The battle of the monsters
Richard Russell
Dow Theory Letters
Jul 17, 2003Extracted from the July 16, 2003 issue of Richard's Remarks
-- As I see it, the US (and the world) are now dealing with two momentous forces. One is the "natural" force of deflation, which has followed the bursting of the greatest financial bubble in world history.
The other force, the opposing force, is the all-out effort by central banks to counter the forces of deflation.The forces of deflation? I'm going to list them again --
Globalism -- the fact that the world's markets are now open and actively competing with each other.
The Internet -- I don't buy anything over ten bucks unless I check for competitive (lower prices) on the net.
Wal-Mart -- which has become an absolute killer in the retail field.
China and India -- China alone could supply the whole world with merchandise at cut-rate prices. India has become a major factor in software and tech and cut-rate prices.
Over-production -- Every nation has become a producer. The US negative trade and negative current account balances have loaded the rest of the world with a flood of dollars. These dollars have allowed the rest of the world to build up their production facilities. As a result, the globe is choking on over-production, meaning that the world is producing more goods than it can absorb. This has killed pricing power.
Against these deflationary forces, we now see the process known as "competitive currency devaluations." Every nation wants a lower currency so that it's exports can remain competitive. The world's economic engine has been the US, the king- buyer of the world's goods. As the US economy goes, so goes the world. As the US consumer goes, so goes the US economy.
The question becomes -- why would deflation be so dangerous? Why is the Fed so panicked at the very thought of deflation?
Two reasons: one -- if actual deflation takes over, the Fed loses its power to manipulate. Deflation can take on a life of its own, with declining prices causing consumers to wait for still-lower prices. In other words, in real deflation the consumer's psychology of "let's buy" changes to -- "let's wait."
Secondly, if deflation hits, then debt looms larger and more difficult to carry. This nation operates on the "fractional reserve system," and if deflation hits and consumers halt their buying and borrowing, the money supply begins to shrink and the whole system starts to work in reverse.
I might add that this is not a normal economy. The US economy is up to its ears in debt, with a commonly accepted figure being that there's roughly $38 trillion in debt built into the US economy. If deflation hits, this tower of debt could become a financial nightmare. It could take on a domino effect and one layer after the next would be crushed by the need for financing, financing that becomes almost impossible to obtain in a deflationary environment.
So that's the big picture as Richard Russell sees it -- the battle of the monsters, the battle of "normal post-bubble collapse" deflationary forces against the inflationary capabilities of the central banks and more specifically the US's Federal Reserve.
My own opinion is that if the central banks fail and the world sinks into deflation, the very thesis of central banking will come into question, and the existence of the Federal Reserve will come into question. That's how serious I think the situation could become.
At that point, the logic of a gold-based system will come to the fore, as it ultimately will, either during this bear market or during the next one.More follows for subscribers . . .
Richard Russell
Dow Theory Letters
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