Creeping Global Deflation: The Greatest Threat to the Planet’s Economy (Part 1), by Al Martin

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by Al Martin

Creeping Global Deflation: The Greatest Threat to the Planet’s Economy (Part 1)

(10-17-12) Recession has arrived all over the world and deflation is becoming more apparent – despite the complete blackout of its existence in mainstream financial media.

Recession can be easily defined because every country defines it the same way – two consecutive quarters of negative GDP (Gross Domestic Product). Now we are hearing more about recession as global GDP is falling. There are already a number of countries that are in recession which have passed this bar, so to speak, most of which are in Europe and include the weaker European states.

However with global GDP now falling, we face negative – or red – numbers, an event which has not occurred since the Great Depression of the 1930s. Now the shills in financial media are saying – don’t worry, this isn’t going to happen because central banks won’t let it happen.

The Fed governors make speeches every day which are closely watched by the markets. On Monday Fed Governor Charles Dudley spoke summing up the situation regarding central banks coordinating their actions together and being able to pull double duty as it were -- making monetary policy or monetary stimulus a replacement for fiscal policy. However this activity has its limits and global central banks are reaching those limits. “Limits” in this case is the proverbial bag of tricks used by central banks, “monetary stimulus” being the last trick in the bag. This then becomes the law of diminishing returns, since we’ve gone through QE1, QE2 and QE 3 – so-called “Quantitative Easing” -- which are becoming progressively less effective.

The problem with monetary policy is that there is a hard and fast wall that is inescapable, namely that you can only drive interest rates down to zero. You cannot do what Japan has done which has proved to be unsuccessful, i.e. driving interest rates into a red number. In fact Japan has increased its debt to GDP ratio so that it’s the highest on the planet, even higher than the government of Uganda. So what’s the problem? Eventually they can’t sustain a 200% debt to GDP ratio, while global exports are falling.

People don’t understand why these nation-states can’t just stand up to the IMF and the World Bank and say “Enough” like Argentina did when it defaulted on its debt in 2001. The only reason why Argentina has been consistently able to get away from what’s called a “containable impact” is that the amount of money involved wasn’t that large. Plus there was a global effort led by the Fed, the ECB, the IMF and the World Bank to restructure Argentina’s debt and bail them out. Then the numbers were relatively small, but now you can’t do that because the global economy can only handle one Argentina at a time.

Now we have a number of frightening would-be Argentinas on the horizon that would overwhelm the planet’s central banks and the peripheral support mechanism that goes along with it -- the IMF, the World Bank, the Export-Import (Ex-Im) Bank, the global institutions of G-20 nation states which were set up in the 1960s, which are specifically designed for one purpose, which is to restructure debt.

The reason the indebted nations don’t do a backroom deal and tell off the banks is because they know what the consequences will be for their own countries and their own people. Their countries would effectively fall apart because they’re no longer able to do business.

If you default on your debt the way Russia did, without any type of mechanism to restructure and continue to service that debt in some fashion, and if you absolutely repudiate that debt, then your ability to conduct global trade is severely impaired. Why? Because you can no longer use the existing institutions that were designed to facilitate global trade.

Nation-states get into fiscal trouble for the same old reasons. It isn’t because a larger central bank or group of central banks or the IMF puts them in hot water, they get themselves into hot water. What is the commonality of nation-states that have defaulted on debt? Massive governmental corruption.

Of all the different forms of government – democracy, social welfarism, communism, oligarchies, theocracies and strong-man governments – it is the so-called strong-man governments that tend to be the ones that default on their debt. The reason why is because there is a long-entrenched ruling elite at the top that has looked at what their countries produce as little more than a wealth-transfer mechanism to themselves. Then a nation-state like Argentina or Venezuela -- and even Russia in 1997 – will attempt to shift the responsibility onto someone else by saying it was the Big Bad Fed, or ECB, or Bank of Japan, or IMF, or World Bank that made me do it. But that’s not the case, since these countries got into trouble on their own by these deeply entrenched system of corruption or in Russia’s case, the attempt to convert from a fiscally corrosive system that had been maintained for 70 years to a fiscally correct system.

Russia was not prepared for the stress that this creates – and it wasn’t just Jeffrey Sachs’s mischief making. There’s an old adage and it’s called the One to One Relationship, meaning that for every year of fiscally corrosive politico-economic system that a nation-state maintains, it will subsequently have to maintain of a fiscally supportive politico-economic model like capitalism and free enterprise.

No government -- and Russia in this case – wants to admit to its own people that it took 70 years of false doctrine, i.e. communism which completely and utterly bankrupted Russia -- the former Soviet Union. It left Russia with broken down factories, industries that couldn’t compete, no central bank, no currency that was worth anything, no ability to raise money in foreign marketplaces, a fiscally exhausted and depleted nation-state.

Politicians would have had to tell the Russian people that they are going to have to go through 70 years of unimaginable deprivation to make up for the previous 70 years of false doctrine.

However all the central banks and the IMF try to prevent a necessary corrective process from being undertaken the way it should be – by continuously giving them loans and debt guarantees so that fiscally depleted nation-states are bailed out again and again.

The standard Republican dictum used to be -- let the excesses be weeded out through the natural process and do not attempt to truncate or frustrate that process by continuously lending a depleted nation-state money, which in turn the nation-state uses in an effort to shield their citizenry from the consequences of the transformation that is necessary. Consequently all the money that is lent effectively becomes wasted.

The greatest threat to the planet’s economy is this creeping global deflation which continues to build. We saw this in the Chinese and Japanese numbers recently. Now we are beginning to see it in European economic numbers and the refusal of governments and central banks to step up and admit that there is a problem and that the problem is deflation and a pernicious cycle of credit quality deterioration.

The reason why nobody is stepping up and recognizing what the problem is – even though they all know what the problem is – is because they don’t have any monetary controls to defeat deflation the way they have the ability to defeat inflation.

You can only defeat inflation by continuously raising interest rates until you break the cycle. You raise interest rates. You raise interest rates. Consumption falls and falls and falls and finally the back of inflation is broken because consumption has fallen enough that prices can no longer continue to increase.

How inflationary cycles are brought to an end is by applying more of the medicine – but doing it in a larger quantity.

Just look at how the Reagan Regime broke the inflationary spiral it inherited. When it came to power in January 1981, the first thing the Reagan Regime did was it moved up interest rates sharply in order to break the back of consumption. Then inflation peaked in the fourth quarter of 1982 and subsequently fell rapidly.

In order to do that you’ve got to be a regime that’s got the balls to create a recession. That’s how you break the back of inflation – raise interest rates to the point that consumption then in turn falls to a point that you create a recession and you squeeze out inflation. These are called inflationary excesses which are squeezed out though falling consumption because no matter how much you raise interest rates, prices cannot continuously rise if the underlying demand for the product is continuously falling.

On the other hand deflation is a lack of net consumption. Therefore you have to continuously reduce interest rates to spur demand.

The problem with combatting deflation and why it frightens central banks, the IMF, the World Bank, etc. is that governments reach the Absolute Zero Wall, i.e. that interest rates can only be reduced to zero. Unless you go to the next step…

Which is effectively putting your economy on life support by maintaining a negative real interest rate the way the Bank of Japan did. You are then essentially printing money in order to maintain demand by making sure that the government becomes the principal consumer of all products being produced. This is what has happened in Japan.

Is what we are now seeing the beginning of a Global Zombie Economy? Tune in next week

(To Be Continued…)

* AL MARTIN is an independent economic-political analyst with 25 years of experience as a trader on NYMEX, CME, CBOT and CFTC. As a former contributor to the Presidential Council of Economic Advisors, Al Martin is considered to be a source of independent analysis for financially sophisticated and market savvy investors.

After working as a broker on Wall Street, Al Martin was involved in the so-called "Iran Contra" Affair as a fundraiser for the Bush Cabal from the covert side of government aka the US Shadow Government.

His memoir, "The Conspirators: Secrets of an Iran Contra Insider," (http://www.almartinraw.com) provides an unprecedented look at the frauds of the Bush Cabal during the Iran Contra era. His weekly column, "Behind the Scenes in the Beltway," is published weekly on Al Martin Raw.com, which also publishes a bimonthly newsletter called "Whistleblower Gazette."

Al Martin's new website "Insider Intelligence" (http://www.insiderintelligence.com) will provide a long term macro-view of world markets and how they are affected by backroom realpolitik.

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