SURPRISE DEFLATION!  DOW DOWN 300!

All stock market upward cycles end with a surprise. In 2000 it was the dot com bust, in 2008 it was the housing bubble and the market fell 50%. This time it could be deflation, as the surprise. The recent budget compromise allows more risky derivative buying by the banks and larger contributions by the financial industry which will make matters worse. . As interest rates are to rise next year, these derivatives could start another banking crisis with the taxpayers in no position for a bailout this time. All boats will sink. On the one hand consumers are reaping benefits from cheaper prices paid at the pump, but on the other hand, investors are weighing whether falling oil prices are symptomatic of deflation in a lagging global economy. Crude oil fell below $60 a barrel for the  first time in five years. This is normally the time of year when money managers are doing window dressing, as portfolios can meet benchmarks. Window dressing refers to the practice of selling poorly performing stocks in favor of high performing stocks.  For window dressing. the market should be rallying, but it is not. SEE SUPPORT LEVELS BELOW

There is a fear that lower oil prices is an indication that world economies are starting to fail and world economies may be headed into a deflationary spiral. The Fed has done everything it can to cause inflation: (near zero interest rates, QE trillion dollar bond buying and economic stimulation).  With all this, the inflation rate is only 1.2%. The Fed can handle inflation, because it means they can pay off debt in the future with inflated currency. That’s what happened after World War II. However, deflation is another matter. With interest rates close to zero and as the Fed has already purchased several trillion dollars worth of bonds (QE), there appears little likelihood that they are in a position to stimulate the economy if deflation raises it ugly head. Also under deflation tax revenues drop and defects get larger and harder to pay off with deflated dollars. SEE BELOW I continue to believe industrial nations are going to have a problem with economic growth, as all the income growth is being sucked up by the top 1%. The working poor earning minimum wages, cannot support a consumer economy in the US and growth in Japan and Europe have stopped. China is slowing.

It is interesting to note that the price of gold is getting some notice, 43 years after Pres. Nixon scraped the gold standard. Gold appears to be reemerging as the centerpiece of a handful of initiatives in Europe, Asia and the Middle East. Voters in Switzerland considered and eventually rejected a populist plan to force its central banks to buy gold to stabilize its currency. Russia and China have both made the headlines by snapping up enormous stores of gold. In France, politicians are calling for the government to start amassing gold and the Netherlands followed suit by asking for its $5 billion of gold in the vaults of New York to be delivered to them. Even the Islamist state is declaring they wanted to avoid the ‘tyrannical financial system’ of the West by buying gold. What’s going on here? Holding gold for people and government reflects our anxieties about the future. Even though it might seem somewhat retrograde to many investors, having it on hand makes people feel safe

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I have been reading a recent book called The Death of Money and the Coming Financial Collapse of the International Monetary System by James G Richards Mr. Richards asserts that he expects the economy to be in a economic bubble. He believes that the old normal is gone, but the new normal has not yet arrived and that the economy is in a phase of transition from one state to another. He believes that a new international monetary system will rise from the ashes of our present dollar based system, just as the British Commonwealth pound system ended at Brenton Woods in 1944. He believes the mortgage problem in 2008 was manageable. However, unmanageable were the trillions of dollars still in derivatives created from underlying mortgages and trillions more and of repurchase agreements. Congress just approved more risk of derivatives by the banks. From 2009 two 2012 the U.S. Treasury increased a $15 trillion cumulative debit and the Federal Reserve printed $3 trillion in new money. The bankers jobs and bonuses were preserved but nothing was achieved for the average citizen. The Fed sees inflation as a way to dilute the real value of US debt and avoid the specter of deflation. He expects deflation or skyrocketing gold prices and the crashing dollar to be two sides of the same coin and that will occur quickly. Deflation is the Federal Reserve’s worst nightmare for many reasons as real gains from deflation cannot be easily taxed. Deflation would increase the real value of government debt making it harder to repay. If deflation is not reversed there will be an outright default on the national depth rather than the less dramatic outcome of default by inflation. He suggests the breaking up of the banks that would eliminate the problem of too big to fail. He believes where larger financing is required small the banks can acquire a syndicate. He believes that if large banks continue to dominate the financial situation, and that financial failure on a global basis will follow and that the task every qualifying the finances of the world will fall to the IMF, because the IMF will have the only clean balance sheet left among institutions. He believes the IMF will then rise to the occasion with a towering issuance of SDR’s, and this monetary operation will effectively end the dollar’s role as a leading reserve currency. If this does occur United States be allowed to print money. So in these uncertain times, gold should be looked at as an alternative investment. Gold holds its purchasing value in deflation and deflation.

Carl M. Birkelbach 12/12/14

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