wpe50.jpg (1913 bytes)     TigerSoft News Service    10/23/2008      www.tigersoft.com  

                  A DEFLATIONARY SPIRAL

Dynamics of The 2008 Deflationary Spiral


                     TIGERSOFT GIVES YOU ANSWERS!
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                                                               by William Schmidt, Ph.D.   

                                                    Author of TigerSoft, Peerless Stock Market Timing.
                                                                  Nightly HotlineTigerSoft Blogs and www,tigersoft.com

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by William Schmidt, Ph.D.
                                                               (C) 2008  www.tigersoft.com  

                                        Allan Greenspan says we are experiencing a once in a century financial
                              tsunami, the causes of which he says he does not  fully understand.  The Federal
                              Reserve and the US treasury are supplying truly massive amounts of NEW credit to
                              banks, almost a trillion dollars since September 3rd.  Most of that money is not yet
                              being used by businesses.  New hiring is at a stand still.  The Fed is pushing on
                              a string.  Business confidence cannot be created with liquidity, though it
                              ought to stop a banking panic.  I say "ought to".  Look at the chart of  
                              Citi-Group.   The stock shows massive insider selling, distribution and
                              professional selling from t he Opening to the Close.  A breakdown below
                              the support level at 12.6 seems highly likely. The measure of aggressive
                              selling (OBV) is making new lows.  So does TigerSoft's powerful Closing Power line.

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                                                World-Wide Recession

TigerSoft's Index of 57 foreign ETFs is now down
                    more than 55% since its May peak.  The breakdown in
                    prices in August showed that a world-wide recession
                    had probably started. That sent commodities of all types
                    reeling downward.
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                       All industries and all markets everywhere in the world
             are in steep declines now.  We often here, there's always a
             bullish trend somewhere.  That is not true now.  There is no
             leadership or sanctuary, except CASH.  That is a pretty good
             working definition of DEFLATION.

                                          Lessons from Economic History

    The Bush Administration has very little credibility anymore.  Just having a
                new President will give a big boost to investor and world confidence.
                Obama will probably win.  As soon as his victory is clear, he will do well
                to tell Americans what his first 100 days will look like.  That will remove
                uncertainty.   And it would offer hope, which is badly needed.    The
                biggest problem now is that Obama will not come to power until January 23rd.
                What he plans to do should reflect the lessons drawn from economics'

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                                                              JM Keynes

                            John Maynard Keynes closely observed the Depression
                 in England from 1929-1933.  He had come to his views from within
                 the British Treasury as a key UK representative at the Treaty of
                 Versailles after World War I.   He correctly foresaw the economic
                 disaster that lay ahead if war debts and reparations were extracted.
                 He was against trying to extract crippling war reparations from
                 Germany and for the forgiveness of Allied war debts by the US.
                 He was not listened to.  England did not fully recover in the
                 intra-war years and Germany was humiliated and impoverished,
                 with the result that Hitler came to power.

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                                                    Sir Alfred Mond

                      As Keynes watched, the Depression unfold, he dusted off the
                 views of a Liberal politician and creator of  ICI,  the huge British    
                 chemical firm.   My own dissertation's research of UK Cabinet
                 Papers shows that Alfred Mond, as First Commissioner of
                 Works from 1916-1921 in the Lloyd George Coalition government
                 ardently advocated for massive public works'  expenditure, 
                 saying that the soldiers coming home from World War I should
                 be given dignifying work to repair the infrastructure of Britain
                 after its long neglect,  because of World War I.  He wanted
                 private investment to become more productive.  He was from
                 Swansea, Wales.  He wanted a jobs creation program in
                 places where it would be most needed.   Mond was very
                 prescient.   His views were squelched in the Cabinet
                 by Conservative Austen Chamberlain, the Chancellor of the
                 Exchequer and brother of Neville Chamberlain.   My dissertation
                 showed that Chancellors in the intra-war period always pursued
                 policies of retrenchment, short-term balancing the budget
                 and protecting the Pound, no matter the level  of unemployment
                 and economic suffering.

                         Keynes, the economist, in the 1930s, contended that left to
                 themselves (laissez-faire) economic conditions would worsen
                 in a recession, when there was deflation.   This was his central
                 proposition.   The economy would not be self-righting as classical
                 economists had maintained.

                         In his General Theory of Employment, History and Money
                 (1935) he made a number of points which have transformed
                 economic theory.  In a deflation era, wages and prices are falling;
                 confidence wanes and so money is hoarded and not invested.
                 The expectation of falling wages and falling prices becomes
                 self-fulfilling as businesses postpone or cancel new projects.
                 Because deflation favors creditors, wealth is re-distributed
                 towards the rich.  But they spend a smaller proportion of their
                 income than those of modest means, so there is under-consumption,
                 in general.  And that makes for over-production, lay-offs and
                 falling wages and prices.  A deflationary spiral develops.   

                          To break the deflationary spiral requires the government
                 to give tax breaks to working people or launch public works' 
                 job creation programs, even though, in the short-run, this causes
                 a budget deficit to grow.  Since workers will spend nearly all
                 of any extra money they get  through tax breaks or new jobs,
                 that will have positive reverberations through out the economy.
                 A single dollar in tax breaks for a worker or a single dollar
                 paid that worker in a new government created job  will add 
                 $3 or $4 dollars to GNP.  In this way, fuller employment can
                 be regained and the surplus of unsold goods will get absorbed.
                 Businesses will start to make profits again.  Confidence can
                 be regained.  And, as economic prosperity is restored, more
                 taxes start coming in and the federal budget will become more

                           Historic Examples

UK   1926-1939  Britain went back on Gold Standard.   Unemployment  remained high. 
                    Public works programs were not pursued.  Instead,  there was one round after
                    another of belt-tightening budget cuts.  Protecting the Pound became the orthodoxy
                    of the British financial establishment.   In the 1930s, Neville Chamberlain, as
                    Chancellor of the Exchequer and then as Prime Minister,  fought Churchill in British
                    Cabinet meetings, and opposed increased defense spending, even as Nazi military
                    power grew.  JM Keynes, the famous economist,  witnessed first hand this deflation
                    and advocated public works programs, since deflation, he said, was
                    not self-correcting.

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                                                    Herbert Hoover - President - 1929-1933
           US 1929-1933
                    By 1929 wealth had become very highly concentrated.  But the rise in
                    stock prices in the 1920s has produced an abundance of confidence
                    and credit. so jobs were plentiful and working people could bottom
                    to buy what they needed.  The market's steep advance was fueled 
                    by margin rates of 5%, not unlike the US Housing bubble from 2003-2006.
                    In 1928, the Federal Reserve hiked interest rates.  In Europe, financial
                    empires started to topple.  In the Fall of 1929, the stock market crashed 49% in
                    only 3 months.

                    As now, the stock market CRASH caused credit to shrink, confidence to
                    disappear and unemployment to rise.  Commodity prices fell, as did the
                    prices for producer goods, though commodity prices fell more because
                    commodity production was more inelastic.  (In 2008, we see the same
                    phenomenon. - See the TigerSoft charts at the bottom of the page
                    and elsewhere.

                    Financial institutions failed left and right.  Personal and business
                    bankruptcies were commonplace.  (My grandfather built and sold houses.
                    When the Depression came, he could not sell them and went bankrupt.)
                    Foreclosures on homes and farms soared.  People could barter for
                    what they needed in rural areas.  But in the city, 25% of the people were
                    unemployed by 1933.  Hoover, his band of classical economists and
                    financiers believed that the best medicine for the economy was for the
                    government to tighten its belt.  Workers should take smaller wages, so that
                    businesses would be able to hire them.  The decline in the stock market
                    was beneficial because it would wring out dangerous speculators.
                    and wealthy.  The economy should be left to itself to recover.  Balancing
                    the budget was seen as necessary to get rid of wasteful spending.  The
                    Federal Reserve did not loosen credit.  The Dollar was strong.  Banking
                    circles liked the international business that a strong Dollar created.  They
                    liked being paid back with Dollars that bought more than when they
                    made their loans.  And, so, Hoover, and his friends among classical
                    economists and bankers waited for the recovery that they thought
                    would come naturally.  They waited in vain.  The Stock Market fell
                    from 383 to 43 shortly before he left office.  Without investment confidence
                    and with investors a lot poorer, businesses contracted, consumption
                    shrunk, as did wages and unemployment reached 25% in early 1933.
                    This further dropped US government revenue.  Deflation spiraled out of
                    control and turned into a Depression.   Monetarists claimed that if the
                    Fed had been more accommodating, the worst of the Depression might
                    have been avoided.  Keynesians say that demand for goods and services
                    needed direct stimulation through fiscal policies, reduced taxation and
                    public works and government spending.

Japan 1990s-2000
                    After Japan's stock market crashed in 1990-1992, the Bank of Japan tried to
                    remedy the debacle by lowering interest rates.  Though interest rates there
                    approached 0%, the Japanese economy remained sluggish.  Only the
                    Global Bull Market of 2003-2007 ended the long stagnation.  Interest rates
                    reductions by themselves did not overcome a spiraling lack of confidence and
                    deflation.   The collapse of real estate prices in Japan was similar to what has
                    happened in the US.
                              "Banks lent to companies and individuals that invested in real estate. When
                                real estate values dropped, these loans could not be paid. The banks could
                                try to collect on the collateral (land), but this wouldn't pay off the loan. Banks
                                have delayed that decision, hoping asset prices would improve. These delays
                                were allowed by national banking regulators. Some banks make even more
                                loans to these companies that are used to service the debt they already have"

                    Japanese Banks had a higher percentage of loans which were "non-performing".
                     That limited their ability to lend more money and shrunk their cash reserves.  In this
                     situation, Japanese people became afraid of bank failures and preferred to buy
                     Gold or Treasury Bonds (especially American).  The deflationary spiral in Japan
                     was intensified by the availability of inexpensive Chinese manufactured goods.

China           Chinese productive capacity keeps expanding.  The pricing of exports from China
                     are a key.  Low priced imports make for deflation.  As the US Dollar strengthens,
                     imports from China will accelerate, hurting US production and jobs.

                    (Source: http://en.wikipedia.org/wiki/Deflation )
                    Readings http://www.voxeu.org/index.php?q=node/2384    


         The DJI is down 35% just since its May 2nd peak this year
              and 26% from its August 11th peak.  How much worse could
              it get historically?  In the 1987 Crash it fell 36.5%, from  a
              zenith of 2722.42 on August 25th to a low of 1738.74 on October
             19th.  Such a decline from the August peak in 2008 to a bottom
             36.5% down would bring a DJI decline to 
7471.  The DJI is already
             down more that it was at its bottom in the 1962 or 1974 bear markets,
             after 9/11/2001 or in the 2002 bear market.  The 1929 Crash saw a
             49% decline.   If such a drop occurred today from the August
             peak, we would see
6100.  I like the 7440 level because that would
             mean a 50% retracement of what the DJi gained from its August
             1982 low to its July 2007 peak.  50% retracements are very

                                            COMMODITIES' DECLINE AND DEFLATION

                     What is happening to commodities is awful.  At the top of
              page you see the last year's prices for Crude Oil.  It has had
              a surge of buying (a bubble) and then a surge of selling (the
              bubble burst).  Commodities often go through these cycles.
              Hedge fund over-speculation using very high leverage
              and precious little regulation has brought us to where we
              are now.  

                    Look at the DJI   chart of 19 commodities (foods, fuels, lumber and
              metals.)     It is down about 30% from its July peak.  Commodity
              prices are very volatile.  They usually are weaker than the prices
              of producer goods or wages in a Deflation.  Supplies are inelastic.
              Even a prices fall, a farmer will still harvest all the wheat he can.              
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                 Dynamics of The 2008 Deflationary Spiral

These bearish tendencies were made much worse by the
                        removal of limitations on short selling and the failure to
                        regulate credit default swaps.                       

                        2006 Housing Bubble Break
                  ---> Lower Housing Prices
                 ----> Consumer buying power declines sharply.
                 ----> Foreclosures and housing prices fall more. 
                  ---> Bank Insolvency and Financial Crisis
                  ---> Extreme commodities speculation driven by trend-following
                         investing seeking performance and lack of alternatives.
                  ---> Rising commodity prices further exhaust consumers' buying power.
                  ---> Heightened bank panic.
                  ----> Commodity bubble breaks .... Hedge Fund De-Leveraging
                  ---> Commodity Panic
                  ---> US White House Scares Country by Demanding $700 Billion
                                     to save banking and financial system.
                  ---> Steep and Broader Stock Market Decline

---> Investor Buying Power Drops
                  ---> Further Drop in Consumer Spending
                  ---> Weakness in Commodity Exporting Economies around the world.
                  ---> Wage Deflation and Increased Unemployment
                  ---> Foreign Currency Weakness
                  ---> Producer Country Inflation and Economic Suffering
                  ---> Overseas Markets' demand, except for China, drop sharply.
                  ---> Political Instability
                  ---> Pressures to nationalize mineral production
                   ---> Further decline in stock markets. 

               How TIGERSOFT Trades Commodities
                             and Commodity Stocks

                       TigerSoft gives automatic buys and sells on commodities and stocks.
                  We teach traders and investors to watch for the tell-tale signs of insider
                  buying and selling.  Learn to see what professionals expect by watching
                  TigerSoft's unique Closing Power.  The Closing Power trends are still
                  down for Gold, Silver and and stocks like NEM, SSRI and PAAS.  People
                  using these charts would have almost certainly saved many thousands
                  of dollars

                       But prices never only fall.  Even in 1929, there was a 48% recovery of
                   what was lost in the first big decline, known as the October Crash.
                   A 50% retracement in a stock Newmont from say a low of 20 back to
                   its high of 55, would bring back to 37.5.  

                    -------------------------------------------- NEM -----------------------------------------------------
                                                                   Newmont Gold

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                   --------------------------------------------- PAAS ---------------------------------------------------
                                                            Pan American Silver
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                    ---------------------------------------------- SSRI ---------------------------------------------------
                                                                        Silver Standard
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See also:       
                    October  18. 2008                The Rise and Fall of Commodities' Hedge Funds
                                            Pump and Dump - Oil, Silver, Gold, Corn, Wheat - It's All The Same.
                                             Systemic Failures: The "Free Market" Is Too Expensive.
                                              Causes of the Crash of 2008.

                    October 11, 2008                   The Causes of The Stock Market Crash of 2008.
                                             Nouriel Roubini's Prescient Warnings Two Years Ago And Recommendations Now.
                                             How Close Are We To A Bottom.
                                             Bush and His Crew Are Wrecking Retirement Accounts.









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