just made another new high, it's by a very small amount for the past six months. Meanwhile the XAU index of gold stocks has made several lower peaks since 2008. It hasn't even taken out the 2008 high. Neither has platinum, and neither has silver. In an inflationary environment—certainly in a hyperinflation or runaway inflation—you get a monolithic move in everything. You're not getting that here; it's a very fractured situation.
JP: Today almost 43 cents out of every dollar the U.S. government spends is being financed with debt. In your opinion, how long can this continue before the U.S. reaches a debt limit very much in the same way that Greece has almost hit a brick wall?
RP: I'll tell you, it'll be longer than I think because I wrote Conquer the Crash in 2002, and I didn't think the markets had another wave of inflation in them. But they did, and they managed one into 2006 plus or minus a year, looking at real estate and stocks. Even now, the world still thinks the U.S. bond market is a good investment. Of course the irony is that the more people buy those bonds, the worse shape the rest of the economy is in, because the corporate borrowers and the municipal borrowers run up against difficulties when people can easily borrow from the U.S. government. The irony is, there's no way out. The more debt the U.S. government goes into, the worse off other debtors are going to be. The other debtors are the ones that hold up the economy, and eventually the contraction is going to impact tax receipts and call into question the solvency of the U.S. government itself.
I think all the forces are towards debt contraction, debt retirement and more conservative operation of the banking system. You see that in the way Congress is behaving and the kinds of laws they're passing now and the kinds of things they're discussing. I think the major change is towards conservatism in the financial area, and nothing can turn that around. So your question is a long-term question, and we can say only that we know it can't last forever. But I can recall people in the 1960s writing about how the government was spending too much, there's too much debt, this couldn't go on forever. It always seems to go on longer than people think it should, certainly than I think it should.
There's an observation—and I don't know who the first person was to say this—that crises always develop slowly and then seem to come out of the blue when they happen. We've been watching this crisis develop for years and years and years. We know we're getting close to the end. I think between now and 2016 you're going to see that flash point when everybody's eyes get big and they realize it's here.
JP: In 1933 at the bottom of the crisis, the Roosevelt administration comes in. In its first week they declare a bank holiday, they reopen the banks with the FDIC, they sever gold, they come in with massive fiscal stimulus and they devalue the dollar substantially. The result was from 1933 to1937 we have positive CPI, economic growth, a robust stock market. If fiscal and monetary measures fail to revive the economy and the market, could the government try devaluation to change the deflationary outcome the way they did 1933?
RP: Well, you have to have a benchmark in order to devalue a currency. Our currency isn't pegged to anything, so I don't understand even what the term devaluation would mean. What would they do to do create a devaluation?
JP: Maybe they come out with a formal saying: the dollar is now worth a half a euro, X amount of yen or it’s a formal statement. They just declare it formally.
RP: Yeah, but everybody already knows what it's worth, because it's floating freely against these other currencies. And they certainly couldn't fix it to a lesser currency like the euro. And then the managers of this other currency would simply make another decree and negate it. That’s not going to work.
Let's take your example, because it's very important. The whole idea of the government being ahead of the curve is bogus. You know the collapse was from September 1929 down to July 1932, right? The government did not act until it was over. They waited for the bottom of the collapse—of course—and then they finally decided they're going to do something about it. So, months after the low in 1932, they finally shut the banks and pass laws such as Glass-Steagall, which created the FDIC, and the Securities and Exchange Act, and that sort of thing, to bring confidence back into the banking system. I think the same thing is going to happen here. They're going to try the same old stuff, more and more lending, more and more borrowing—which is the problem, not the solution—until everything collapses, and then they'll go, “Oh maybe we should try something else,” and by that time we'll already be at the deflationary nadir, and it'll be time to look for an inflationary outcome.
My whole thesis is exactly along those lines. We want to stay prepared for a deflationary crash, and when it’s over, we're going to convert whatever money we have to stocks, and raw land, and gold, and whatever else we want to buy. That's when—if the government makes a political decision to inflate through currency printing—it would make the decision. They're not going to make it before the bottom. The government has never acted before the bottom, never acted in a new way. Right now these bailouts and other schemes are simply pressing the accelerator harder on what we've been doing since 1913.
JP: You know, unlike the '30s when there were other currencies, even in the ‘20s during Germany's hyperinflation, there were other currencies that were backed by gold. But say we live in a fiat world where all currencies are fiat, what's to stop the process of competitive devaluations where countries keep devaluing against each other during that period of time; the one benchmark that rises is, let’s say, the value of gold?
RP: Well, they can't devalue, because their currencies are not pegged to anything. The only way that a country can effect something like a devaluation is to print money. So they can't simply devalue and say, “Well, now our franc is worth so much gold, or now our dollar is worth so much gold.” Everybody already knows what gold is trading for in dollar terms, so there's no decree that could devalue the currency. It has to be valued to something before you can devalue it. And I don’t see what they would accomplish by establishing a new, false value.
JP: All right, let’s take the situation like the Fed last March, where they said, “We're going to monetize $1.7 trillion.” People thought the ECB would be steadfast, and they came up with their trillion-dollar equivalent rescue package. What's to stop them from saying, “All right, we're going to this time to try and monetize three or four million dollars?”
RP: Nothing! theoretically. But I think eventually social mood is going to stop them in their tracks. People are already upset at the government and the Fed, and they're going to start throwing congressmen out who keep acting this way. At the moment there are no restrictions on the Fed from monetizing. But even its own governors are arguing about the amount of monetization that they've already undertaken. I think there's internal resistance to the idea of doing far more.
Even if they did another five trillion, there's a quadrillion dollars worth of bad debt over the entire world, and they can't monetize it all. They're not going to the local courthouse and buying these bad mortgages, are they? They bought some through Fannie and Freddie that were more or less guaranteed by the Treasury.I just can't see the Fed saying, “Yes, we're going to buy everybody's rotten IOUs.” If they said that, people would start writing IOUs, wouldn’t they? I would.
There are going to be limits. There’s more bad debt out there than the Fed could possibly handle. And not only that, I want to make one more point: Even if the Fed monetizes old bonds that people thought were good, that doesn't change the net supply of money plus credit. It simply changes credit into money, so I don't think that that necessarily creates inflation. Under a robust economy it does, because those dollars can be re-lent. But if nobody wants to borrow, if nobody can borrow, there's still no net inflation. That's why you can have a year like 2008 and early 2009 despite trillion-dollar bailout packages by the government and the Fed.
JP: I want to come back to government spending, but first I want to move onto the stock market. In your last two Elliott Wave Theorist issues, you laid out a scenario that would put the Dow and S&P, which in your opinion may have peaked on April 26, as the top from here. You feel that this top is the biggest top formation of all time, a multi-century top and we could head straight down in a six-year collapse that would end in 2016 that could see a substantial portion of the S&P and the Dow wiped out in a similar way that we saw between 1929 and 1933. Let's talk about that and the reasoning behind it.
RP: Yes, you're exactly right. I did a lot of work on technical forms, cycle forms and Elliott wave forms in April and May and put them in a double issue. Let’s talk about the cycles first.
The 7¼-year cycle has been quite regular since the first bottom in 1980. The next bottom was at the crash in October 1987. The next one was November 1994, which is when the economy went through four years with lots of layoffs; it was a recessionary period throughout until that cycle bottomed. The next one was between September 2001, which was the 9/11 attack, and the October 2002 bottom. And the latest one was at the low in March 2009. All those periods are 7¼ years apart, so we are in the uptrend portion of the 7¼-year cycle.
However, notice for example that in 1987, the market went up until August of that year and then bottomed in October, just a couple of months later. So the decline occurred very, very late in the cycle. This time it occurred a little bit earlier in the cycle, topping in '07 and bottoming in '09. In the current cycle, prices should peak the earliest of all of them. It's what we in the cycle prediction business call “left-hand translation.” The market’s already gone up for about a year, and I think that's just about enough. I think we're going to spend most of the cycle going down. But the important thing to note is that the next bottom is due in 2016. That means I think we're going to have a repeat of what happened between 1930—which was the top of the rally following the 1929 crash—and the July 1932 low. Instead of taking two years, it's going to take about six years.
It's going to be a very long decline. It's going to be interrupted by many, many rallies, just as the decline from 1930 to 1932 was. And every time it bottoms and rallies, people are going to say “OK, that's enough; it's over.” But it won't be over. It's just going to be a long, long process. I think you and I will probably be talking a few times during this period. One of the interesting aspects of this process is that optimism should actually remain dominant through the first three years of the cycle. That will carry us into 2012. Even though prices will be edging lower, most people are going to think it's a buy, and you shouldn't get out of your stocks, and recovery is just around the corner, probably for the next three years. And then, for the final half of the cycle, the final three years, that's when you'll get the capitulation phase when everyone finally gives up.
JP: I want to come back to that period, because we saw, beginning with Hoover, widespread intervention of government. We had a lot of pronouncements from the Secretary of the Treasury to the President to the head of the Federal Reserve to prominent people such as John D. Rockefeller. His famous saying was: “Me and my son went down to the floor and started buying.” There was this kind of hope, I guess, in the sense that government could fix a problem, and I believe that we're still in the hope that government can fix the problem. Look at this tragedy in the Gulf of Mexico and everybody's turning to Washington, like Obama is going to put on a deep sea diving suit and go down a mile below the ocean and plug the hole. Are we in that similar type period were people are looking at government and saying, “OK, fix this”?
RP: We are in that period on steroids. Back then, in October 1929, people didn't turn to government right away; they turned to private bankers. There was a banking consortium of the big banking guys who said, “We're buying stocks here,” and you'd get these half-day rallies where the market would go up like 12 percent and then close unchanged. This time we have a much bigger gorilla, two gorillas actually: the Treasury and the Fed. They're saying, “We're going to make money available for nothing, and we're going to give credit for nothing, and we're going to bail everybody out that's possibly having trouble.” It's a similar consortium, but this time it's much bigger and it's all public. Last time it was at least partly private. Today no one turns to the private sector for answers to these systemic problems. They think the government can solve them all.
So, government right now, to me, is the naked king riding down the street on a horse, and people haven't noticed that he's not wearing clothes yet. But they will by the time it’s over.
As I see it, in 1929 to 1932, the lesson people took away from that time—which Franklin Roosevelt exploited—is that private interests failed. And this go-round, by the time it's over, I think people are going to conclude that government has failed. They already are very sour on government, but the deeper we get into this cycle the more people are going to realize that the government doesn't know what it’s doing. There's nothing it can do to alleviate the problem. And even deeper than that, it is the cause of most of our problems today. We can go through the litany, but it was government that created all of these credit-pushing agencies that ballooned up the real estate market and made houses impossible to afford so that people had to borrow 99 percent of a house just to live in one. Congress created Ginnie Mae and Fannie Mae and Freddie Mac and the Federal Home Loan Banks, and every one of them was pushing credit on the public and forcing up housing prices and making it incredibly hard to buy a house for cash. It’s doing the same thing with the price of education by pushing student loans.
All this credit is the problem, and now everybody owes money and no one has any money to pay it off. The banks are ruined; they've lent out everything. The paper that they hold, most of which is mortgages, is becoming worth less every day that they hold them. They're trying to liquidate homes, and they can't liquidate them fast enough, and when they do they're getting 40 cents on the dollar if they're lucky. In my view, most of the banking system is already bankrupt; people just haven't lost confidence yet.
This upturn in the cycle has allowed people to regain some confidence. You know, back in February of 2009 people were starting to get afraid, very afraid, but it was brief. That was the bottom of the 7¼-year cycle, and this time around, they're going to feel just fine for probably another couple years even as stocks fall. But eventually it's going to lead to a banking crisis, and I don't think the FDIC has the resources to handle it.
JP: You know, one thing that happened in the markets between '29 and the bottom of '32, there were some very astute investors, such as Bernard Baruch. And one investor that everybody knows is Jesse Livermore; he made a fortune shorting the markets in the '29 crash, but he got back in stocks in 1931-1932 and got wiped out. Is this going to be a difficult market to navigate?
RP: This is exactly what's happening today. If there were some smart people out there that said “Let’s short them” in '08, they're not going to short them this time around because many people have decided that we're in a real recovery and the most we can do is double-dip. But as happened to Jesse Livermore, the '29 crash was simply the first shot across the bow. The real destruction occurred from April 1930 to July 1932. Stocks lost over 80 percent of their value over that period. I think that's exactly the kind of environment we're in, and it's going to fool the smartest people on the planet. If you ask the people in the administration, the smartest people on the planet are running the Fed and the Treasury. I think they're going to get fooled. They think they can guarantee all this debt and get away with it; they're even talking about how they're going to make a profit. There's no way that's going to happen. They're going to dig themselves deeper and deeper into the hole until they finally blink. They're going to realize that if they're going to maintain any credibility with creditors on the face of the earth, they're going to have to stop.
JP: In your May issue of the Theorist, you talk about this recent top as being the beginning of something big and describing how financial bubbles always get resolved through a price collapse, despite the efforts of government. We've talked a little bit about the technical aspects of that cycle, the seven-year time period. Let's talk about the socionomic reasons for this viewpoint as well.
RP: I think that markets, particularly the stock market, move up and down on waves of social mood. It is not buffeted by the news; the news results from waves of social mood. When the trend is up and people are feeling more positive, they buy stocks. It’s a natural, unconscious action. They always have an excuse and a rationalization, but the point is that they're feeling better and are willing to gamble.
Business owners do the same thing. They'll decide, “I’m going to borrow some money and expand my business.”That decision doesn't show up for a couple of months, because he has to go down to the bank, they have to negotiate a contract, they have to come to an agreement, the money has to change hands, then he has to put it to work. That's why the economy lags the stock market: People can buy and sell stocks in an instant based on their mood changes, but you don't see the economic numbers change until several months later. The recession always ends after the stock market turns up, and the economy always peaks after the stock market rolls over. That's why people are always caught at those turns.
In the year 2000, the market finished a very major uptrend in social mood that had been going on for many decades. It culminated in the greatest financial mania we've ever seen. And it's been unwinding ever since. It had a bubble rebound in 2003 to 2007 that's now over. It's having a last try at the upside, which is failing. I believe this ended in April, but I could be wrong by a few months; it should end sometime this year. But somewhere between 2010 and 2016, we ought to have the resolution period, which is a complete change in social behavior as it relates to social mood. People are going to get more and more negative, more and more pessimistic, and more and more conservative with their money, all the way down. That is the essential reason why the trend is changing. And there's nothing that anyone can do to change it, because mood changes are endogenously regulated. That simply means they're internal to the system.
Human beings have been changing their moods for thousands of years, and nothing is going to change it. Nearly everything we see in society is a result of that. That's why we study wave behavior rather than news. Very often we're able to predict the news, just as we talked about in 2009 when we said that at the end of the coming rally you're going to see up quarters in the economy and everyone is going to say, “We saved the financial system,” and so on. We're seeing that now. The next wave of news is going to be negative. Sometime later this year or in 2011, we're going to start seeing negative quarters again. Eventually I think we're going to see unemployment jump to 30 percent or even higher. I think we can predict headlines years ahead of time based on what the waves are likely to do. People who are looking at economic numbers now to try to decide whether there's deflation or recession or recovery are looking at lagging indicators. You have to look at the leading indicators to get a handle on the future.
JP: You know, I think a lot of investors around today would forget, but after the experience of what happened in the '30s and up into the war, there were a lot of institutions that couldn't even own stocks because they were considered risky investments. If you did own a stock, the dividend yields were higher than what you got paid in bonds, a lot higher. And that lasted for a long period of time.
RP: You are absolutely correct. In the 20th century, dividend yields would get as high as six to seven percent, and of course in 1932 they were 17 percent very briefly. I spoke with an academic from one of the Ivy League schools who told me he was very happy about the fact that in the late 1990s he figured out a way to trick employees into buying more stocks through the pension plans that companies offer. They let people decide where they want the pension money to go. He said a lot of people chose cash, but he figured out a way to get people to choose stocks. And that is the complete opposite of the way people felt in the 1940s. They were conservative and thought stocks were risky. In the past decade, people said that the risk is being out of stocks, you want to be in them. That is a multi-decade change in attitude that is completely based on this trend in social mood. I’m convinced that by the end of this decade people are going to feel even more negative towards stocks than they did in the '40s. They'll tell their children and grandchildren not to touch the stock market.
JP: You know it's interesting, too, because when I got in this business in 1979 and '80 we were going through a series of bear markets, and in 1981 the dividend yields were back in that six to seven percent range. It happened twice at least when I began my career, that's where dividend yields were.
RP: Yeah, in 1974 and 1982, and those were great buying opportunities. That's when I wrote my bullish book with AJ Frost called Elliott Wave Principle. We predicted a great bull market and it would end in a mania because it was to be a fifth wave under our Elliott wave model. That was a major bottom. And when I look at March 2009, as much as I said “they're going to rally from here,” that was not a major bottom. It had none of the earmarks from a valuation standpoint, a psychological standpoint or a momentum standpoint.
JP: I want to take two well-known investors who would take the opposing view of a declining market. One is Dr. Marc Faber, who believes the S&P low of 666 will stand and that the government will simply inflate, because its debt is denominated in its own currency, unlike let’s say what we saw in Mexico where Mexico experienced some problems as a result of devaluation, they saw an increase in their stock market from the lows in nominal terms. So Marc believes because the U.S. debt is denominated in its own currency, the government will simply print, print, print. To add to Marc's views I want to take famed investor Felix Zulauf. In a recent interview in Barron's he also said one day the world's financial system will reach a financial reckoning day where the Fed's balance sheet will expand not by just a trillion or two, but by multiples of that, five, six, seven trillion, which would negate the deflation scenario. How would you argue against Faber and Zulauf's views?
RP: I don't think I have to. These are political predictions that may or may not come true. In other words, why does it have to go that way? Someone else could say just as easily, “Well, it's also possible that the voters will all become Tea Partiers, they'll throw all these people out, and they'll elect conservative guys who will balance the budget and eliminate the Fed.” How would you argue against that? You can't. It's just a scenario. It's not an argument, just a possible scenario.
Still, I don't think it's likely because of what I already said. I think the change in social mood towards the negative is already showing results. Here we are in a positive rebound, yet you’re still seeing Tea Parties and you're still seeing incumbents pushed out of office. I think by the time the trend really turns down again and breaks those 2009 lows, you're going to see the public so angry at their representatives that they're going to start forcing a difference in behavior. Congress is not going to be spending like it was before. They'll probably be drawn and quartered if they try to bail out another giant bank or certainly if they try to bail out the European banks as they did in the AIG disaster. All of this spendthrift behavior people are cluing into, and it's spreading on the Internet, and it's spreading through word of mouth.
You have this scenario that politicians are just going to monetize and they're going to go crazy. But it’s not a given. It requires that politicians are somehow untouchable by politics. But in a democracy, they're very subject to politics. Even in Greece, the leaders of that country wanted nothing more than to keep spending and borrowing and spending and borrowing. The creditors finally came in and said, “Enough. You can't continue or you're going to be literally out of power and bankrupt tomorrow.” So they agreed to some austerity programs, some creditors came to the door; some European governments, for example, came to the door. It's always the creditors who are in control—these bond vigilantes. Even Clinton was upset when he found out they existed. The U.S. government depends on these people for all of its borrowings. The Fed hardly has any U.S. Treasury bonds anymore; its portfolio is full of mortgages and all sorts of junk. The private market and other governments have sopped up all these Treasury bonds. The government could decide to “print, print, print,” but the only thing it can print are bonds. It can't print Fed notes; it can only print bonds. If the creditors shut down and say we're not taking any more of Treasury bonds, there's going to be a real disaster. They're going to have to raise interest rates to double digits, maybe 80 percent or 100 percent or some crazy amount. That's going to suck money from every other corner of the earth, and the economy is going to crash one way or another.
A crashing economy is going to be deflationary, because it means the debt that exists won't be paid off. It's the collapse in existing debt that's the problem. Now the Fed and the Treasury are trying to shore up some of this debt. The Treasury said, “Look, we're going to guarantee Fannie Mae and Freddie Mac,” and the Fed gave money to help bail out Greece. The IMF did the same thing, which is mostly funded through the American taxpayer. But relative to the amount of outstanding credit, these are actually small moves, even though they're unprecedentedly large. That's because the amount of credit that has been building up for 70 years dwarfs the amount of money that we have in circulation. I think the problem is too big for them to solve. It's too late. The only thing they have to offer is more credit, more credit, more credit. So far, they really haven't offered much more money. Credit is the problem, so printing more bonds in my view is not going to solve the problem. The government has already been borrowing at a mad pace. Wouldn't you agree that the last year or two has seen the greatest government borrowing ever? And yet you certainly don't have runaway inflation according to the commodity indexes. What is it going to take to create inflation? It's going to require that they create something like 100 trillion dollars worth of new money, and I don't think Congress is going to be able to stand up to the people and do that.
These scenarios are matters of social analysis, political analysis and opinion. What I’m saying is, let's look at present conditions in the U.S. We can also look at Japan, which had quantitative easing like crazy, and they still ended up deflating: Stock prices are down, and real estate prices are way down in Japan. And the same thing is going to happen here. And that's the best scenario. The Japanese economy kept going because the rest of the world was still expanding. Now the whole world is basically on the edge of depression. Nobody's going to be able to bail out the world, because we're the only people in it.
I think it's a one way road to the nearly complete collapse of outstanding credit. And if you count all the derivatives, all the domestic and foreign debt that exists, you've got about a quadrillion dollars worth of IOUs out there and already written. I just don't think central banks can or will replace all of that debt with money. It would mean their own self-destruction. And not only that, there's this thing called moral hazard. As I said in a recent issue, the Fed is not a moral institution; it does not care about morality. But if it were to announce that it was literally going to monetize all the bad debt that anybody can create, the first thing that would happen is everybody would be out there creating new debt as best as they possibly could and selling it to the Fed. The scenario is not realistic. It comes from people who think the Fed and the government are machines. They don't realize that they're run by people who are going to have to survive politically. I don't think they're going to be allowed to do it. But time will tell.
JP: This brings me to an interesting question. Right now, the government spends about four trillion, and they take in close to two trillion in revenues. Every dollar they spend, 43 cents is coming from debt. Then we have $54 trillion in total debt as a country and another equal amount of unfunded liabilities. Social Security this year is paying out more than it takes in, and we have problems with Medicare. Despite the fact that these programs are going broke, we just added a new healthcare entitlement. Can you have a situation—let me just throw this one out because I’m dealing with my own state of California, which I think will be bankrupt. California has a habit of putting all these initiatives on the ballot. We want this, we want that. And the initiatives get passed, but then we block the tax increases to pay for it. People like the entitlements that they get, but they don't want to be taxed to pay for them, and even some of these Tea Party people, if you told them, “OK, this is a situation we're in: We're broke. We can't afford these entitlements. And I know you paid into social security, and I know you are entitled to Medicare, but we're not going to be able to do that. We just don't have the money to pay for it.” Do you think that will change social mood? In other words, we've got these looming, big deficits on the horizon, with these entitlement programs that are over 60 percent of the government's budget. How does that get resolved? Do you see a politician looking at the people and saying, “Look I'm going to give it to you straight; here's the situation we're in?”
RP: No, not a chance. They'll run it into the ground. Governments always do that. The Soviet Union was a disaster from the day it started, but the rulers didn't give up until they squeezed every penny out of the entire country and it was a wasteland. A lot of people in government know that they're heading towards complete bankruptcy. Certainly the state governments, which can't print their own bonds willy-nilly and can't print their own money through the Fed, know this, and yet they're doing it anyway! They're all going bankrupt, and they're flat broke. They're not only broke, but they are indebted up to their eyeballs. You can't pay interest on debt or the principal on debt if you're broke. Every possible solution simply sucks more money out of the economy.
Everybody always talks about the federal government spending more money as “stimuli.” It's ridiculous. Every dollar the government spends is a drag on the economy. It has to come out of someone else's hide: either by direct payment from the taxpayer or by borrowing the money, which means it can't be lent to a private business. The more the government spends and the more the government borrows, the weaker the economy gets. The weaker the economy is, the less chance it has to pay off the principal and interest that the debtors owe. If public servants’ behavior were any different, then the outcome may be different. But studying world history tells you that governments always take from the economy until it's completely destroyed. It's sad, but it's pretty predictable. You don't see someone coming into California and saying, “Let's clean all this up. Let's cut the budget by 60 or 70 percent and start paying our bonds off so we're completely out of debt in 15 years.” It's easy to do, anybody could do it. But they won't.
JP: I want to move on to the public. The public got into the stock market game late—in the late ’90s, especially after '97 with the tech boom. They got their clocks cleaned in the correction, the bear market let’s say, from 2000 to 2002. Then they moved their money over into the real estate market and from real estate, they got back into the stock market. They got their clocks cleaned again. Now for the last seven consecutive months, the public is moving into bond funds: junk bonds, corporate bonds, Treasury bonds. Is this another recipe for disaster?
RP: You read my mind. On several recent interviews when I was on television, I went through that exact list. Now everyone thinks that they don't want stocks; they don't trust stocks anymore. They don't want commodities; they got creamed in the oil market. They don't want real estate; they can see that that's not going to recover for 20 years. So what are they buying? They're loading up on bonds, especially municipal bonds and corporate bonds, many of which are junk. They think they can get their 6½ to 8½ percent yield. This is going to be the biggest disaster of all of them, because we're headed down the road to complete debt collapse. They're putting their money into these instruments, and one day the debtors are going to announce, “We're sorry; we can't honor any of these IOUs.” The people who've invested in these things are going to realize that, instead of that 100,000 dollars or million dollars or 50 million dollars that they thought they had in safe places in municipal debt, in corporate debt, they're going to have zero. One by one, these debtors are going to give up on paying any part of it. They're just going to default or go bankrupt. This is another thing that happened to some degree in the early 1930s. There were counties and cities that declared bankruptcy; their debt was no good anymore. It certainly happened to some corporate debt.
This time the situation is 20 times worse than it was in 1929-1930. We’re heading into a much bigger collapse. So I agree 100 percent: The last thing you want to do is what everyone else is doing. This is why ever since Conquer the Crash, I've been very, very consistent in saying that you want the safest possible cash and cash equivalents. That means cash notes, Treasury bills—not even Treasury bonds—and certainly no municipal debt, no corporate debt, and no foreign debt, except maybe for Swiss money market claims, which are the equivalents of T-bills; in other words, none of the things that people think they find attractive. They find bonds attractive because they think they have a yield. That yield is actually, in the end, going to come out of the principal.
JP: I find it almost astounding in looking at the monthly inflows in municipal bond funds, because we know next year the top tax rates under the Bush tax cuts expire, so people are saying if you're going back into a 40 percent tax bracket, buy muni bonds. I saw an advisor who was addressing some of these issues that you and I have been talking about, about municipal debt problems and the fact that they can't print their own money, and he was talking about, well, in a fund or in an ETF, you're diversified. But if you own 200 bonds in California, and California goes bankrupt, what good is the diversification?
RP: That was the argument that they used to sell people a bunch of crummy mortgages: “Oh yeah, they're all individually no good, but you put them together and you're fine, you're diversified.” So that doesn't work for me. It's a bogus argument. It's a great way to sell the worst stuff you’ve got.
If you're a financial planner, you're probably telling your clients to make sure you have a lot of different types of bonds. There's some value to diversification in certain restricted situations. For example, when I say I think people should be completely in cash, I would like them to be in several different forms of it. That's a safe way to diversify. The people who really believe that municipal bonds are the place to be are being prudent when they say, “OK, you should have different ones just in case I'm wrong about one of them.” What these people are missing is that the problem isn't going to be just one city or one state. It's systemic. The only state that I know of that doesn't have a serious debt burden is Nebraska, because they have a law against it.
JP: I want to move on to the topic of gold. It's gone up for ten consecutive years, including this year so far. I know at times you've recommended gold after severe pullbacks, but you've been generally bearish towards the metal. Has its relentless rise surprised you?
RP: Yes. It went higher than I originally thought. I actually put out a very bullish comment on gold the day of the bottom in February 2001. Barron's had run an article that day showing that nobody was bullish; even the industry was bearish, and they were putting out hedges. I said this is a real good buy. But I only rode it up for about a year, year and a half, and it's gone much higher than I originally thought. However, I also think that it's very much a situation such as we had in the oil market, or in the real estate market, or in the stock market, or now in the muni market. It's an area where people have focused particularly in the last two years at the expense of other areas. And that means it's going to probably pay the price and have a serious correction. There are two things that make me feel that way. First are the non-confirmations against other metals and the gold stocks. The XAU topped in 2008, platinum topped in 2008, and silver topped in 2008, so gold has gone to new highs in the last two years all by itself. The second thing that I think is important is the fact that at a recent peak in gold we had a reading from the Daily Sentiment Index put out by MBH Commodities that showed 98% of futures traders in the gold market were bullish. That's the same reading we had on the euro when it topped out and the dollar bottomed. It's not a good time to be betting that gold is going to keep going up.
I'm very patient. I think we're going to have a buying opportunity in gold sometime in the next few years. I certainly wouldn't want to be overly leveraged in gold right now. It's stretched about as far as it's going to go. I also realize that I've said that a couple of times. We'll just have to see how it turns out. I think people in gold stocks have been very disappointed for the last two years; they've actually lost money even though gold has made new highs. It's definitely not a monolithic market. It's the single market that's doing well. I'll also point out that most of the people who believe in hyperinflation do not talk about those other markets very much. They point to the gold markets, but they don't point to the silver market, which is still 60 percent below where it was in 1980, or platinum, which is way under its old high. I think they're being selective in pointing one finger, and it's better to look not only at gold but also at these other precious metals, the gold stock index, and especially the CRB index of commodities, which includes oil and agricultural commodities and everything else.
In a hyperinflationary environment, such as Germany in the 1920s or Zimbabwe in the last decade, everything went up; prices were soaring all the time. And now, very few commodities are moving on the upside, most of them are very stagnant. They're down 50 percent from their 2008 highs and don't seem ready to go anywhere. That could change. But so far, I think people who are saying gold is making new highs because inflation is a threat aren't looking at the rest of the indicators of inflation.
JP: Is it possible that your deflationary scenario plays out only against gold? In nominal terms asset prices rise, but in terms of gold they continue to deflate? I know you've written something similar about this in the past.
RP: Well, that would be inflation. That would be the hyperinflationary scenario such as happened in Germany and in Zimbabwe. Real stock prices were actually going down even though nominal prices were going up. That's the stagflation scenario, a replay of the 1970s but bigger. I don't believe it. I think nominal prices are finally ready to follow real prices on the way down.
Probably my best forecast, but unfortunately not one that I pushed, was one I published in early 2001. It was a picture of the Dow Industrial Average priced in ounces of gold, going back 200 years. At that time, I said I think it's going to go from the current level, which was in the low 40s—I think the Dow peaked being valued at 42 ounces of gold—all the way back to 1. So we're going to go down to par; the Dow and the dollar price of gold are going to be equal. Stock prices are not only going to go down in nominal terms, but they're also going to go down in real terms by 40 to 1. The Dow has already fallen to a value of 10 ounces of gold, so it’s gone a long way towards fulfilling that forecast. It's possible that that forecast, as I said at the time, could happen no matter what happens to the currency, even if it's inflated. That outcome to me is unavoidable. The ultimate decline in the stock market is going to take prices to depression levels. In January 1973, when the Dow made a new high in nominal terms but not real terms, it led to a decline in nominal terms. We had the same thing happen in 2007: The Dow made a new high in nominal terms but was not even close in real terms. It really turned turtle at that point, falling 57 percent in the S&P in 2007 and 2009 in nominal terms. I think that's the beginning of the big decline we're looking for.
We'll have to see how it plays out. Six years is a long time. I think we'll see a decline in nominal terms. Whatever money survives is going to be able to buy a lot more than what it can buy today. This ocean of credit, as you pointed out earlier, that's now being supported by the Fed and the Treasury instead of private interests, has managed to hold prices up. I think it's more precarious than ever. When the implosion begins, it's really going to be relentless.
JP: What would cause you to change your position on deflation? What would you like to see before you would change that position?
RP: If the major benchmarks that were pushed up by credit make new highs, then I'll say somehow these brilliant directors of our financial life and economic life have won the inflation game. That would mean if real estate went to a new high above its 2006 peak, the stock market averages went above their 2007 highs, and the commodity indexes went above their 2008 highs, I would probably have to conclude that they must be printing money faster than credit is imploding. I have been arguing from the beginning that outstanding credit is already there and it can implode faster than anybody can monetize. We'll just have to see.
JP: If I were to summarize your views: The greatest part of the economic and market downturn lies ahead of us. On the economic side, you see an economic depression unfolding. From a stock market perspective, you see a near 90 percent downturn unfolding over a six-year period. And most bonds will fall in a major wave of deflation. Have I left anything out?
RP: You've nailed it.
JP: Once this bottom is reached, is that when you see hyperinflation kicking in?
RP: Well, that's when it would be politically possible. Maybe I should even say financially possible. I don't think it's possible now, because we have so much outstanding debt. If the debt market collapses and bonds are no longer any good, then at that point Congress could make a political decision to get its hands on a printing press and start printing notes. Right now, it doesn't have that ability, and the Fed is somewhat of an independent bank. I don't think it really wants to own the worst debt on the face of the earth to back its notes. It generally tries to buy things that it believes will hold value. That behavior hasn't changed. But it might later.
JP: Under your scenario, how would you be positioning your portfolio? You've talked about the most secure cash type of instruments such as Treasury bills. Anything else you would own?
RP: That’s the most important question, so I'm glad you're bringing it up near the end of our discussion. Now, you know that we try to call markets all the time, so we have services for people who want to trade, who want to get in the dollar, get out of the dollar, get into the stock market, get out of the stock market, or maybe sell short for certain declines. But typical investors in my view should not be in any financial market. They should be in cash and safe cash equivalents. The people who have been holding cash occasionally look around and say, “Look at the big bull market I'm missing; I'm missing this whole move in oil,” and so on. But the people who bought oil futures believing that oil was going to go up forever got killed. They got slaughtered. The people that bought real estate: same thing. There are stories of people in Las Vegas or Florida that had 24 homes, which they had pyramided one on top of the other; all was credit, all was collateral for more credit from banks. All it took was a 20% downturn and they were wiped out. They have no money left. These people are flat broke.
Even though there will be bounces in some investments, whether it be commodities, or oil, or gold, or stocks, or whatever, by the time this whole process is over it'll be the people like Bernard Baruch, who went to cash somewhere in 1928 or 1929 and stayed out of the way, allowing their cash to be worth more and more, who come out winners. For example, the dollar is now worth twice as much “house” as it was in 2008. I think more and more of that is going to happen. The people that are holding onto cash are eventually going to find bargains in consumer prices as well. Consumer prices are the last prices to turn, so they really haven’t had much of a turn yet. Their rate of change is still near zero, but I think eventually deflation is going to affect consumer prices. We've recently seen Wal-Mart and some other discount stores cutting prices. How could that possibly happen in a hyperinflationary environment? I think the pressures are already there.
In hyperinflation, what's the classic scene in your mind? It's people with wheelbarrows full of marks and Zimbabwe dollars, or whatever they call them, trying to get rid of them in whatever way they can. Today, it's exactly the opposite. People are out there scrounging for dollars. They can't get them from banks; banks are stingy and won't lend. The stores want dollars from the customers, but the customers don't have the dollars to go in and buy the stuff, and that's why you're seeing bargains appear. People are trying to find jobs, but it's very difficult to get an employer to part with a salary because he's trying to cut corners. Dollars are hard to come by now despite all of the inflation, despite all of the stimulus, and despite all of the stupid government programs, which are actually making things worse. To me, the reality here, even though it's not really severe yet, is the opposite of a hyperinflationary environment. People are trying to get hold of money; they're not trying to get rid of it.
JP: Finally Bob, is there anything else I've left out or an important point you'd like to make to end our discussion on?
RP: One of the consequences of a positive social mood is that society is lots of fun and great to be in. You saw an example of that in the 1980s and '90s. People were entertained; they were in a good mood; there was very little mayhem, very little social unrest. When the trend turns down, the opposite happens. Shortly after the top occurred in 2000, we finally had an attack on the American continent from an outside source for the first time since the War of 1812. Then the government decided we had to go to war. We've now been in the longest war we've ever fought. You're starting to see threats from North Korea, telling South Korea they're going to turn them into a sea of flames. You're hearing Israel talking about maybe attacking Iran. These are consequences of a negative social mood. Our lives are going to get very, very difficult. I think when the banks fail and people with little money find out they now have no money, it's going to get far more challenging.
I think that four years from now people won't even be listening to financial interviews because they won't care about the stock market, they won't care about investments; they'll all be down, and the money will be gone. They're going to be worried much more about their livelihoods. As much as calling the market is a fun thing to do and can be a profitable thing to do, I think people should also start to think about what their alternatives are and how they can protect themselves against social unrest. I talk a little about that in Conquer the Crash; I'm not really an expert on all the ways that you can be defensive. But choosing your place to live for example could be very, very important. Certainly where your major banking is done could be very, very important. Being in an area that suffers from war or attacks or severe social breakdowns would not be good for your health.
Now—while you can think calmly and things have recovered—remember back in the first quarter of 2009, people could not think calmly. If they were told, “Here's a good way to get safe,” they could barely even get themselves to fill out forms or contact people and get the information, they were so upset with what was going on. Now we've had a recovery and people are calmer. This is the time—probably the last opportunity—to act. When the storm returns and prices are collapsing in the stock market and there's some terrorist act that's worse than the last one, it's going to be very, very hard to concentrate. That's why I try to do my media tours near the tops. I started in October 2007 doing media again. I really stepped it up from November 2009 through April of this year because I wanted to get stragglers to act when prices were up and they could get out of stocks in a nice orderly manner, in a nice calm way. We even had a little bounce in real estate. I hope that near the end of the rebound people unloaded whatever they were still stuck with. This is the time to make all of your plans. You can calmly read a book like Conquer the Crash. Maybe there's another one out there, but I don't agree with most bearish books because they're recommending foreign markets and all sorts of dollar-inflation hedges.
Whatever your camp, whether you’re a deflationist or an inflationist, you need to get your escape hatches built now, and you need to have your plans in place because its going to be a tough ride. It's going to be harder to think when the mayhem is at its peak
JP: You mention something interesting, so just a little anecdote as we end here. We have a nice, suburban mall with the big 18-movie complex and I just noticed we don't go to the movies that often because it's just too crowded. The last time I went to the movies, Bob, you used to have the ushers with the blazers on and the flashlights who told you to be quiet or ushered you in. These guys are now packing stun guns and nine-millimeters.
RP: Like the people in the movie!
JP: I said, “I don't believe what I'm seeing,” and sure enough, when we got out of the movie, I guess they have gang problems that come into the mall there, and there were squad cars.
RP: If you get into incidents in movie theaters, people are going to stop going to the movies. This is how negative social mood impacts everything throughout the economy. You can't say, “Well, the movie industry will be fine.” No, the negative mood is going to permeate people's behavior. It's going to make them afraid. When we had the attack on the twin towers, people wouldn't fly in planes for weeks afterwards. There are repercussions that people haven’t even thought of from this trend towards negative social mood.
Another thing I tell people: Remember how you felt after 9/11? Remember how you felt in March of 1980 when we had that Volcker jump in rates and everything was collapsing, commodities were falling, gold and silver were crashing and the stock market was going down, all at the same time? Those kinds of fears under the Elliott wave model have certain degrees attached to them. Those were bear markets of “Primary” degree. We're heading into a Supercycle degree decline. It's going to be a scary time before it's over. The time to prepare psychologically and physically is now.
JP: I couldn't agree more. As always, it's a pleasure speaking with you. If our listeners would like to follow the work that you guys do at Elliott Wave International, please give out your website.
RP: You can find us at elliottwave.com. We've got a lot of free things that we give out, you don't have to spend any money, and most of the things we do offer are very affordable. Our books are in the 20-dollar range, you can get our monthly market analysis for $19 a month. You can move up the ladder from there if you’re a really serious commodity trader or something like that. I think our publications are one of the best bargains in the world. We're the hardest working group I know. We do more market research than anybody I can name, and we back up all of our opinions with graphs and evidence. You can at least look at that research and decide whether you agree that what we conclude is important or not. Make up your own mind.
JP: I hope in the meantime between now and 2016 you'll come back, and I’m sure we'll have some more interesting conversations
Submitted by: Ray Tennant
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