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Access Robert Prechter’s free report and read in-depth analysis -- including an 84-year study of stock values -- that will help you prepare for and understand today's critical market juncture. Download Robert Prechter's Free Report. Symptoms of Deflation - Guest Post from - Mish - Mike Shedlock - Full Link BelowSymptoms of Deflation- Guest Post from Mish SYMPTONS OF DEFLATIONSymptoms of Deflation 1.Falling Credit Marked-to-Market 2.Falling Treasury Yields 3.Falling Home Prices 4.Rising Corporate Bond Yields 5.Rising Dollar 6.Falling Commodity Prices 7.Falling Consumer Prices 8.Rising Unemployment 9.Negative GDP 10.Falling Stock Market 11.Spiking Base Money Supply 12.Banks Hoarding Cash 13.Rising Savings Rate 14.Purchasing Power of Gold Rises 15.Rising Number of Bank Failures
Scorecard - When you go to a doctor for diagnosis of an illness, the first thing the doctor inquires about is symptoms. So let's do just that for the second time. Let's take those 15 conditions one would expect to see in deflation and see how many apply.
1- Falling Credit Marked-to-Market The mark-to-market value of credit on the balance sheets of banks and financial institutions is the hardest of the 15 items to measure. Indeed, the mark-to-market value of credit cannot be directly measured at all. The reason is banks do not mark-to-market assets unless those assets are worth more than they paid for them. The Fed, FDIC, and FASB (Financial Accounting Standards Board) lets banks get away with just that. Mark-to-Market rule enforcement has been postponed twice. Moreover, banks hide non-performing loans off the balance sheet in SIVs and by other tactics. However, one can easily impute the direction of of the value of credit on the balance sheets of banks and financial institutions by watching prices of bank shares. In 2008 shares of financial corporations plunged. In March 2009, financial assets valuations soared. That action kept up for longer than I expected. However, early this year, bank stocks started showing weakness (long before the rest of the market), then crashed in the last couple weeks. $BKX Banking Index
Pater Tenebrarum presents a superb analysis of the situation of U.S. and European banks in Welcome Back To The GFC, written August 11, 2011. Bank of America (BAC) find itself increasingly under suspicion from investors, as it continues to choke on its acquisitions made during GFC, Phase 1. Readers may recall our comments on the take-over of Countrywide by BAC - at the time we noted that in our view, the takeover was done because Countrywide was one of the biggest counterparties of BAC. By taking it over, the losses that would have come due on occasion of Countrywide's bankruptcy could be swept under the rug. Moreover, BAC had invested a lot of money in Countrywide and strove to make it appear as though these investment had been wise. That the then management of BAC paid such a high price in the takeover was clearly a dereliction of its fiduciary duties. It could have gotten the carcass a few weeks later for next to nothing. Instead it decided to pay a high price for what has likely turned into a sheer bottom-less well of losses. This was then topped off with the acquisition of Merrill Lynch, likely at the behest of the administration - again in order to avert what would likely have become a major bankruptcy otherwise. If this reminds you of the story of Creditanstalt in the early 1930's, we say it should. BAC appears to be on the brink again. Its new management keeps saying that no new capital will have to be raised and that the bank's 'fundamentals are strong', but since it continues to sell 'non-core assets' at a fast clip, it evidently does need more capital. The market's verdict is rather worrisome. That is one small clip in a lengthy but very worthwhile discussion that also includes credit default swap analysis of numerous US and foreign banks.
Nothing Fundamental Ever Changed It is important to point out that nothing fundamental ever changed in regards to the health of US and European banks. They were and still are bankrupt. However, what did change (temporarily), is the market's mark-to-market valuation of bank assets. Alternatively, the market was willing to overlook suspect assets, perhaps in belief that rising earnings would eventually cover the losses and more capital would not have to be raised. The recent plunge in bank shares globally, shows without a doubt the market once again questions the value of debt on the balance sheets of banks. Once that happened everything fell apart, quite rapidly. Those not paying attention to mark-to-market issues never saw this coming. The debt-deflationists did. 2 - Falling Treasury Yields Yield Curve as of 2011-08-10 Shades of Japan 03-Mo = .01% 06-Mo = .06% 12-Mo = .09% 02-Yr = .18% 03-Yr = .33% 05-Yr = .92% 07-Yr = 1.50% 10-Yr = 2.15% 30-Yr = 3.51%
2-year, 5-year, and 10-year treasury yields hit all-time lows on 2011-08-10. This happened in spite of a downgrade of US debt by the S&P. 3 - Falling Home Prices The Case-Shiller home price index briefly turned positive in 2010 but is now down 4% year-over-year. 10 years of price gains have been wiped out in many cities.
My proxy for corporate bonds is JNK, the Lehman High-Yield Junk Bond Index. When risk appetite drops, prices fall, and yields rise.The rapid decline in price represents a rise in yields and a reduced demand for risk.
Producer Price Index Intermediate Goods
Producer Price Index Raw Goods
The above charts from the BLS PPI Release. $CRB - Commodities Index
This makes six for six.
7 - Falling Consumer Prices
This data point is the weakest of the lot so far given that it is a month-over-month comparison rather than year-over-year. However, in the wake of plunging crude prices, gasoline prices will drop as well. More CPI weakness will follow. This makes seven for seven.
8 - Rising Unemployment Let's consider both Employment and Unemployment. Employment
There was never a rebound in employment from the last recession. Unemployment Rate 
The number of people employed fell by 38,000! The only reason the unemployment rate dropped is 193,000 people dropped out of the labor force. Why? Because most of them became so discouraged they stopped looking for work. And if you stop looking for work, even if you want a job and need a job you are not considered unemployed. The preponderance of evidence is clear. This makes eight for eight.
9 - Negative GDP The BEA Gross Domestic Product: Second Quarter 2011 release states "Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 1.3 percent in the second quarter of 2011, (that is, from the first quarter to the second quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the first quarter, real GDP increased 0.4 percent." This is exceptionally weak. Indeed I think GDP is below the stall rate and the US is headed for recession. I wish I had worded the condition a bit more thoughtfully. In a period of deflation GDP will be weak, not necessarily continually falling. However, let's call this a near miss. This makes eight for nine.
10 - Falling Stock Market I could produce hundreds of charts for this category but let's go with the S&P 500 Index. $SPX Daily
However, like a drug addict on heroin, the medicine has worn off. The money sits as excess reserves at the central bank. Base Money Supply
That makes ten of eleven.
12 - Banks Hoarding Cash I wrote about banks hoarding cash and paying negative interest rates on deposits on August 4, 2011 in Bank of New York Mellon to Slap Fees on Big Deposits Following "Global Dash For Cash"; When was Hyperinflation Supposed to Start? Excess reserves is another measure of willingness to lend. Excess Reserves (Editors note see financial investment advice.
It did not happen nor will it. Simply put, the excess-reserve money-multiplier theory is potty. Banks do not lend just because they have reserves. Indeed reserves do not enter the equation at all. Rather, banks lend as long as they are not capital impaired and as long as they have good credit risks willing to borrow. In this case, banks are capital impaired, and there are too few credit-worthy clients who want to borrow. The result is banks do not lend and money sits as excess reserves. That makes eleven of twelve.
13 - Rising Savings Rate
That makes twelve of thirteen.
14 - Purchasing Power of Gold Rises Many deflationists thought gold would drop in deflation. However, my theory, explained years ago is as follows: 1. Gold is money 2. Gold is in the senior currency rises in value in deflation. 3. Gold, as money, would benefit (rise) in response to Fed actions to defeat deflation by printing fiat money. It happened in the great depression and it is happening again. That makes thirteen of fourteen. 15 - Rising Number of Bank Failures Bank closings remain elevated. We have had 106 bank failures so far in 2011. That makes fourteen of fifteen Doctor, Doctor Gimme The News If you went into a doctor and had 14 of 15 symptoms of a disease and the 15th was close, you can be sure the doctor would know what was happening. In this case, the diagnosis is crystal clear: The US is back in deflation.
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