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Recovery, Inflation, Or Deflation?

05/28/03 03:52:28 PM PST
by Bruce R. Faber

There seem to be three very different opinions about which route our economy is traveling. Which one is correct? Investing minds want to know!

Turn your TV to almost any financial program and the chances are excellent that you will find a Wall Street cheerleader giving his or her version of why the market is ready to resume its long-term upward trend. Likewise, your favorite radio station's "market minute" will likely have an ad script from the sponsoring brokerage company, declaring that the market's declining days are behind us. Those not buying stocks this very minute, the radio announcer will cajole, will rue their decision to stay off the back of this brand-new bull. Hurry! Hurry! Hurry!

These are the same people, and the same sort of ads, that have been saying the same things for the last 15 years. These people make money every time someone buys or sells stocks. Keep in mind that 10 of the major US brokerages just agreed to a $1.4 billion settlement with the government as a penalty for flat-out lying to their clients in order to continue selling stocks to their misinformed clients.

Other experts in the field of finance, experts who don't make a commission every time someone buys or sells a stock, have looked at the current economic state of affairs, examined the history of what has happened in earlier, similar circumstances, and have come to conclusions that differ considerably not only from the contemporary Wall Street cheerleaders, but also from each other.

One of these experts, Robert Prechter Jr., is the author of Conquer The Crash: You Can Survive And Prosper In A Deflationary Depression. His credentials and arguments seem solid, and his predictions in the late 1970s about the coming 1980s bull market led to good investment returns. Raveendra N. Batra and Ravi Batra also looked at what has happened in the past. They applied what they learned and wrote a book about the future titled The Crash Of The Millennium: Surviving The Coming Inflationary Depression.

The final result — a huge depression — is the same in both books, but their paths there are very different. The two pathways head off in nearly opposite directions, though they end up at the same depressing place. Intelligent investors can better prepare for the future if they know where they are going and by which route.


Remember "Baghdad Bob," Saddam Hussein's Minister of Information, Mohammed Saeed Al-Sahaf? The man who made incredibly false and fantasized statements during the war in Iraq? With US tanks only a mile away, Baghdad's airport under coalition control, and American GIs taking showers in Saddam's gilded palaces, Baghdad Bob was telling reporters, "We have killed most of the infidels, and I think we will finish off the rest soon." His job was to spread the brand of propaganda that was the most beneficial to those signing his paycheck. The regime's reality at that point in the war was beyond hope and, for their purposes, reality no longer mattered. All that mattered was keeping up the pretense that all was well as long as possible.

As I wrote this article in May 2003, the four-week moving average of initial jobless claims in the US was 446,000, an increase of 3,250 from the previous week's revised average of 442,750. For the past 12 weeks, the average had been well over 400,000 per week, or more than five million total initial claims. The unemployment rate for the country was 6% and edging higher. That's a lot of money that was not being made. It would follow that it also represented a lot of money that was not being spent.

Investors in the US markets have already lost trillions and the war rally appears to have lost much of its momentum. The strength of the US dollar is down well over 20% over the last 14 months.

On top of all this, a new cloud has formed over some of the trading specialists on the floor of the New York Stock Exchange (Nyse) for their practice of "front-running." According to, this is where brokers trade an equity based on information from the analysis department before their clients have been given the information. This comes in addition to the outright lying that several of the top brokerage houses had to pay a $1.4 billion penalty for.

However, after listening to Baghdad Bob, it is easier to understand how market gurus can sit in New York or Fort Lee and continue to tell the ever-hopeful investor that the new bull market is alive. Nevertheless, although Baghdad Bob has allegedly not been seen in Iraq since about April 8, I doubt that Al-Sahaf, beret slightly askew, is the one leading the large black bull down Wall Street.

In fact, if you turned on the TV right now, you could probably catch an entire band of Baghdad Bobs singing a ditty that goes like this: "We have killed most of the bears, and I think we will finish off the rest soon." Maybe. But will somebody check to see who is taking a shower behind that $6,000 curtain in Tyco ex-CEO Dennis Kozlowski's old apartment? Odds are good that it's a bear cleaning up in there.

Often, it is difficult to follow the cheering section's double-speak about why the market is on its way back to the top. A lot of the time, the most comprehensible reasoning presented is simply that the markets always seem to go up after they have gone down. If that is the case, then we may really have something to look forward to, because in the last three years equities have gone down a lot.

Stocks are now cheap compared to what they once were, so the reasoning goes that it must be time for a change of trend. It is easy to follow that train of thought, but such thinking is subjective at best. It doesn't take into account the possibility that while Mr. Bear may have gone over the cliff, he hasn't finished falling. He may be resting on a crumbling ledge on the face of a much-higher precipice.


No matter which of the "coming depression" lines of reasoning we look at, the logic of those arguments — combined with the realities of today — are easy to follow and simple to understand. Federal Reserve Board Governor Ben Bernanke has pointed out, "The US government has a technology called a printing press. . . that allows it to produce as many US dollars as it wishes . . ." At the same time, he is cursing deflation, and Federal Reserve Board Chairman Alan Greenspan is telling Congress of his fear concerning "the probability of an unwelcome substantial fall in inflation."

What Greenspan is trying to say, in government-speak, is that he is afraid of deflation. He is afraid that Americans might pay less for the things they need to live their lives. When the central bank of the country announces openly that it fears deflation, it becomes easy to see how rampant inflation could come to quickly steal the savings and pensions of our nation. Likewise, such inflation would destroy the quality of life for those on fixed incomes. The history of the world is littered with the carcasses of inflation-bloated empires.


In the words of Hans Sennholz, president emeritus of the Foundation for Economic Education (FEE) in Irvington, NY:

The popular notion that an increase in the stock of money is socially and economically beneficial and desirable is one of the great fallacies of our time. It has lived on throughout the centuries, embraced by kings and presidents, politicians and businessmen. It has shattered numerous currencies, inflicted incalculable harm, and caused social and political upheavals. It springs forth, again and again, no matter how often economists may refute it.

If we are headed for hyperinflation of the type experienced by Germany in the early 1920s, then our current US practice of going as far into debt as possible is the right course of action. Of course, such a hyperinflation scenario wipes out the real savings of everyone who is trying to make prudent preparations for the future. Such an inflation route also puts all of those on fixed incomes directly on the path to extreme poverty. This might seem to be acceptable if you follow the logic of Spock, the favorite Vulcan of the TV show Star Trek: "The needs of the many outweigh the needs of the few." But keep in mind that while those who save in the United States may be relatively few, more than a few Americans live on fixed incomes.


But what happens if it goes the other way? What happens if the investors from outside the US suddenly realize that they are getting back less than 80 cents on each dollar they invested in our economy a year ago? Foreign investor confidence in the US dollar has remained thus far, even though the dollar, as indexed against a basket of foreign currencies, has fallen from over 1.22 at the high in March 2002 to a low of something under 0.95 in May 2003. Granted, the dollar index had a brief rally to somewhere over 1.02 on one of the first really good days at the beginning of the war in Iraq, but the upturn was short-lived once reality again became the market's focus.

One of the big reasons that the bear market has not waddled more rapidly down the equity hill is because foreign investors continue to pour well over a billion dollars into our economy every single day. Once it dawns on those investors that they are buying a guaranteed loss, they might decide to put some of that billion dollars into the economy of a country where their investments actually give them a positive return on their money. What a concept!

Without that inflow of foreign money propping up our economy, there is just an off chance that our market's downward trend would accelerate — rapidly. Of course, we never want to completely discount the strength, means, and ingenuity of the President's Working Group on the Financial Markets (see my Working Money article, "Why Doesn't The Fat Lady Sing?").


The worst part of all this is that the Wall Street chorus that continues to sing about the stock market's return to the previous bullish pattern is largely the same group of songbirds who rode the bull to complete exhaustion back in the 1990s. They are singing the same bullriding ballads today that were so popular when the financial arena was the only place to get a buck. Those melodies were pretty much on key until spring 2000, but they have sounded a little sour over the past three years.

Not only have those notes turned sour, but the Securities and Exchange Commission forced a change in some of the lyrics with the billion dollars in fines and penalties. To a lot of very knowledgeable market watchers, the US bull market certainly appears to be as dead as the Iraq Baathist party. There is a remote possibility that both the Baathist regime and the US bull market of the 1990s could return to their former power, but — given the current realities — perhaps Baghdad Bob and the Bullriders should consider learning some new tunes.


Some seasoned veterans have had good track records in both the old bull and young bear markets. Several of these newsletter editors with more accurate predictions, both up and down, feel that this bear still has a long autumn ahead before any hibernation is scheduled.

The difference between those in the bullrider chorus and those who beg to differ is a willingness to look at the realities. For instance, price to earnings ratios were very high when the market topped out, somewhere near 43. As the market has already fallen a terrible distance, we would think the price to earnings ratio should be much better now — but that's not so. The reasons that P/Es are still so high are: (a) as the market fell, companies laid off millions of people; (b) fewer people are earning money, and in turn, they are spending less money; and (c) the earnings of the companies have declined almost as precipitously as the price. The bottom line is that the ratios are still well above the levels they achieved at previous market peaks.

The point: the beginning investor is getting hit from all sides with contradictory information. And it isn't only the beginning investor who is having trouble deciding what is true. The great controversy extends from the top of the multimillionaire ranks down to the lowliest investor sitting in front of his computer at home, and it demands a hefty payment from everyone involved. The multimillionaire heads of the brokerage houses are seeing their earnings taxed by the SEC settlement for lying, and the lowly investor at home is seeing his retirement funds disappear because he believed the ads and recommendations of those brokerage houses.

If there is still a question as to which way the market is going, then use this simple rule of thumb. If someone tries to convince you one way or another, look at his or her motivations. Look at which storytellers rely on both past and current realities, and which just paid large fines for distorting the facts (and are still under investigation for using their power to take advantage of the average investor). Robert Prechter, Martin Weiss, Ian Gordon, Richard Daughty, David Tice, Doug Noland, and Marc Faber have pretty good records. A good number of brokerage firms have $1,435,000,000 worth of egg on their faces for misleading their clients.

This looks like a great opportunity for the investor to make a calculated choice for the future. Now if there was some way to get a handle on whether the route is deflation or inflation, then we would know whether we should be wise and save our pennies, or just continue to spend like crazy and let inflation bail us out in the end. Eh, maybe we should just buy gold.

Bruce Faber may be reached at


Baghdad Bob Quotes

Batra, Raveendra N., and Ravi Batra [1999]. The Crash Of The Millennium: Surviving The Coming Inflationary Depression, Harmony Books.


Davidson, James Dale, and William Rees-Mogg [1993]. The Great Reckoning: Protect Yourself In The Coming Depression, Simon & Schuster.

Faber, Bruce [2003]. "Why Doesn't The Fat Lady Sing?" Working Money: April.


Merrill-Lynch Indictment By New York State

New Jobless Claims

Prechter, Robert R., Jr. [2002]. Conquer The Crash: You Can Survive And Prosper In A Deflationary Depression, John Wiley & Sons.

Rally To Year's End

Remarque, Erich Maria [2002]. The Black Obelisk, Simon Publications. (Originally published in 1957.)

SEC Settlement

Varchaver, Nicholas [2002]. "The big Kozlowski," Fortune: December.,15114,389957,00.html

Bruce R. Faber

Title: Staff Writer
Company: Technical Analysis, Inc.
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Seattle, WA 98116
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