Debt Mania and Debt Phobia

Debts owed by nations

Every new crisis seemed to hatch a new way of thinking about debt, depending on who is lending, who is borrowing, for how long, and many other factors.

• Mexico's "tequila crisis" of the mid-1990s started with short-term bonds.  This led to focus on the dangers of short-term debt.
• The Asian financial crisis started with debt to foreigners, and foreign loans became the new obsession.

The best predictor of these meltdowns:  five straight years of rapid growth in private-sector debt.  

A decade after the global financial crisis, the Bank of International Settlements, the IMF and other international authorities concurred the most consistent precursor of major credit crises going back to the "tulip mania" in 17th century Holland was that private-sector debt - borrowing by corporations and individuals - had been growing faster than the economy for a significant length of time.

The authorities also reached another surprising conclusion:  the clearest signal of coming trouble is the pace of increase in debt, not the size of the debt.  

• Size matters, but pace matters more.  
• Government debt play a role but usually rises later, after trouble starts in the private sector.  
• A sharp increase in private debt is the leading indicator.

The key issue is whether debt is growing faster or slower than the economy.   

• A country in which private credit has been growing much faster than the economy for 5 years should be placed on watch for a sharp slowdown in the economy and possibly for a financial crisis as well.

Thailand in 1997

From the prime minister to farmers gets swept up in the mania for cheap loans. 

A housewife borrows to invest in "four million of anything."  

By 1997, private debt amounted to 165% of GDP in Thailand, but debts of that size would not necessarily have signaled a crisis if the debt had not been growing at an unsustainable pace.

• Over the previous 5 years, private debt had been growing at an annual pace more than twice as fast as the roaring Thai economy and had rise by 67% points as a share of GDP.  

To anticipate coming trouble, the number to watch:  the five-year increase in the ratio of private credit to GDP.

Successful nations avoid debt manias

Successful nations avoid debt manias and are often best positioned for sustained growth after a period of retrenchment.  

• The upside to the rule is that if private credit has been growing much slower than the economy for 5 years, the economy could be headed for recovery, because banks will have rebuilt deposits and will feel comfortable lending again.  
• Borrowers, having reduced their debt burden, will feel comfortable borrowing again.  

That is the normal cycle anyway. 

Debt phobia can be almost as destructive

 After particularly severe credit crises, lenders and borrowers may be paralyzed for years by debt phobia, which can be almost as destructive as debt mania.

The Real Inflation Threats

Inflation generally refers to the pace of increase in consumer prices.

1.  Historical inflation data

1970s

Consumer prices were rising at a double-digit pace and wreaking economic havoc all over the world.  

In early 1980s, they began to recede under pressure from rising global competition and a concerted attack by central banks.  

Raising interest rates to painful heights, central banks choked off money flows and won the war on inflation just about everywhere.

1981 to 1991

The average rate of inflation in developed nations fell from 12% to just 2%, where it remains today.

Meanwhile, in emerging nations, the average rate of inflation peaked at a staggering 87% in 1994 and reached the hyperinflationary triple digits in major countries like Brazil and Russia.  Then, over the subsequent decades, it receded to its current, much calmer rate of just 4%.

2.  Average inflation rates today

Any emerging nation with a rate of inflation much above 4% or any developed nation with a rate much above 2%, has cause for concern.  

In a world where double- and triple-digit consumer price inflation is a rare threat, the outliers are worth watching closely because they are out of balance and seriously at risk.

3.  Traditional thinking focuses on consumer price inflation only

High consumer price inflation is a growth-killing cancer

In the short term, 

• rapidly rising prices compel central banks to raise interest rates, 
• making it more expensive for businesses and consumers to borrow.  
• High inflation also tends to be volatile, and its swings make it impossible for businesses to plan and invest for the future.

Over the longer term, 

• inflation erodes the value of money sitting in the bank or in bonds, thus discouraging saving and 
• shrinking the pool of money available to invest in future growth.

4.  Post crisis of 2008 slow-growth environment fears outright deflation

The central banks are now fighting a very different war.  

Central banks often worry that inflation may be too low, not too high in the slow-growth environment that took hold after the crisis of 2008.  

In developed countries, instead of raising rates to make sure inflation doesn't increase too far above a target of 2%, they now cut interest rates when inflation is falling too far below 2%.  

Their big fear is that low inflation will lead to outright deflation - the dreaded but overblown "Japan scenario."

5.  Low inflation and deflation can be bad (depressed demand) and can be good (driven by new innovation and expanding supply)

History, shows that neither low inflation nor deflation are necessarily bad for economic growth.

"Bad deflation"  

Japan suffered a rare bout of "bad deflation" after the collapse of its stock and housing bubbles in 1990.  

• Consumer demand dried up, prices started to fall and shoppers began delaying purchases in the expectation that prices would fall further.  
• The downward spiral depressed growth for two decades.  

"Good deflation"

However, deflation can also follow a new tech or financial innovation that 

• lowers production costs and 
• boosts economic growth.

High inflation is always bad for growth, deflation maybe neither bad nor good

If inflation is too high, it is almost always a threat to growth but the same cannot be said of low inflation.  

Even if low inflation threatens to devolve into deflation, it could be good for growth if the falling prices are driven by new innovations and expanding supply, rather than by depressed demand.

6.  Post 2008 low interest rates environment

After central banks won the war on high consumer price inflation, they cut interest rates to levels that have fueled a massive run-up in prices for 

• financial assets, including stocks, bonds and 
• houses.  

In recent decades, stock market and housing bubbles have been increasingly common precursors to financial crises and recessions.

7.  The Real Inflation Threats

Economists have been very slow to recognize this new inflation threat, and central banks have been very slow to think outside their official mandates, which focus on stabilizing the economy by controlling inflation in consumer prices, only.  

But successful nations will control both kinds of inflation, 

• in consumer markets and 
• in financial markets.

Conclusions

The general rule is that strong growth is most likely to continue 

• if consumer prices are rising slowly or 
• even if they are falling as the result of good deflation, driven by a strengthening supply network.

In today's globalised economy, cross-border competition tends to 

• suppress prices for consumer goods but 
• drive them up for financial assets (stocks, bonds and houses).  

Thus watching consumer prices is not enough.

Increasingly, recessions follow instability in the financial markets.  

To understand how inflation is likely to impact economic growth, you have to keep an eye on stock and house prices too.

Money figures show there's trouble ahead

Money figures show there's trouble ahead
Private credit is contracting on both sides of the Atlantic. The M3 money data is flashing early warning signals of a deflation crisis next year in nearly half the world economy. Emergency schemes that have propped up spending are being withdrawn, gently or otherwise.

By Ambrose Evans-Pritchard
Published: 8:48PM BST 26 Sep 2009

Comments 92 | Comment on this article

Unemployment benefits have masked social hardship unto now but these are starting to expire with cliff-edge effects.The jobless army in Spain will be reduced to €100 a week; in Estonia to €15.

Whoever wins today's elections in Germany will face the reckoning so deftly dodged before. Kurzarbeit, that subsidises firms not to fire workers, is running out. The cash-for-clunkers scheme ended this month. It certainly "worked".

Car sales were up 28pc in August, but only by stealing from the future. The Center for Automotive Research says sales will fall by a million next year: "It will be the largest downturn ever suffered by the German car industry."

Fiat's Sergio Marchionne warns of "disaster" for Italy unless Rome renews its car scrappage subsidies. Chrysler too will see some "harsh reality" following the expiry of America's scheme this month. Some expect US car sales to slump 40pc in September.

Weaker US data is starting to trickle in. Shipments of capital goods fell by 1.9pc in August. New house sales are stuck near 430,000 – down 70pc from their peak – despite an $8,000 tax credit for first-time buyers. It expires in November.

We are moving into a phase when most OECD states must retrench to head off debt-compound traps.

Britain faces the broad sword; Spain has told ministries to slash 8pc of discretionary spending; the IMF says Japan risks a funding crisis.

If you look at the sheer scale of global stimulus this year, what shocks is how little has been achieved. China's exports were down 23pc in August; Japan's were down 36pc; industrial production has dropped by 23pc in Japan, 18pc in Italy, 17pc in Germany, 13pc in France and Russia and 11pc in the US.

Call this a "V-shaped" recovery if you want. Markets are pricing in economic growth that is not occurring.

The overwhelming fact is that private spending has slumped in the deficit countries of the Anglosphere, Club Med, and East Europe but has not risen enough in the surplus countries (East Asia and Germany) to compensate. Excess capacity remains near post-war highs across the world.

Yet hawks are already stamping feet at key central banks.

Are they about to repeat the errors made in early 2007, and then again in the summer of 2008, when they tightened – or made hawkish noises – even as the underlying credit system fell apart?

Fed chairman Ben Bernanke spoke in April 2008 of "a return to growth in the second half of this year", and again in July 2008 that growth would "pick up gradually over the next two years".

He could only have thought such a thing if he was ignoring the money data. Key aggregates had been in free-fall for months.

I cited monetarists in July 2008 warning that the lifeblood of the Western credit was "draining away". For whatever reason (the lockhold of New Keynesian ideology?) the Fed missed the signal.

So did the European Central Bank when it raised rates weeks before the Lehman collapse, blathering about a "1970s inflation spiral."

Yes, the money entrails can mislead. The gurus squabble like Trotskyists. But you ignore the data at your peril.

Tim Congdon from International Monetary Research says that US bank loans have been falling at an annual pace of almost 14pc since early Summer: "There has been nothing like this in the USA since the 1930s."

M3 money has been falling at a 5pc rate; M2 fell by 12pc in August; the Commercial Paper market has shrunk from $1.6 trillion to $1.2 trillion since late May; the Monetary Multiplier at the St Louis Fed is below zero (0.925). In Europe, M3 money has been contracting at a 1pc rate since April.

Private loans have fallen by €111bn since January. Whether you see a credit crunch in Euroland depends where you sit. It is already garrotting Spain. Germany's Mittelstand says it is "a reality", even if not for big companies that issue bonds. The Economy Ministry is drawing up plans for €250bn in state credit, knowing firms will be unable to roll over debts.

Bundesbank chief Axel Weber sees no crunch now, yet fears a second pulse of the crisis this winter. "We are threatened by stress from our domestic credit industry through the rise in the insolvency of firms and households," he says.

Draw your own conclusion. Western central banks will have to "monetize" deficits on a huge scale to stave off debt deflation. The longer they think otherwise, the worse it will be.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/6234939/Money-figures-show-theres-trouble-ahead.html

Deflation can be good, but now it's bad

From The TimesMarch 24, 2009

Deflation can be good, but now it's bad

Ian King, Deputy Business Editor


Deflation does not have to be bad. There are, it is generally accepted by economists, two types of deflation — one good, one bad.

Good deflation is the type that Britain enjoyed during the Victorian era. Prices fell for most of the 19th century, thanks to a “virtuous circle” in which higher demand led to greater profits, which led to greater investment, better productivity — mainly due to the spread of railways — and, in turn, lower prices. There was huge industrial expansion, the advance of mass production, the rise of the City of London and the advent of the large corporation as we know it today.

In the period between 1870 and 1896, wholesale prices fell by 50 per cent, while Britain’s economy grew, on average, by a staggering 4 per cent each year.

Good deflation was also a key factor in the US during the Roaring Twenties when technological advances — in mass electrification and car manufacture — led to huge increases in productivity.

The common factor was that productivity improved so rapidly it led to excessive supply — and hence lower prices.

From the mid-1990s onwards, it seemed reasonable to suppose that the world was in for a rerun of those happy times, with the advance of the internet, increasingly powerful microchips and the development of mass communications. This belief was given greater impetus with the emergence of China as the workshop of the world, churning out ever-cheaper goods in ever-greater quantity.

Unfortunately, in this instance, the virtuous circle was broken because that vast output, quite literally, required fuelling. China’s insatiable demand for oil, petrochemicals and other commodities fed through to inflation elsewhere in the world — eventually hampering demand for its goods.

Instead, there is now a danger that we are in for a period of “bad” deflation. Bad deflation, like good deflation, occurs when supply exceeds demand. The difference is that, while good deflation is caused by booming supply, bad deflation is caused by weak demand. This was the case during the Great Depression of the 1930s in the US and, more recently, in Japan.

Bad deflation sucks the life out of economies. Rather than a virtuous circle, the effect has been likened to a “negative feedback loop”, in which one piece of bad news leads to another. An example of this would be how consumers react to a fall in the stock markets — by cutting back their spending. This forces companies to slash the price of goods and services, leading to lower profits, and then to lower employment and a further reduction in spending.

The reason that most observers fear we are in an era of bad deflation is because of the vast amounts of debt now in the economy. That is particularly true of the US and Britain.

Just as inflation is good for people with large debts, such as homeowners with big mortgages, deflation is even more painful because the size of the debt becomes relatively bigger. That is why governments everywhere are spending vast amounts on trying to provide economic stimulus. Demand needs to be reintroduced to the world economy — and fast.

http://business.timesonline.co.uk/tol/business/article5962898.ece

Deflation expected to return to UK for first time in 50 years

Deflation expected to return to UK for first time in 50 years



Deflation is expected to return to the UK for the first time in nearly 50 years with the announcement that prices are falling nationwide rather than increasing.

By Caroline Gammell
Last Updated: 9:26AM GMT 24 Mar 2009

George Buckley: George Buckley, Deutsche Bank's chief UK economist, told The Daily Telegraph that he is forecasting an RPI reading of -0.7 per cent





The retail price index (RPI) - which measures the average month-to-month change of the prices of goods and services - is thought to have slid into negative figures.

The last time the UK experienced deflation was in 1960 when Harold Macmillan was prime minister.

Inflation expected to fall as oil retreats and VAT cut kicks inThe widely expected downturn follows figures released by the Office for National Statistics in January which showed that RPI increased by just 0.1 per cent compared with the previous year.

Consensus forecasts by leading City economists suggest RPI fell -0.5 per cent in February, forced down by falling mortgage rates and rapidly decreasing house prices.

The latest RPI figures will be released by the ONS at 9.30am.

The Bank of England is worried about the effect deflation could have on indebted families.

It says families with high debts could fall prey to the debt deflation trap. This means that the cost of their debts, which are fixed, would rise compared to average prices throughout the economy.

While inflation erodes debts, deflation makes them relatively higher.

There are also fears that millions of public sector workers - teachers, nurses and council workers - could face pay freezes for the next three years as deflation takes hold.

Public sector pay, which accounts for about a quarter of all public spending, is tied to RPI.

George Buckley, Deutsche Bank's chief UK economist, told The Daily Telegraph that he is forecasting an RPI reading of -0.7 per cent, and believes it could get as low as -4 per cent over the summer months.

Asked if the negative reading will lead to pay freezes, he said: "That's certainly a possibility. You won't see anywhere near the increases in pay that we've been used to. But few are unlikely to see falling pay."

Economists at BNP Paribas warned over the weekend that prices in Britain will continue to fall for another two-and-a-half years.

The French bank's UK economist, Alan Clarke, said that he expected gross domestic product (GDP) to contract by more than four per cent this year, and deflation to linger through to 2012.

http://www.telegraph.co.uk/finance/financetopics/financialcrisis/5041459/Deflation-expected-to-return-to-UK-for-first-time-in-50-years.html





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What is deflation?

Q&A: What is deflation?
Gary Duncan

What is deflation?

The dreaded “D” word, one of the most feared economic blights, refers to sustained falls in prices in the economy for goods and services.

Don't we already have falling prices for some products?

Yes. For goods such as many types of clothing, Britain has got used to steadily cheaper prices as a result of intense high street competition and cheap imports from Asia. But deflation is different, meaning falls in prices more or less across the board.

But that sounds good. What's the problem?

The trend can sound like a money-saving bonanza. A short-lived burst of deflation for only a few months might end up like that and need not be a disaster. Problems start when consumers collectively curb spending, constantly waiting for ever-cheaper prices. In turn, this sucks the lifeblood of demand from the economy. With spending falling sharply, businesses sell less and less and are forced to cut wages and lay off staff — leading to even less spending, lower demand and sharper falls in prices. A vicious, downward spiral takes hold that can spell deep and prolonged recession. Once deflation sets in, it can be tough to reverse it, as negative effects feed on themselves. For example, if interest rates have been cut sharply to try to rekindle spending, then once they fall to zero it is impossible to cut them further and, after factoring in falling prices, this means that real interest rates are still higher than zero.

Are there any other effects?

Unfortunately, yes. Debt is a headache. Where prices and incomes generally are falling in a bout of deflation, this means that the real value of people's debts, relative to falling incomes, is rising. So debts become an ever bigger burden, stretching the time that is needed to pay them off to longer periods. This is known as “debt deflation”. In an economy such as Britain's, where households have the highest burden of debt of any leading economy, it poses a particularly severe danger.

How can economies escape?

With great difficulty. Deflation is like quicksand. Once in it, it is very difficult to escape the mire. Solutions to “reflate” the economy are found in flooding the financial system with ultra-cheap money. This can be done by governments printing money to give away in tax cuts, although this risks irreversible damage to a country's finances, or by a central bank buying up assets from banks, effectively handing them extremely cheap cash.

Is deflation likely to take hold now?

There is a significant danger. Headline inflation in the United States could turn negative as soon as this week, after a huge reversal of last year's surge in fuel prices. In Britain, the Bank has said that it expects inflation on some measures to fall into negative territory for at least a few months. This may fall short of full-blown deflation, but will magnify the danger of it.

http://business.timesonline.co.uk/tol/business/economics/article5750994.ece

****Deflation Survival Briefing

Gala Issue: Biggest Sea Change of Our Lifetime! by Martin D. Weiss, Ph.D.



Dear,
The Fed, the Treasury and all major governments on the planet are throwing the kitchen sink at this debt crisis. But their efforts are being overwhelmed by a monumental sea change — the shift from rising prices to falling prices, from booming asset values to crashing asset values, from wealth creation to wealth destruction, from inflation to deflation.



For my entire lifetime, and probably yours as well, we have been living with inflation — sometimes tame, sometimes rampant — but consistently eroding the purchasing power of our dollar.Inflation pervaded every money decision we made or thought about making, every retirement plan or business model. Inflation was factored into our leases, our employment contracts, our budgets, our investment programs.



Now, all of that is changing; and it's doing so dramatically! Suddenly, the polar opposite of inflation is taking hold in America: Deflation!


Suddenly, prices are plummeting — not just for real estate, but also for automobiles, appliances, clothing and gasoline. From peaks reached just a few months ago to the latest bottoms, the price of oil has plunged 73% ... copper has fallen 66% ... lead and nickel are down 73% ... platinum is down 66% ... and wheat is off 64%.



Even the government's slow-to-change, lagging index of inflation — the CPI — has caved in to deflation, falling by the most since the government first introduced the index in 1946. These are not numbers that denote less inflation. They are hard evidence of outright deflation! This is crucial for you: If you continue investing as you did in inflationary times, you risk losing almost everything. However, if you acknowledge this historic shift and make the right moves now, you'll have the opportunity to build substantial wealth. This inflation-deflation switch is turning the entire world of investments upside down and inside out.
It means you must consider the grave new dangers deflation brings your portfolio and, at the same time, the unique new opportunities deflation gives you to grow your wealth. This past week, during our Deflation Survival Briefing, I covered both topics with Jack Crooks, the only currency expert I'm aware of who, unlike his peers, not only warned unambiguously about deflation but also has a unique way to profit from the deflation. I assume you attended the event online from start to finish. At times, however, the sound may have been unclear, and I apologize. So here's an edited transcript for your convenience. It's a double-length gala issue especially for you, my way of underscoring the vital importance of this sea change.



Deflation Survival Briefingwith Martin D. Weiss and Jack Crooks(Edited Transcript)
Martin Weiss: Jack, the division of labor I've mapped out is this: I will focus on the dangers and protective strategies; you can focus on the opportunities and profit strategies.



Jack Crooks: That makes sense, but I think it's pretty obvious what the dangers are.

Martin: Specifically, you're referring to ...

Jack: Losing money. Losing a lot of money. Deflation means most asset prices go down. When asset prices go down, anyone who owns those assets loses money. It's that simple.

Martin: What most people don't seem to grasp is how much money — the sheer magnitude of the losses. But the Fed just released the numbers, and I want to show them to you. I want you to see for yourself the amazing drama that literally bursts from these pages. On the Web, just go to Flow of Funds, pdf page 113. From this table, I've pulled out the main numbers to walk you through this step by step, because it's probably the most important set of facts you've seen — or will see — for a long time:
The Fed tracks five key sectors that go into household wealth: real estate, corporate equities, mutual fund shares, life insurance and pension fund reserves, plus equity in noncorporate businesses. Now let me show you how the wealth destruction is spreading throughout the U.S. economy. First quarter 2007: Every single wealth sector is still growing, except one — real estate. This $53 billion loss in real estate is a time and place that will go down in history as the great turning point of our era.Second quarter 2007: Another $190 billion in real estate wealth destroyed. Third quarter 2007: Households suffer a whopping $496 billion in losses — nearly 10 times as much as in the first quarter.Fourth quarter 2007: The wealth destruction spreads to nearly all other sectors. Households lose $708 billion in real estate, the most in history. Plus, they lose $377 billion in stocks, $145 billion in mutual funds, $265 billion in their life insurance and pension reserves.First quarter 2008: The carnage deepens. Households lose $911 billion in stocks, $297 billion in mutual funds and $832 billion in insurance and pension fund reserves. Plus, the losses spread to the last major sector, equity in noncorporate businesses. Second quarter 2008: The Bush economic stimulus package kicks in, and it slows down the pace a bit. But the hemorrhaging continues. Not one single sector recovers.Third quarter 2008: Earth-shattering losses across the board, with households losing

...ANOTHER $647 billion in real estate
$922 billion in corporate equities
$523 billion in mutual funds
$653 billion in insurance and pension fund reserves
$128 billion in noncorporate businesses

Grand total: Nearly $2.9 trillion in losses — the worst in recorded history.

Grand total lost over the past year: $7.2 trillion.

Jack: And this is not just a bunch of numbers. It's a hard-nosed reality that almost everyone is up against.

Martin: Absolutely! At the peak of the housing boom, one of our associates had his home appraised at $1.4 million. Three weeks ago, he had it appraised again and it was down around $700,000. That's a 50% decline. And it's not just the high end of the market. In May 2005, another home in our area sold for $175,000; now it's listed at Realtor.com for only $64,000.

Jack: People think that since home values have already fallen so far, they must be near a bottom.

Martin: I don't agree with that view. Most of the price declines we've seen so far merely represent a recognition that the peak prices of the mid-2000s were a fantasy built upon "Frankenstein Financing" — wildly speculative credit terms such as option ARMs and liar loans. The hard-core declines in housing, driven by basic things like recession and unemployment, are just now getting under way.

Jack: How much further do you see home prices falling?

Martin: My personal opinion is that that over half of the declines are still ahead. That applies not only to housing, but also to commercial properties; not only to real estate, but also to stocks and other assets. Consumer prices just began to fall in October. Outright contractions in the economy are just now getting under way. Deflation is still in its early stages. The wealth destruction has a long way to go.
Jack: You call this wealth destruction and I don't deny the validity of that term. But another way to describe it is rampant deflation. Deflation in the value of real estate and other investments, deflation in energy, deflation at the car dealer and deflation at every mall. In each and every sector that you've described, the U.S. dollar buys more.
Martin: That's the positive side of the story. But whatever you call it, these numbers don't lie. You can see with your own eyes that it's massive and that it's spreading throughout the entire economy.
Jack: Martin, all this raises some urgent questions in my mind and probably in the minds of our readers as well. First, can the government offset this massive destruction of wealth with more bailouts, more Fed actions and gigantic economic stimulus packages? Martin: They can buy some time or they can slow down the process temporarily, as they did in the second quarter of 2008, for example. But still, my answer is a flat NO! Not even Washington can print enough money fast enough to halt this deflationary spiral; it's just too huge. And all the printing press money in the world won't do much if it's not lent or spent. Bottom line: No matter which companies Washington bails out, this is a house of cards. It's coming down. And you must get out if its way.
Jack: Still, a lot of people have big expectations for President-elect Obama's stimulus package starting next year.
Martin: The highest estimates for the Obama stimulus package are $1 trillion. But even if it's that big, it's still small in contrast to the wealth destruction we're already seeing. And it's going to take a couple of years before all of that money reaches Americans. By that time, trillions more in wealth could be lost.
Jack: Every economist I read likes to leave some wiggle room for future butt-covering, just in case they turn out to be wrong. But you're not pulling any punches, are you? Why is that?Martin: It's not needed in this situation — because of the sheer enormity and speed of the wealth destruction: $7.2 trillion just through over the past year. In contrast, the Trouble Asset Relief Program (TARP) is $700 billion. So these losses are already ten times more than the entire bailout program.
Let's compare how much is being lost vs. what the government is doing to offset it. Here's the progression we just saw:
$1.5 trillion lost in the fourth quarter of 2007
$2.7 trillion lost in the first quarter of 2008
$630 billion lost in the second quarter of 2008
$2.9 trillion in the third quarter
Now, let me demonstrate why the government's efforts are unable to offset this wealth destruction. Congress has authorized $700 billion for TARP. But the Treasury Department reports that in the fourth quarter, only $330 billion has been committed so far.
Jack: Committed or actually disbursed?
Martin: Committed.
Jack: The ol' check-in-the-mail routine, eh?
Martin: Yes. But let's assume the $330 billion is already at the banks. And let's say that in the first quarter of 2009, they are able to disburse all of the rest. That's still minuscule in comparison to the wealth destruction.
Jack: Meanwhile, the wealth destruction continues.
Martin: Right. We don't know how much. But let's assume the wealth destruction does not decelerate or accelerate. Let's just assume it continues at the same pace.
Here's what it would look like. Moreover, most of the money being funneled to the banks is not reaching consumers and businesses. Instead, it's sitting idle at the banks, to rebuild their capital, to try to offset all the losses they've sustained.
Jack: How much of the TARP money are the banks actually lending out?
Martin: We don't know.
Jack: Isn't this why Congress is so ticked off, trying to find a way to force the banks to lend out the TARP money?
Martin: Yes. But it's a tough sell. The banks are going broke. They're being asked to lend it to borrowers, who they fear will also go broke. So the resistance is great. But even if you assume that Congress can force the Treasury Department to, in turn, force the banks to loan out some fraction of the TARP money, it would still be only a fraction of the total TARP funds.
Jack: A drop in the bucket.
Martin: Absolutely! The huge red areas in this chart represent the tremendous power of deflation. The small black areas represent the impotence of government to offset the deflation.

The power of deflation is hundreds of times larger than the government's ability to counteract it. This is why the U.S. government was not able to prevent deflation in the 1930s. And it's also why the Japanese government was unable to prevent its deflation in the 1990s.
Jack: Still, most people think the government can just print more money at will. They're now talking about a total bill of $8.5 trillion. Your numbers don't seem to account for that.
Martin: Because those bigger numbers are almost entirely guarantees and swaps — not net new money added to the economy. Plus, please bear in mind one more thing: The wealth destruction we've been discussing today does not include the losses by financial institutions, corporations and governments.
Jack: Good point. But let me go to the second major question I get from readers: What's causing this and when will it end?
Martin: What's perpetuating the deflation is excess debts. Look. Debts were usually bearable. As long as people had the income to make their payments — or as long as they could borrow from Peter to pay Paul — they could keep piling up more debt, and life went on. Deflation alone is also not so bad. It makes homes more affordable, college education more accessible, and basic necessities of life cheaper.
Jack: But when you put debts and deflation together
...Martin: That's when things fall apart! That's when you get not only wealth destruction but DEBT destruction.
Jack: And we have evidence of that as well, I presume.
Martin: Yes, undeniable, smoking-gun evidence. For decades, we've almost always seen more debt piled up quarter after quarter, year after year. But then, beginning in the third quarter of 2007, all that changed. For the first time, we saw massive debt liquidation — debt destruction. It started in the commercial paper market, where corporations issue short-term corporate IOUs to borrow in massive amounts: In the third quarter of 2007, instead of growing as it almost always has, commercial paper was being liquidated at a rapid pace. That was the canary in the coal mine.
Jack: And now?
Martin: Now the debt liquidation has spread: In addition to the liquidation of commercial paper, we're seeing massive debt liquidation in mortgages and corporate bonds.Jack: How big?
Martin: The biggest ever in recorded history. Look at mortgages! The Fed reports how much in new mortgages are created each quarter at an annual rate. Ever since you and I were born, all we've even seen is net new growth in mortgages. That's how it was when we were growing up, that's how it was in recent years, and that's what we saw in the third quarter of 2007. See?
Jack: $1,005 billion.
Martin: Yes. Net net, after all mortgage paydowns, new mortgages were added at the rate of $1,005 billion per year. Almost the same in the fourth quarter of 2007. But then look: First quarter 2008 — $539 billion. Second quarter 2008 — new mortgages begin to vanish from the market. Yet, up until this point, we're just talking about a credit crunch.
Jack: In other words, less new credit.
Martin: Yes, and that's already a powerful deflationary force: Most people can't get mortgages. So they can't buy. Since there are few buyers, prices fall. That's when people think: "This is terrible. It couldn't possibly get any worse."
Jack: But it does, doesn't it?
Martin: Dramatically worse: In third quarter of 2008, the volume of mortgages going bad is so big and the volume of new mortgages being created is so small, we have a net decline in mortgages outstanding. For the first time in recorded history, we have a net destruction of debts in this sector. This is far worse than a credit crunch. It is a DEBT COLLAPSE, an unprecedented, unstoppable deflationary force.
The same kind of debt collapse also hits corporate bonds. Third quarter of 2007 — no problem. New bonds are issued at the annual rate of nearly $1,481 billion per year.Fourth quarter of 2007 — big decline, to $821 billion.
Jack: Credit crunch begins to hit.
Martin: Exactly. First and second quarters of 2008 — credit crunch hits even harder. Third quarter of 2008 — debt collapse strikes! It's the biggest net reduction of corporate bonds in recorded history, running at the annual rate of $755 billion (red bar in chart). Again, one of the most powerful deflationary forces of all time!
Jack: So what's the next stage?
Martin: A chain reaction of corporate bankruptcies.
Jack: But it looks like they're going to save companies like General Motors and Chrysler.
Martin: Even if they do, they cannot save hundreds of thousands of smaller and medium-sized companies that are going bankrupt all over the country ... tens of thousands of municipalities and states running out of money ... tens of millions of Americans who have gotten smacked with the trillions in losses I've just showed you in the household sector.
This wealth destruction and debt liquidation is classic; and despite all the government intervention, it is fundamentally very similar to the collapse we saw in 1929 and the early 1930s.
Jack: But many people believe the 1930s Depression was caused by the failure of the federal government to fight the decline. This time, they say, the government is doing precisely the opposite.
Martin: In reality, America's First Great Depression wasn't caused by what the government failed to do to stop it. Rather, it was largely caused by all the wild things the government did do to create the superboom in the Roaring '20s that preceded it. They dished out money to banks like candy. They let banks loan money to brokers without restraint. And they encouraged brokers to hand it off to stock market speculators with 10% margin. But if you want to see what happens when a government intervenes aggressively after a bust, just look at Japan since 1990. Japan lowered interest rates to zero, just like the Fed is doing today. Japan bailed out banks, brokerage firms and insurance companies, much like the Fed is doing here. Japan embarked on massive public works projects, much like President-elect Obama is proposing now.
But it did not end the deflation. And it did not prevent their stock market from making brand-new lows this year. All it did was prolong the agony — now 18 years and counting.
Jack: So precisely how much longer do you think the deflation will continue in the U.S.?
Martin: Nobody knows. But it's clear that this is not a short-term situation that will be resolved in the foreseeable future. It could take years to flush out the bad debts and restore confidence. The key is the debt liquidation. That's the main engine behind the deflation and a major element in vicious cycles that are just beginning to gain momentum. Consider the housing market, for example. The more debts are liquidated, the more prices fall ... and the more prices fall, the more people abandon their homes and mortgages, leading to more debt liquidation. This is what's happening all around the country right now — not only in housing, but also in every asset imaginable. These vicious cycles are like hurricanes striking every city and state in the country. Until they exhaust themselves, the deflation will continue.
Like you said at the outset, deflation is falling asset prices across the board. Not just falling home prices, but falling prices on land and commercial properties. Not just stocks and bonds, and commodities, but also collectibles — art, antiques, stamps and, soon, rare coins as well. There may be some exceptions. But overall, unless you have some very convincing evidence to the contrary, you must assume the value of your assets are going down and going down hard.
Jack: So what's a person to do?
Martin: If you don't need something, seriously consider selling it. Real estate. Stocks. Corporate bonds. Even collectibles if you consider them an investment.Jack: Even if it has already gone down a lot?
Martin: Don't look back at what the price was. Just look ahead to what the price will be after a massive deflation. You don't have to sell everything all at once at any price. Every time the government inspires a rally in the stock market, use that as a selling opportunity. Every time the government stimulates some activity in real estate or in the economy, grab that chance as well.
Jack: Suppose market conditions are so severe, there are no buyers. Then what?
Martin: Then, you can afford to wait for a temporary stabilization or recovery. Markets never go straight down. And even in some of the worst markets, there are ways to sell most assets.
Jack: What about antiques and art?
Martin: For the first time in many years, you're seeing a contraction in major auctions sales. For example, annual sales of contemporary art at Sotheby's and Christie's auctions in New York and London are down 17% in 2008. In the two years before that, they doubled in sales. So that's not a huge decline yet. But it's a sign.You won't get peak prices. However, if you act swiftly, you can still sell. If you wait, you'll get caught. Ditto for stamps and rare coins.
Jack: Gold is holding its value the best compared to the much larger percentages you cited earlier for other commodities. But I believe it's only a matter of time before gold succumbs to the deflation as well. What do you think?
Martin: This is hard for a lot of people to accept, but it's also hard to envision a situation in which gold defies gravity for much longer. It's still a good insurance policy against governments that could run amuck. But I suggest you reduce your holdings to a bare minimum. No matter what, the key is to pile up as much cash as you possibly can. Then put that cash into the safest place you possibly can — short-term Treasury securities. You can buy them from the Treasury Department directly, through their Treasury Direct Program. Or for even better liquidity, I recommend a Treasury-only money market fund. Our favorites are Capital Preservation Fund and the Weiss Treasury Only Money Market Fund. There are many more to choose from and they all provide the same safety.
Jack: Last week, there were some Treasury bills auctioned off at zero yield. Doesn't that discourage you?
Martin: Not in the slightest. As long as your cash is in a safe place, the deeper the deflation, the more your money is worth. My last word: Just make sure you keep it safe!
Jack: Martin, I'm going to assume that's my cue to jump in and take us beyond just safety and protection, so we can talk about turning this deflation into a profit opportunity.
Martin: Yes, please do.
Jack: There is just one thing that always goes up with deflation: The U.S. dollar! By DEFINITION, when the price of investments or goods and services goes down, the value of each dollar goes UP. That's the essence of deflation. And here's the key: When the value of the dollar goes up in the United States, it inevitably goes up abroad as well.
Martin: Please explain that connection more specifically.
Jack: Virtually everything that matters in the global economy — trade, commodities, GDP, debts — is measured in U.S. dollars. The dollar is the world's reserve currency. So just as we see domestically, when your dollar buys more, its value also rises internationally.
Martin: There was a lot of talk about other currencies replacing the dollar as a reserve currency. Jack: Talk, yes; action, no. It never happened. And now, it's going the other way: Your dollars now buy more than two gallons of gas for every one gallon they bought just a few months ago. The dollar now buys three times more oil and copper than just a few months ago. Not just 20% more or 50% more, but three times more! We're seeing the same thing happen against currencies. The dollar is in a massive, long-term uptrend against the euro, the British pound and virtually every currency in the world. Yes, we've witnessed a temporary dollar setback in recent days, but it does nothing to change the big trend.
Martin: It certainly does not change the deflation. But please give us specific reasons why the dollar is rising against currencies in particular.
Jack: There are three big reasons. The main one is that, as I said, the dollar is the global measure of virtually everything. So when there's global deflation, the dollar is the prime beneficiary. Look. We've had decade after decade of inflation and global expansion. During most of that period, the worldwide supply of dollars and dollar-based credit expanded dramatically. And those dollars became the key funding source of bubbles in nearly every major asset class — real estate, stocks, commodities, energy and metals. As the supply of dollars expanded, the dollar lost value. Now we have deflation and global contraction. So now everything is turning the other way. Despite the Fed's efforts to lower interest rates, credit — dollar credit — is drying up all over the world. The overall supply of dollars is contracting. So U.S. dollars are suddenly scarce and their value is going up.
Martin: Still many people in the U.S. don't see that. They think: "If the U.S. economy is in so much trouble, isn't that bad for the dollar?"
Jack: No, that's simply not how it works. A country's currency is never valued based on how well or how poorly that particular economy is doing in isolation. It's always measured against another country's currency. So it is always valued based on how a particular economy is doing relative to another economy. It's not the U.S. dollar vs. some other measure. It's the U.S. dollar versus the euro, the British pound, the Aussie dollar, etc. So the relevant question is never, "How well is the U.S. economy doing?" The question is, "How is the U.S. economy doing compared to the European economy, the U.K. or Australia?" In this environment, it's not a beauty contest. It's a contest of which economy is the least ugly ... which leads me to the second reason the dollar is rising: The U.S. is winning the least ugly contest hands down.
Martin: Please elaborate.Jack: Europe's banks have lent more than $2.7 trillion to the high-risk emerging markets, and those emerging markets are being crushed by deflation. Europe's banks have big exposure to Hungary, and Hungary is collapsing. They have big exposure to the Ukraine and to Russia, which are also collapsing.
Europe's economy is in much worse shape than ours. In Germany, export demand has vanished. So it's just now starting to accelerate downward. Worst of all, the Eurozone's governing bodies are a mess. You've got each member nation making its own monetary policy and each going off on a different course with its economic stimulus plans. For example, the European Central Bank wants to retain some semblance of moderation in its monetary policy. But the leaders in countries like Italy, Greece, Spain, Portugal and Ireland are scared. So they're going to whatever it takes to try to prop up demand, no matter what the central banks says.
Martin: It's adding political chaos to financial chaos.
Jack: Precisely. These are the reasons the euro has been falling and, despite a sharp rally, will likely continue to fall — probably down to parity with the dollar, or lower.
Martin: That's a huge drop — over 30% from these levels. What about the U.K.?
Jack: Worse. Their housing bust is more extreme than ours. Their reliance on revenues from a sinking financial center — London — is far worse than ours. Their consumers have more debt than almost any other developed country.
Martin: And the Australian dollar?
Jack: Solid as long as commodities were going up ... but a disaster with commodities going down! In just the last five months, the Australian dollar has lost 31% of its peak value. Other currencies tied to commodities are also getting killed: The New Zealand dollar is down 39% from its peak; the Brazilian real, 35%; the Canadian dollar, 23%.
Martin: And going forward?
Jack: Deflation means more declines in commodities. And the more commodities fall, the more these commodity currencies plunge. It's that simple.
Martin: You said you had three reasons for the dollar's surge.
Jack: The third reason is the flight to the center. Think of the world currency market as a solar system. The dollar is the sun; the other currencies, the planets. As the system expands, investors migrate from the core currency, the U.S. dollar, to the inner planets — currencies like the euro, the Swiss franc or the pound. And as the system expands even more, they migrate to the next tier of currencies, like the Australian dollar or the Canadian dollar ... and then, still further, to the system's periphery — outer planets like the Brazilian real, the Mexican peso or the South African rand. At each step of the way, they take more risk with less stable economies, use more leverage, go for bigger returns — all fueled by abundant dollar credit.
Martin: OK. What happens when the global economy contracts?
Jack: Precisely the reverse. As the global economy begins to come unglued, they rush back to the center, creating a massive flight back to the U.S. dollar. They have no love affair with the dollar. They just see the peripheral economies going down and they dump those currencies. These are the first risky investments they sell, almost invariably switching back to U.S. dollars. The U.S. economy, despite all its troubles, is still the dominant world economy. Militarily, it's the only remaining superpower. Financially, it's still the world's capital. So it's natural that when investors are running from risk, they rush back to the dollar, bidding up its value.Martin: Is this true across the board, regardless of the currency?
Jack: No. There's one notable exception: The Japanese yen. Japan is the world's second largest economy and also one of the world's largest sources of capital. So when the other currencies go down, a lot of that money goes back to Japan, boosting the yen. But the main point is this: The single most consistent consequence of global deflation is a rising dollar.
Martin: So in the midst of all these bear markets, if you're looking for a big bull market
...Jack: You've found it! It's the U.S. dollar. I think the U.S. dollar is in the early stages of a powerful bull market that could last for years. It's the single cleanest way to make windfall profits from the deflation.
Martin: A year or two ago, you were betting against the dollar, and you were right. Now you're betting on a rising dollar. That's a big change.
Jack: You're darn right it is! It goes hand-in-hand with the big sea change you've so clearly illustrated today.
Martin: Can you explain to our readers how to go about betting on a rising dollar?
Jack: There are several ways. You can place your bets in favor of the dollar, using instruments that are tied to the dollar index. So as the dollar index rises against other currencies, you profit directly. Or you can bet against foreign currencies. Remember, the flip side of a rising dollar is falling currencies. The more those currencies fall against the dollar, the more you make. I prefer betting against the currencies because that lets me choose the weakest of them all.
Martin: What instruments do you use?
Jack: I use a revolutionary investment vehicle called currency ETFs. They're simply exchange-traded funds, just like any other ETFs. The same ease of trading and flexibility, the same low commissions, the same availability through any stock broker. If you buy stocks or any other ETF, you can buy currency ETFs.
Martin: Before we get into this any further, can you give us full disclosure on the risks?
Jack: All investments have risk. If the currency goes the wrong way, you lose money. But the advantage of the currency market is that it's divorced from the stock market. The stock market could be crashing, and it would not interfere with your ability to make large steady profits in the currency market. The U.S. economy could be sinking into a depression, and it would still not interfere with your ability to make nice large steady profits in the currency market. No matter what happens in the global economy or the world's financial markets, there is always at least some major currency that's going up in value.
Martin: Please explain that.
Jack: Currencies are measured against each other. When one is going up, the other is going down, like a seesaw. Therefore, there's always at least one currency going up. There's always a bull market in currencies and, therefore, always a bull market in currency ETFs. I don't recommend currency ETFs for all of your money. But at a time when nearly all other investments are going down, it's a great place to get away from the disasters and find a whole separate world of investment opportunity.
Martin: A world that's far removed from those disasters.
Jack: Exactly. I also think that it's the ideal vehicle for average investors to profit from deflation and a rising dollar.
Martin: Specifically, which ETF do you use to profit from a rising dollar?
Jack: There's an ETF that's tied directly to a rising dollar index. The more the dollar rises, the more money you can make. And there's virtually no limit to how far it can go.
Martin: Before we end today, please name it for us. But of course, it's a two-way street. If the dollar falls, then this ETF would fall in value as well.
Jack: Of course. But there are also ETFs tied to specific falling currencies. When the dollar is rising, it means other currencies are falling. And with these ETFs, the more those currencies fall, the more money you can make. Plus, you can do it with two-for-one leverage.Take the euro, for example. If the euro falls 10%, you stand to make 20%. If the euro falls 20%, you can make 40%. And if you want to be more aggressive and buy them with 50% margin, you can double that leverage. In other words, every 10% decline in the currency gives you a 40% profit opportunity.
Martin: Do you recommend margin?
Jack: I don't think you need it. The currency market offers plenty of profit opportunity without margin.
Martin: Can you give us some specific examples without using margin?
Jack: Sure. Let's say you bet against the British pound last August. In just three months' time, you could have grabbed the equivalent of a 52% annual return on your money. The return on the euro would have been even better. If you could have bought the ETF that's designed to profit from a falling euro, you could have grabbed the equivalent of an 81% total annual return. On the Aussie, you could have made a 68% annual return.
Martin: With the way the stock market is performing and the way yields have fallen, I think most people would be happy with a lot less than that. Jack, if you can help folks make, say, 30% or even 20% per year, and you do so regularly, that would be a great service you provide.
Jack: Plus, we're not talking about speculating on some little-known stock or exoteric bond. When you buy currency ETFs, you're investing in the currency itself — CASH MONEY. You never own a single share of stock or any kind of bond.You're also not affected by financial failures. Since you never buy stocks or bonds in a bank or corporation that could default, currency ETFs help insulate you from the debt crisis. In fact, the debt crisis overseas, which is far more frightening than the debt crisis here, is driving investors into the U.S. dollar, which can actually help investors make more money in their dollar ETFs.
Martin: Since the ETFs are not investing in stocks or bonds, please explain what they are investing in.
Jack: In most cases, interest-bearing money markets. So in those ETFs, on top of the appreciation in the currency we're aiming for, you also earn interest. And with many currency ETFs, the interest yield is higher than what you can make in any U.S. money market.
Martin: Let's say you're wrong about the dollar and the dollar turns down. Then what?
Jack: In 2007, when the dollar was falling, we did very nicely. I have a service dedicated exclusively to currency ETFs, called World Currency Alert. And in it, I can recommend currency ETFs that are available now on every major currency. There's an ETF for the euro, the Japanese yen, the British pound, the Swiss franc, the Australian dollar, the Canadian dollar and more.
Sometimes we'll focus on just a couple of special opportunities; sometimes, when we have a broad movement in the currencies, we'll recommend you diversify among many different ones.
Martin: Does that require a larger investment?
Jack: No. Remember, these are just ETFs, just shares traded on the exchange. So you could buy just one share of each if you wanted to. In other words, there's virtually no investment minimum. With just $1,000, you could buy a whole range of different ETFs across several different currencies.
Martin: What kind of fees are we talking about to buy and sell the currency ETFs?
Jack: You pay a broker commission. But if you use a discount or online broker, your commission costs can be slashed to the bone.
Martin: How does this compare to trading standard ETFs, like those that focus on particular stock sectors?
Jack: I think it's a lot easier and better.
Martin: Why is that?
Jack: Instead of thousands of stocks and stock sectors, you only have to track six major currencies — the euro, British pound, Swiss franc, Japanese yen, Australian dollar and Canadian dollar. Instead of choppy and crazy stock market surges and plunges, currencies tend to give you much bigger, sweeping trends.
Martin: Because ...
Jack: Because once you get these massive macro global trends — like the deflation we talked about — turning them around is like turning a big tanker at sea. They can last for many years. It's like sailing with the Gulf Stream. You just follow the currency current as far as it will take you.
Martin: How would you characterize this current you're riding right now — the deflation pushing the dollar higher?
Jack: I've seen big currency trends before, but nothing quite like this one, nothing as powerful and large. Your numbers bring that home very convincingly, I think.
Martin: Tell us why you think investors should buy your service, and don't be bashful. I think it's safe to say that our readers want to know how to make real money from this deflation, and if you have a unique way to do this, its information they're going to want to pay close attention to. Jack: Actually, you don't need World Currency Alert to invest in currency ETFs. It's very easy to do, and like I said, they're readily available to anyone with a regular stock brokerage account. You buy and sell them just like a stock or any other ETF. You don't need any new accounts. They're extremely liquid. You just aim to buy them low and sell them high, like any other investment.Martin: What would you buy when?
Jack: Whenever you see a setback in the dollar, I would buy the PowerShares Dollar Bull ETF.
Martin: OK. So why should someone buy your service?
Jack: You don't need my service to buy them. You need World Currency Alert to make money in them, to take your profits, and to do it with some degree of consistency.
If your goal is to take no risk whatsoever and keep all your money 100% safe, then buying currency ETFs would be a mistake, because there IS always risk of loss. But if you're concerned about this deflation — or a future return of inflation — then NOT taking this opportunity is the mistake you'd be making, in my view. There's nothing, absolutely nothing standing in your way.
Martin: Except the cost of the service.Jack: No, I don't see that as an obstacle. The cost of World Currency Alert is just $295 per year. If you invested just a couple thousand in one of the trades I just mentioned, you could cover an entire year's cost very easily.
Martin: In terms of timing, when would be a good time for investors to start with your service?Jack: There's no particular time that's better than any other. Right now, we've had a setback in the dollar. So I'm looking to jump in with a new batch of recos, perhaps around the first week of the new year. So you could wait until then. The key timing issue is the price change we're going to put into place: Starting January 1, we're raising the price to $395. So don't wait until then. Because as long as you join before December 31, you save $100. Plus, there are even bigger savings if you join for two years. In fact, I think the two-year membership makes the most sense.
Martin: Because
...Jack: Because, like I said, it offers the biggest savings. And no matter what, if you're not happy, if it doesn't work for you or you just decide to change your mind, no problem — 100% money-back guarantee in the first 90 days; pro-rated refund at any time thereafter.
Martin: That's very fair. Please provide a web link for more info and to order your service.
Jack: It's http://images.moneyandmarkets.com/1195/88357.html
Or you can call 800-393-0189.
Martin: One way to look at this is like a home business to generate extra revenues.
Jack: I agree. All it takes is a couple of minutes each day, and for each minute of your time, you could be looking at a thousand or two in revenue per hour. Just remember, the price goes up January 1, 2009.
Martin: Thank you, Jack. And thank YOU, our readers, for joining us today. Let's talk again soon.Good luck and God bless!Martin


About Money and MarketsFor more information and archived issues, visit http://www.moneyandmarkets.com/Money and Markets (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Tony Sagami, Nilus Mattive, Sean Brodrick, Larry Edelson, Michael Larson and Jack Crooks. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM, nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical in as much as we do not track the actual prices investors pay or receive. Regular contributors and staff include Kristen Adams, Andrea Baumwald, John Burke, Amber Dakar, Michelle Johncke, Dinesh Kalera, Red Morgan, Maryellen Murphy, Jennifer Newman-Amos, Adam Shafer, Julie Trudeau and Leslie Underwood.Attention editors and publishers! Money and Markets issues can be republished. Republished issues MUST include attribution of the author(s) and the following short paragraph:This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com/.From time to time, Money and Markets may have information from select third-party advertisers known as "external sponsorships." We cannot guarantee the accuracy of these ads. In addition, these ads do not necessarily express the viewpoints of Money and Markets or its editors. For more information, see our terms and conditions.View our Privacy Policy.Would you like to unsubscribe from our mailing list?To make sure you don't miss our urgent updates, add Weiss Research to your address book. Just follow these simple steps.© 2008 by Weiss Research, Inc. All rights reserved.15430 Endeavour Drive, Jupiter, FL 33478

We explain why deflation (falling prices) could wreak havoc with your finances

From The Times
December 18, 2008

The party's over if deflation grips the economy
We explain why falling prices could wreak havoc with your finances


Inflation is tumbling and fears are growing that deflation, where prices actually start falling, may become a feature of the economy next year.
This week the Office for National Statistics reported that the consumer prices index (CPI), a key measure of inflation, fell to 4.1 per cent last month, down from a high of 5.2 per cent in September. Jonathan Loynes, chief European economist at Capital Economics, the consultancy, says: “November's CPI figures are another step along the path that is likely to lead to the first bout of deflation in the UK for almost half a century.”
While falling prices may sound great, deflation is actually considered bad for the economy. When prices fall, consumers defer purchases on the assumption that they will be able to buy the same goods cheaper at a later date. This damages demand which can undermine company profits, trigger unemployment and entrench a destructive economic cycle.
Here we explain what falling prices might also mean for your savings, investments, pension, house price and mortgage - and how to guard against the worst effects.

Related Links
Q&A: deflation
Spending power down in 70% of households

Savings
To some extent, deflation is good news for savers because it increases the size of deposits relative to prices, making them more valuable in real terms. However, the downside is that the rates on savings accounts are likely to tumble if deflation takes hold because the Bank of England would reduce the base rate to 0 per cent or close to it. Savings rates are already falling fast. At the start of October, when the base rate was at 5 per cent, you could lock in to accounts paying an impressive 7 per cent. But now, with the base rate at 2 per cent, the most you can earn is about 5.5 per cent.
Returns in Japan, which suffered a decade of deflation, are close to non-existant. Simon Somerville, of Jupiter Asset Management, says: “The most you can earn from a Japanese bank account is about 0.4 per cent, but most pay nothing in interest. It is no wonder that many Japanese savers have abandoned banks and put their cash in safes or under the mattress.”
Savers in the UK may not end up quite so badly off, but only because our banks desperately need to bolster their finances. Some may continue to offer decent rates, as it is one of the easiest ways for them to raise money. So the pitiful state of the UK's banking system could yet offer a silver lining for savers.
Kevin Mountford, of the comparison website moneysupermarket.com, says that the best way for savers to guard against falling returns is to lock in to a long-term fixed-rate account. He says: “The best one-year fixed rate is from Anglo Irish Bank, at 5 per cent, but be quick as such rates could disappear soon. It is probably safe to lock up savings for up to two years, but any longer and there is a risk that the base rate - and savings rates - will start moving higher again. Nationwide is offering a two-year Isa bond paying 4 per cent.”
Pensions
Deflation could wreak havoc with retirement plans, especially if the problem persists for years. As prices fall, so will corporate profits and stock market investments. Given that many individuals and companies rely on shares to fund pension growth, many savers will have their retirement plans cast into doubt. Tumbling share prices have already wiped nearly a quarter off the average personal pension fund in the past year.
Even investors in final-salary plans, which guarantee a pension based on income, could hit the skids. As companies struggle to finance their pensions, the remaining final-salary schemes could close en masse. Even the Government, which backs the biggest final-salary scheme of all for public sector workers, may be forced to take drastic action, perhaps closing it to new entrants.
Tom McPhail, of Hargreaves Lansdown, the independent financial adviser, says that anyone approaching retirement should consider locking into an annuity sooner rather than later. He says: “As long as your pension fund has not been decimated by the recent stock market turmoil now might be a good time to buy a retirement income because annuity rates could well fall over the coming year or so. If you can afford to do so, deferring your state pension could also help. Provided that you are prepared to take the longevity and political risk - by which I mean that you don't think that you will die any time soon and you trust the Government to meet its promises - then you can boost retirement income by 10.4 per cent for every year you defer taking your pension.”
Those who are already retired could be among the few winners. Benefits, including the state pension, are linked to the retail prices index and can't be cut if inflation goes negative. The worst that can happen is that benefits remain unchanged. Many pensioners have fixed incomes, so inflation erodes their spending power. If prices drop, they will be able to buy more with their pensions.
House prices and mortgages
Homeowners are already experiencing deflation, with the average house price having fallen by almost 15 per cent over the past year, according to the Halifax.
Deflation in the wider economy would be a further blow because mortgage debt would increase in real terms, by becoming more expensive relative to prices. Fionnuala Earley, Nationwide's chief economist, explains: “Inflation tends to be good for borrowers, as it shrinks the real size of debt. In inflationary periods, wages also tend to rise, making it easier to meet mortgage payments. If there were deflation, debt would hang around longer and even grow in real terms, as wages would not be increasing and prices in the shops would be falling.”
Sadly, there is little that borrowers can do to mitigate the effects of deflation. Melanie Bien, of Savills Private Finance, the mortgage broker, says: “The first step is to keep up with your repayments. The mortgage should be your priority; everything else should be paid after that. You can also help by reducing your mortgage by overpaying. If you are lucky enough to have a tracker mortgage, you could overpay by the amount you are saving from lower interest rates.”
Most lenders will let you overpay by up to 10 per cent of your mortgage each year without penalty.
Ms Bien adds: “If you have an interest-only deal, it is worth considering switching to a repayment mortgage to ensure that the capital is paid off by the end of the mortgage term. This will mean significantly higher monthly payments, but it will be worth it in the long run. Speak to your lender about switching - it is very straightforward and can usually be arranged over the phone.”
Recent housing market history gives no indication whether residential property would be viewed as an attractive investment during a sustained period of deflation. Mortgages would continue to be available but the miserable experience of overextended borrowers could result in widespread aversion to debt, particularly among members of the younger generation.
At the same time, the lack of any meaningful returns from savings might persuade some people with spare cash to put it into property because bricks and mortar would be a tangible asset in an unfamiliar and insecure environment.
Additional reporting by David Budworth
Japan still licking its wounds
The most recent guide to what deflation might mean for UK investors is to look at what happened in Japan in the 1990s, writes Mark Atherton.
When Japan's property and stock market bubble burst with a vengeance in the early 1990s, the country experienced a prolonged period of deflation.
With consumers reluctant to spend because of falling prices, the economy stagnated, company profits fell and the stock market tumbled. The Nikkei index stood at nearly 39,000 at the start of the 1990s but now stands at a lowly 8,500, even though deflation has been eradicated for the time being.
John Hatherly, of Seven Investment Management, says: “What happened was that everyone started to draw in their horns and conserve their cash, rather than put it into assets that were falling in value. Investors deserted shares and property for safer havens.”
One of these safe havens was government bonds. Mick Gilligan, of Killik & Co, the stockbroker, says: “Investors reckoned, correctly, that the Japanese Government would not go bust and that government bonds were a safe bet, even though the interest they paid was small.”
Corporate bonds, on the other hand, tend not to fare so well in deflationary times because, with profits falling, there is less money to cover the bond interest payments and there is always the possibility of defaults on the payments or a collapse in the value of the bond itself if the company goes bust.

http://www.timesonline.co.uk/tol/money/consumer_affairs/article5366383.ece

Dollar roars back as global debts are called in

Dollar roars back as global debts are called in
For six years the world has been borrowing dollars to bet on property, oil, metals, emerging markets, and every bubble in every corner of the globe.

By Ambrose Evans-Pritchard Last Updated: 3:48PM BST 23 Oct 2008

The strong rebound in the dollar has surprised some analysts
This has been the dollar "carry trade", conducted on a huge scale with high leverage. Now the process has reversed abruptly as debt deflation - or "deleveraging" - engulfs world markets. The dollars must be repaid.
Hence a wild scramble for Greenbacks which has shaken the global currency system and shattered assumptions about the way the world works. The unwinding drama reached a crescendo yesterday as the euro fell to $1.28, down from $1.61 in July. The slide in the Brazilian real, the South African rand, the Indian rupee, and the Korean won, among others, has been stunning.
Stephen Jen, currency chief at Morgan Stanley, said US mutual funds, pension funds, and life insurers invested a big chunk of their $22 trillion (£13.5 trillion) of assets overseas to earn a higher yield during the boom. They are now in hot retreat as the emerging market story unravels. "There is a complete rethink going on. People are bringing their money back home," he said.
Hedge funds are 75pc dollar-based, regardless of where they come from. Many are now having to repatriate their dollars as margin calls, client withdrawls, and the need to slash risk forces them to cut leverage. The hedge fund industry had assets of $1.9 trillion at the peak of the bubble.
Data collected by the Bank for International Settlements shows that European and UK banks have five times as much exposure to emerging markets as US and Japans banks, with surprisingly big bets in Latin America and emerging Asia - where they rely on dollar funding rather than euros.
The fear is that deflating booms in these frontier economies will have an 'asymettric' effect on the currency markets, setting off another round of frantic dollar buying. "It is not impossible that the euro could collapse completely against the dollar, going back to 2001 levels," said Mr Jen.
He said the "composite" dollar-zone including China, the Gulf oil states, and other countries locked into the US currency system, will together have a current account surplus next year. The de-facto euro bloc of the core euro-zone and Eastern Europe is moving into substantial deficit. This creates a subtle bias in support of the dollar.
Of course, much of the currency shift this year is a natural swing as the crisis rotates from the US to Europe and beyond. The dollar was pummelled in the early phase of the crunch when economists still thought Europe, Japan, China and the rest of the world would decouple, powering ahead under their own steam. The Federal Reserve's dramatic rate cuts were seen then as a reason to dump the dollar.
The decoupling myth has now died. The euro-zone and Japan appear to have fallen into recession before the US itself, led by a precipitous fall in German manufacturing.
The ultra-hawkish stance of the European Central Bank - which raised rates in July - is now viewed as a weakness. Foreign exchange markets are no longer chasing the highest interest yield: they are instead punishing those where the authorities are slowest to respond to the downturn.
A hard-hitting report by Citigroup this week said the ECB had unwisely ignored screaming signals from the bond markets earlier this year for a rate cut. "The ECB did not listen. Not only did they no reduce rates as they should have but they increased them in one of the biggest policy mistakes of 2008," it said.
The spectacular dollar rebound has geostrategic implications. Heady talk earlier this year that dollar hegemeny was coming to an end - or indeed that the US was losing its status as a financial superpower - now seems very wide of the mark.

http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/3242927/Dollar-roars-back-as-global-debts-are-called-in.html