THE GREEN SHOOTS OF HYPERINFLATION
By Adrian Douglas
One of the hardest things to do as an analyst is to keep an open mind. The S&P 500 topped out in October 2007 at about 1565. Since then it has had a series of five dramatic bear market declines and also five quite impressive bear market rallies. It is very easy to develop Pavlov dog response. Over 20 months we have seen the market fall and rise, fall and rise, fall and rise, fall and rise, fall and rise…so what will it do next? If you answered “fall” you are probably wrong! Until recently I was thinking that the economy is bad and getting so much worse that the stock market MUST continue to fall. It would defy logic for it to do anything else….or would it? Imagine if the US Government were to announce tomorrow that they are replacing the existing dollar (USD) with a “New Dollar” (NUSD) where 1 USD= 2 NUSD and if currently the S&P500 is trading at 900 then what would the S&P500 be tomorrow? It would be 1800. So with out any improvement in the economy the stock market would double. Of course with such an announcement spelling out to everyone what was transpiring no one would be fooled into thinking that this was a big bull market move, but merely the result od devaluation. But now consider what happens if instead of making any announcements the government just surreptitiously, over a few months, doubled the money supply. If the usual manipulation of BLS statistics of CPI and PPI continues then this inflation would be masked and the resulting debasement of the dollar would manifest itself, among other things, as at least a doubling of the nominal value of the stock market. Because this is done without many people realizing what is going on the rise in the stock market would be heralded as a turn in economic fortune and the “green shoots” of recovery when it is really the green shoots of hyperinflation! If you think that people are not that stupid to fall for it then ask yourself how in the presence of the biggest monetary debauchery ever in the United States history the current chatter is whether we can avoid deflation! The most ridiculous argument is that the average American is so tapped out he can’t borrow anymore so the money supply can’t grow. This totally ignores the multi-trillion dollar expenditure of the US government which is multiples of its tax revenue and is being funded by money that is created by the Federal Reserve. The US Government can spend into existence as much money as it desires to create. For the critics who say that M3 is not yet reflecting the monetary debauchery I would remind them that inflation is relatively more money chasing relatively fewer goods and services. So a contraction of things to spend money on with even a static money supply will lead to an increase in the general price level. The economy is contracting so the supply of things to spend money on is contracting. More importantly, though, the massive derivatives market is largely ignored in discussions of inflation. A 600 trillion dollar market can not be ignored in a 60 Trillion dollar global economy! The derivatives market essentially was a tool of the US government to suppress interest rates and commodity prices. It is now contracting rapidly so clearly the opposite effect must happen that interest rates and commodity prices will rise. I will discuss this in detail in an upcoming article.
The stock market during the infamous Weimar Republic hyperinflation delivered stellar nominal gains as has the stock market of Zimbabwe in the most recent example of hyperinflation.
Figure 1 Comparison of inverted USDX, Commodity Index (CCI) and S&P500
In figure 1 the USDX is displayed in red. It is on an inverted scale such that when the curve rises the USDX is actually falling and vice versa. The blue curve is the Continuous Commodity Index (CCI) and in green the S&P500. It can be seen that in general the trends in commodities and the S&P500 can be correlated exactly with dollar strength or weakness. The only exception is indicated by the blue boxes (Q4 2007 to Q2 2008) where dollar weakness was also accompanied by a falling stock market. It can be seen that since early 2009 dollar weakness correlates with rising commodities and a rising S&P500. But perhaps this is coincidence and the S&P500 could fall again like it did in the blue box as the dollar weakens further. To address this we need to investigate the S&P500 more closely.
When over a sustained period of time buyers are more dominant than sellers a market will be in a primary bull trend while when sellers are more dominant than buyers the market will be in a primary bear trend. At Market Force Analysis we have developed a proprietary indicator which is called “Potential Energy” (PE) which uses the intraday data to determine whether buyers or sellers are more dominant. In figure 2 the S&P 500 is shown in black and the Potential Energy (PE) in blue. When the PE is rising the primary trend of the market is up and when it is falling the primary trend is down. It can be seen that this indicator is excellent at identifying a change in the primary trend. In the last 19 years only 4 turning points are identified as indicated by the arrows. The latest is a transition from bear to bull in March 2009. What is clear from PE is that the rise and fall cycles of the S&P500 in 2008 where the PE was falling are not the same as the rise we have seen since March 2009. The most recent rise is very similar to what was seen in 2003 when the market turned from Bear to Bull.
This turn is only 3 months old and could turn out to be an erroneous large blip as was seen at the beginning of 2002 but other indications not discussed here lead me to believe that is not the case. In a few weeks it will be abundantly clear if this is the change in primary trend that it appears to be.
Figure 2: S&P 500 Potential Energy Chart
If this turns out to be the case then the bears will be in a losing trade.
Debasement of the currency is not the route to a booming economy but for a while it will look like the real thing! Companies will report increased revenues due to inflation and investors will overlook rising costs (also due to inflation). It should be remembered that the Nasdaq boom was created by companies who had increasing revenues and wall-to-wall losses for as far as the eye could see!
Debasement of the currency distorts all economic assessment. Imagine you had a watch that was counting 60 minutes in an hour this week but only 54 minutes in an hour next week and then only 49 minutes the week after etc. In a few weeks time what would a speed of 60 MPH mean? What you can be sure of is it will not mean the same as today! Likewise if the dollar is debased by 30% then if the S&P rises to 1100 from 900 it has actually dropped 15% in real terms!
Many precious metals investors are nervous as they anticipate another stock market nose-dive and wonder how their mining equities will hold up. If I am correct this is not going to happen. Once the smart money investors realize that it is inflation they have to worry about then the Cartel will no longer be able to suppress the price of precious metals due to massive demand. Gold and Silver will rise faster than any other asset and mining equities will outperform general equities due to the intrinsic value of the assets they own in the ground.
From my work I see the green shoots of hyperinflation. When a government is determined enough to debase its currency it can distort the measurement of economic value such that nominal prices rise while the value in real terms is falling.
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