Should You Be Worried About Deflation?

10/04/2011 11:00 am EST

Focus: MARKETS

Steven Hochberg

Chief Market Analyst, Elliott Wave International

Concerns over inflation seem to dominate the news, but Elliott Wave International’s Steven Hochberg explains why he thinks that deflation is the real problem, in this exclusive interview with MoneyShow.com.

When the first stimulus and the second quantitative easing came into play, a lot of people were worried about building inflationary pressures. What’s happening now?

Well if you’ve been following along these videos that we’ve been doing over the last several years, the one thing we’ve been very consistent about is that we’re in a deflationary environment. That deflation would persist and actually get worse going forward.

What we’re seeing right now in the world is pointing strongly to increasing and burgeoning deflationary pressures and deflation events in the economy and financial markets. We’ve been on an 80-year binge of borrowing. Ever since the depths of the last Great Depression, and its debts piled on top of debts piled on top of debts.

We’ve come to the point where the world has simply run out of money. We don’t have the income levels to service the amount of debt that we’ve accumulated. Now we’re seeing whole countries marked down to junk status, like Greece and Portugal, and Italy is now being marked down, and people have their cross-hairs on France.

What we’ve had simply is debt is now imploding upon itself. When the aggregate amount of dollar-denominated debt in the world starts to contract, that is the definition of deflation, and that is what we’re seeing right now.

How do we deal with this? What are we supposed to do, just watch it...just kind of the air coming out of the bubble?

You can, but it’s very difficult in this environment because it’s so rare. We haven’t experienced this since the 1930s.

People are used to inflation, and they’re betting on the next inflationary event. That’s what the Fed is trying to create...they started with TARP and then they went to QE1, QE2.

But notice that despite record amounts of quantitative easing, the stock market is down from its May high, the same level it was in late 2009. Commodities are down, oil is down, world markets are down, so things are moving in sync...as credit was expanding they all went up more or less together, and as credit contracts they're now moving and rolling over and going down more or less together.

The thing to do as an investor is try to get out of the way. It’s a very difficult thing to do, but you have to be in safe cash or cash-equivalent instruments. Even though they’re yielding nothing right now, at least you’re not in assets that are going down in price.

When I heard that Bernanke said we’re going to keep short-term interest rates at virtually zero well into 2013, the first thing I thought of was, that’s got to start inflation percolating, and that would get the economy going. Is that what he had in mind, do you think?

It might be what he had in mind, but don’t forget rates have been at zero for several years, more than a year right now.

The economy has gotten progressively weaker, the stock market has gone nowhere, and we’ve had a bear-market rally that topped in May of this year. Commodities have made a lower high than they were in 2008, as has oil. Foreign markets are going down, and real estate is still in the doldrums. A quarter of all mortgages are underwater.

So the Fed is not in control of the situation. They’re trying to dump water on a forest fire, a bucket of water on a large forest fire. It’s not working, and it won’t work in the future in our estimation.

So it’s imperative that individuals get out of the way, get out of assets that are declining in value, be in safe cash or cash equivalents, and there will be a time when we can redeploy money...but now is not it.

Didn’t the Bank of Japan try this same thing about a decade ago?

That’s a great point. The Bank of Japan moved their rates down to effectively zero, and have been zero for a decade, and look at the Japanese stock market, look at the Japanese economy. It didn’t work there, and it’s not going to work here.

Related Reading:

Legendary Fund Signals Market Shift
5 Contrarian Investment Plays
Should You Short Treasuries Now?

Related Articles on MARKETS