It seems you have JavaScript disabled.

Ummm.. Yeah... I'm going to have to ask you to turn Javascript back on... Yeah... Thanks.

Signs of Deflation You Might Not Be Able To See Clearly at Trader’s Narrative

Guest post by the Editorial Staff of Elliott Wave International:

The following market analysis is courtesy of Elliott Wave International. Elliott Wave International is currently offering Prechter’s recent Elliott Wave Theorist, free.

Continuing—and Looming—Deflationary Forces
The Fed and the government quite effectively advertise their efforts to inflate the supply of money and credit. But deflationary forces, to most eyes, are invisible. I thought I would point some of them out.

1. Banks Are about 95 Percent Invested in Mortgages

treasury holdings relative to bank assets

Figure 4, courtesy of Bianco Research, shows that U.S. banks used to be fairly conservative, holding 40 percent of their assets in Treasury securities. This large investment in federal government debt, the basis of our “monetary” “system”, served as a stop-gap against deflation. In 1950, even if mortgages had been wiped out by a factor of 80 percent, banks still would have been 50% solvent and 40% liquid. Today, banks hold federal agency securities (backed mostly by mortgages), mortgage-backed securities (meaning complicated packages of mortgages), plain old mortgages that they financed themselves, and a few business loan contracts. If these mortgages become wiped out by a factor of 80 percent, which in turn would cause many of the business loans to go into default, the banks will be only about 22% solvent and 1% liquid. I believe the coming wipeout will be bigger than that, but let’s be conservative for now. The point is that, unlike Treasuries, IOUs with homes as collateral can fall in dollar value, and such IOUs are pretty much the only paper backing U.S. bank deposits. The potential for deflation here is tremendous.

2. More Mortgages Are Going Under

It has been well publicized recently that commercial real estate has been plunging in value as business tenants walk away from their leases, leaving properties empty. Zisler Capital Partners reports, “Returns were negative for the past five quarters, the longest streak since 1992. Property prices have fallen by 30 percent to 50 percent from their peaks. Much of the debt is likely worth about 50 percent of par, or less.” (Bloomberg, 11/11) Needless to say, the fact that commercial mortgages are plunging in value is stressing banks even further, which in turn restricts their lending. This trend is deflationary.

3. People Are Walking away from Their Homes and Mortgages

Great numbers of people are ceasing to pay their mortgages, even if they have the money to pay them. When people walk away from their mortgages, they are reneging on a promise to pay the interest on the loan. … Refusal to pay interest is deflationary. When banks can’t collect fully on their loan principal, as is the case by law in the above-named states, it is deflationary. Even in states where banks can go after other assets held by borrowers, default is still deflationary if the borrowers are broke. The reason is that, in all these cases, the value of the loan contract falls to the marketable value of the collateral, and a contraction in the value of debt is deflation.

Some people who walk away from their mortgages purposely damage the homes when they leave. New businesses have sprung up to take on the job of cleaning up the houses that former occupants trashed as they left. Angry defaulters are stripping coils out of stoves, pulling electrical wiring out of walls, ripping fixtures out of bathrooms, yanking seats off of toilets, punching holes in walls and leaving rotting food in the fridge. (AP, 8/9) Such actions, and the threat of more such actions, lower the value of the collateral behind mortgage debts, thereby lowering the value of mortgages, which is deflationary.

4. Bank Lending Standards Have Stayed Restrictive

survey of credit standards May 2010

As people default on mortgages, banks are tightening lending standards. Figure 7 shows that banks loosened credit standards from late 2003 through the summer of 2007. By the end of that time, you could borrow money if you were breathing and could operate a ball-point pen. Banks have been tightening credit standards ever since. The rate of tightening peaked in October 2008, but the graph shows that over the past year various banks have either left their new, tighter standards in place or continued to tighten their standards further. Across the board, it is harder to get a loan, and it’s staying that way. Lending restrictions reduce the credit supply. This condition is deflationary.

5. Banks Are Cashing Out of the Credit-Card Business

total consumer credit May 2010

Articles have revealed that banks are doing everything they can to get credit-card debtors to pay off their cards. They are raising penalties and rates, lowering ceilings and otherwise bugging their clients to pay up, one way or another: Transfer your debt to another bank’s card; default; pay us off; we don’t care which. And it’s working. Through September, consumers have paid down credit card balances for 12 months in a row. Figure 8 shows the new trend. The credit-card business was another formerly humming engine of credit that is sputtering. You might call the new program “cash from clunkers,” and it is deflationary.

For more information from Robert Prechter, download a FREE 10-page issue of The Elliott Wave Theorist. It challenges current recovery hype with hard facts, independent analysis, and insightful charts. You’ll find out why the worst is NOT over and what you can do to safeguard your financial future.

This article was syndicated by Elliott Wave International. EWI is the world’s largest market forecasting firm. Its staff of full-time analysts lead by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

Enjoyed this? Don't miss the next one, grab the feed  or 

                               subscribe through email:  

5 Responses to “Signs of Deflation You Might Not Be Able To See Clearly”  

  1. 1 burt

    “Today, banks hold federal agency securities (backed mostly by mortgages)”

    Agencies are also backed by the US government. I am always suspicious of analysts who write like lawyers arguing a case.

  2. 2 Kristjan

    What is it with good bloggers/financial commentators that they keep on posting Prechter’s worthless research? Prechter has been pounding deflation and Dow 2000 since the late nineties. As you well know, statistically speaking, he is bound to be right some time or another. But that’s like a broken clock that’s correct twice each day. Is the money you receive from being an Elliott Wave affiliate really that good? Furthermore, since you post some top notch research from you and others and have done a great job at educating your readers at no expense to them, you must be trading with your own money. It would be hard to imagine that someone would have an interest in the markets without really trading them. With the quality of your research, I find it is not that difficult to take large amount of money out of the markets. Hence it is difficult for me to understand why you would want to mix Elliott Wave with your own research. I understand sidebar ads, because I’m a blogger myself and I’d like the blog to pay for itself. Nonetheless, Elliott Wave’s analysis has been missing the target for most of the time.

    So, my question to you, Babak, is why do you keep posting Prechter’s ad-articles on your site? I can understand the sidebar ads, but having those low quality articles appear among your top-notch articles deflates the status of the whole blog. Do you really find his analysis useful to your readers, especially given that they’ve been wrong so many times and don’t really offer a credibel explanation as to why that is so.

    Thank you.

  3. 3 jezza

    Kristjan, i could not agree more..i am sure debt monetization, and a rising gold price do give us an early warning of deflation (not)!

    How many times does someone have to be wrong to be 100% discredited?

    Bakak dos a great job-if only you would stick to serious commentators like Wayne, Lowrys and Ned Davis!

  4. 4 Babak

    Kristjan, if you would stop reacting emotionally you’d realize that the deflation thesis that Prechter is outlining is very similar if not the same that others have been talking about. For example, David Rosenberg. Needless to say there is ample data to back it up.

    As well, Prechter was one of the few that was calling for a top in April and stood alone in that call… this after nailing the March 2009 bottom. Did you nail the low and ride it all the way up?

    Here he is offering something for free. And since I value his analysis I pass along the offer. There is no obligation to take Prechter up on his offer or to even read his analysis. It is up to each person. The vast majority of my readers enjoy it and appreciate this gesture.

    I understand that certain individuals in this field, like Prechter, are polarizing but when you make calls of that stature backed up by data and analysis then you can come back here and post this sanctimonious drivel.

  5. 5 MachineGhost


Leave a Reply