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Mish Deflationista vs Current Stagflation Environment

Economics / Inflation Feb 28, 2012 - 10:23 AM GMT

By: David_Petch


Best Financial Markets Analysis ArticleThis article deals with the current environment of stagflation we are in that will see periods of defined inflation, followed by short but intense deflation, unlike a constant "Deflationista" environment as insinuated in the writings of blogger, Mike Shedlock. A few years back he came out with an article about legendary Strategic Investor Donald Coxe (Who is an extremely captivating writer with his vast knowledge of history and amusing ways in which words are spun together), titled "Donald Coxe Jumps the Shark". Mike got the call on deflation of 2008 correct...KUDOS to Mike. However, the constant beating of drums about deflation deflation deflation is kind of like someone waiting for over 20 years for that 3rd of a 3rd of a 3rd down that just never really seems to materialize. The discovery I made back in July of 2011 that a Contracting Fibonacci Spiral nailed every major high since the 1934 low after much thought defines why the markets are behaving as they do. By completion, this article should explain why defining the present environment as deflationary is like only using one sense to describe an elephant when using the collective of all senses provides a much better answer and explanation.

One important definition I want to state up front is stagflation. Stagflation is defined as waves of inflation coupled to waves of deflation operating in unison that cancel each other out for the most part, but with the inflationary wave being stronger and in operation longer per unit time than any bout of deflation. Deflationary forces are present with rising debt levels that can not be serviced against inflation that can be due to rising levels of fiat introduced into the economy. One of Mish's arguments is that if a trillion dollars of money is printed and is buried, it does not create inflation because it does not hit the system....true, but printing one trillion dollars to bail out banks and keep them afloat helps to sustain a background level of inflation by cancelling out any deflation. Think of the economy as an individual drowning...there are two choices, sink or swim...what we are witnessing is a "response" to a situation that would be done by anyone under those circumstances, irrespective of what those sitting on shore smoking pipes are contemplating about how the swimmer should be reacting. As it will be shown and as we are seeing within the stagflationary environment, inflationary periods are longer, while deflationary periods are shorter. Yet, the period of deflation can wipe out most of the gains accumulated during the inflationary time period.

Basic Fibonacci Recap

I am not going to go into detail about the Contracting Fibonacci Spiral (CFS) because I have dealt with it in numerous articles. Google "David Petch Contracting Fibonacci Spiral" and around 5 different articles pop up. There are further internal details of this cycle but those will go to the grave with me.

Fibonacci number sequences take the current number and combine it with the previous to create a sequence. As the sequence gets larger, dividing the previous number into the latter gives 61.8%, which is Phi, the Golden Ratio. Robert Prechter is probably the leading authority on Socio Economics and how Fibonacci sequences, ratios are seen throughout nature, so use Google to find out more in this area if interested. The sequence of Fibonacci starts like this: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89 etc. This has only been viewed as an expansionary sequence, as opposed to a contracting sequence.

The Contracting Fibonacci Spiral was induced by monetary expansion back in 1932 with gold fixed in price although the US Government essentially doubled the price after they robbed the citizens by stating "Sell your gold to us or go to jail". Cycles that are bound to a mathematical sequence are locked in and require an immense force to dismantle it (See "Why We are Headed to Where We Are Headed"). The CFS takes into account the collective human psychology and has a defined law that "The Collective Human Psychology that follows a monetary expansion and triggers a CFS is independent of events that form its basis. Rather, each time point along the path can be defined as to where the collective lies and how it should react. News events and such that are minor are random and play no role as to when the major time points of the CFS are reached". This is a very profound observation because it takes the human collective into the lab so to speak and provides a glimpse into the future for what lies ahead based upon observable data.

The following hyperlink is the best definition of Fibonacci Spirals I have ever seen. It is rather complex, but shows that Fibonacci spirals occur at the quantum level and builds itself with increasing mass to produce these patterns on larger scales. This information can be extrapolated into the Contracting Fibonacci Spiral that the markets are in...a very fascinating link, but make sure to really listen and think of how this relates to the evolution of the cycle with respect to the Stock Markets.

Effects of CFS From 1932 Until Present

Mish stated that gold does well during deflationary bouts. This is not an entirely accurate statement. First, it really depends what post gold is hitched to. At present, gold is hitched to fiat and has been throughout a big chunk of time since Gutenberg invented the printing press. In the 1930's, gold was fixed in price while the US Government expanded its fiat currency. As the population expanded, gold and silver supplies remained near constant levels or declined(actually declined over time) with prices remaining fixed. In 1971 once Nixon closed the gold window, we have seen the evolution of a cycle that thinking back in retrospect, makes sense.

If gold and silver "were" in coins for monetary exchange, then the money supply can only increase as more is actually minted. Under this scenario, gold and silver would not decline in price during deflation because the price is fixed into the currency...actually, holding money during deflation that is based in gold and silver would see no asset deflation. This sort of Utopian view is not practical in the real world of modern finance (computers, growing world population, chances of one nation holding all the gold would lead to wars etc), because it is easier to fix prices to fiat for exchange. Although gold and silver are rising in price, it is a phenomenon of seeing an exit out of fiat to something that is tangible. Any deflation seen during implementation of fiat currency will see all assets decline in price, even gold and silver...higher lows will be put in place, but still, they will respond to deflation by a decline in prices. Money during deflation, does not lose value unless it is a currency that is declining relative to a Reserve Currency.

The US Dollar is the Reserve Currency of the world at present, so periods of deflation within this cycle makes strategic sense for switching to stockpiles of US Dollars or Treasuries until that portion of the cycle passes and then back into tangibles (precious metals, PM and energy stocks, other currencies etc.).

So gold doing well during periods of deflation (years, not a month here or there) really depends upon what post it is hitched to and where one is in the cycle...if gold "is in currency and fixed in price" then it holds its value...if it is fixed to fiat, then it will decline in price during deflation. As we have seen as a society the past 40 years, gold does well with stagflation whether the cycle has rising interest rates or low interest rates until price reaches a climactic top. I think a better way view the 1970's as a period of stagflation in a demographic environment with a young population needing things and requiring items against the back drop of excesses from the bull market of 1932 -1966 needing to be worked off. We had the stock markets top in 2000 and are now again in a stagflationary environment that has the baby boomers further down the snake (pig in the python), distorting that portion of space it surrounds. High debt levels dictate the reserve currency have rates low, otherwise the system blows up...sink or swim...we are seeing a fight for survival of the US Dollar. So, we have different circumstances for how stagflation is operating, all relative to positioning within a cycle.

Please note that the CFS only calls for the market does not specify how long the declines will last, but that the declines will be very sharp (usually between 40-50%). The CFS saw a 34 year boom period during a World War, several smaller wars which was the first leg of the CFS, so in reality, this was the best period of growth on a percentage basis with true economic growth. The subsequent point of 1987 (Part of the 21 year cycle top of the CFS) occurred after a 16 year bear market and 5 years into the longest bull market in history for broad stock market indices. Note that this correction was very brief, yet markets suffered a 40% decline in days, rather than months or years. From 1987 until 2000, we saw a stock market mania develop, with expansion of the economy built upon that of generations past. From 2000 until 2008 markets rebounded to touch or exceed former highs, followed by a very sharp correction that saw a brief period of deflation actually register.

Now, here we sit in February 2012, quickly approaching the next turn date later this year/early 2013. There are smaller details of the cycle going on, but when the magic date is hit, things quickly should turn south into a very intense period of deflation. Those that are not ready or are waiting for confirmation of a top will quickly find out how quickly it was reached. The sell-off for the next decline will be very sharp and brief. Each period of time that passes will see economic events happen in shorter time frames. The year 2011 saw an entire business cycle happen within one year. The year 2012 will see strong growth and rises in commodity prices due to fiat expansion that will have many screaming hyperinflation. This will not happen because of where we are within the CFS. Since laws of nature follow a pattern to completion, the collective human psychology will drive this...there is nothing that can be done to prevent the final outcome, since the pattern has already been set in motion unless Government absolutely seizes control of every asset owned by the collective.

So, to preach that we are in deflation at present is downright wrong. More accurately, we are in a period of stagflation that is seeing the inflationary wave soon to crest and trigger completion of the "5" portion of the CFS. The "3" portion of the CFS will likely start with a strong deflationary wave, followed by a very strong rebound into 2016 where again, a top will be formed. There are other factors I will not mention for success of this cycle because it is obvious, but most will fail to master. Being caught in the collective human psychology will sweep most out to sea in the tide of emotions...a very simple cycle, but the inner machinations are very complex.

In 1987, Glenn Neely called the sharp correction that occurred and also stated the DOW would reach at least 12,000 by the year 2000 (many did not think that was possible). He also stated in his long-term NeoWave (higher level of Elliott Wave) that the DOW would hit 200,000 at some point in time this century. It is very interesting how the stock market has been in a mode of expansion, yet the time cycle is contractionary. These two principles dove tail each other nicely to show that a compression of time related cycles can cause prices to top out. Anyone following Elliott Wave should consider purchasing "Mastering Elliott Wave" by Glenn Neely because his method of analysis scientifically quantifies the process, rather than traditional Elliott Wave which is rather Laissez Faire.

Full Circle

To return to the original thesis for this article, the state of persistent deflation as stated by Mish is rather inaccurate. Rather, we are in a stagflationary environment within the CFS the markets are trapped in that has defined segments for when inflation and deflation will be dominant. Both of these mechanisms are in constant operation, but the cumulative effect is similar to the infinite combinations of greed and fear that drive stock markets.

Others, such as Fish Head Guy got caught up in the mass psychology of assumed deflation in late 2011, but quickly changed his stance to reflect the present environment we are in...a good trader, so this is only like Jumping a Minnow...a very small flaw that is not going to change much in the long run. An important lesson is to be aware of environmental surroundings and make changes in accordance rather than being fixated with one idea.

The coming 8 years are going to be tough, even knowing when the time points arrive for making trades. Markets have a funny way of working and will make most get it wrong...chances are we will all make some mistake as the market plays out in a fashion that only makes sense in retrospect. The hypothesis that the markets are trapped in a CFS is more likely to be proven fact, given that it is following the pattern to a tee and is a clearly observed pattern of nature.

There are a few take home lessons from the thought that markets are trapped in a CFS:

  1. The markets have a clear and quantifiable path if the data is observed in totality rather than a portion. This translates into broad stock market indices extending into the branch of science known as Socio Economics.
  2. All events occurring e.g. shorter business cycles, volatility, inflation and deflation, higher energy prices are symptoms of where we are the Contracting Fibonacci Spiral rather than cause (i.e. Some may assume higher energy prices are causing the shorter periods of economic growth).
  3. Since the stock markets really are a gauge of the collective psychology, lessons of fiat expansion can be learned so that CFS's such as the one we are trapped in are not induced by those in power i.e. Governments for future generations.
  4. One or the prime operatives from science is being able to harness discoveries into tangible technologies to benefit human kind. Everything discovered can be used for good and evil (i.e. Nuclear fission). We are witnessing the "Evil" part of how the CFS can be implemented, so a focus should be made by Socio Scientists for how to run future currencies without inducing cycles such as these from starting...once in motion, these are very difficult to dismantle.

I treat all of these articles I have written as scientific papers, obviously watered down without going into extensive terminology or principles so the reader falls asleep after the second paragraph. Anyone thinking we are in deflation as a whole are simply Jumping the Shark at present...rather we are following a complex cycle that does have quantifiable dates in time for when inflation and deflation will become dominant (deflationary bouts are shorter, but more intense). To quote Einstein, "Make things simple as possible, but not simpler".

At some point in the future, democracy may have to be sacrificed for the greater good of Earth...someone will have to play God, in a sense and when that happens, often many new Gods appear for exerting how they feel things should go...this likely will happen at some point this century, which by reasoning of the above information will happen when the DOW reaches a peak near 200,000, as per Glenn Neely's long term NeoWave (more complex version of Elliott Wave) count.

One final side note, it would be interesting to see if the CFS has application to birth rate models, much like that of Harry Dent whose work accurately nailed the 2000 and 2008 top, with a supposed return to a bull market in 2020-2025, based upon demographic trends. I will leave this for others to pursue...

Have a great day.

By David Petch

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