Inflation, Deflation Collide, Exposing Warren Buffett’s Naked Swimmers

What comes after a trillion?

We ask because today brings word that the world’s derivatives have surpassed US$500 trillion. In other words, they’re halfway to somewhere. We suspect they are halfway to Hell…but we don’t know how many zeros there are in the netherworld.

When we left you last week…things were getting interesting.

The unstoppable force of inflation was about to smash into the immovable object of deflation.

Friday’s news told us that the two are getting closer and closer. Pretty soon, there’s going to be a collision.

Most newsworthy, Wednesday, the Dow sold off. Dow stocks were down another 211 points, triggering a Dow Theory sell signal. According to Richard Russell, who keeps track of these things, stocks are now in a primary bear market. As near as we can figure, that means that stocks will go down – until they go up. We’ve never gotten the hang of Dow Theory, but some of the smartest guys in the business swear by it.

Of course, it appeared to us a couple of weeks ago that stocks were in a bear market. “The tide has turned,” we wrote. With earnings now falling…and liquidity disappearing from the financial markets, generally…we guessed that stocks would have to go down.

What this means, in a broader sense, is that wealth is ebbing away. When the tide goes out, says Buffett, you see who’s been swimming naked – meaning, you find out who’s forgotten to put on his shorts. Prices go down…and he finds he has nothing to protect his most vulnerable parts. But even the investors who were more careful lose money.

Everybody loses money. And as Russell puts it, the winner is just the guy who loses least.

When the tide goes out…all the assets that had been buoyed up by flowing liquidity begin to fall down. Of course, we’ve already seen this in the housing market – where, according to the latest reports, sales are off in 46 states…and prices are falling all across the USA, for the first time since the Great Depression. “We still have not hit the worst point in resets, delinquencies and ultimate losses on mortgages,” says a report from the OECD. The United States is “on the brink of recession,” says the UK Times.

The fall of stock prices so far has wiped out a couple trillion in implied wealth. The fall of the dollar has wiped out a couple trillion more. Goldman Sachs (NYSE:GS) estimates that the credit crunch will take out US$2 trillion in credit. And, of course, there are the direct losses from the credit crunch itself…which could add another US$300 billion or so. A trillion here…a trillion there…pretty soon, you’re talking real money.

That’s the immovable object we’ve been talking about… prices fall…money disappears. It’s deflation, with a capital ‘D’.

Meanwhile…the unstoppable force of inflation is heading our way. Prices all over the world are heading up…

“Would you believe it…on the rue de Passy they have cakes in the shop windows selling for 30 euros (about US$45)?” said a Frenchwoman we met yesterday. “They say inflation is low in France…but I don’t believe it. Many things are as expensive in Paris as they are here in London…”

All over the world people are saying the same thing: official inflation figures lie. And all over the world, they’re probably right. Consumer prices are going up. Yesterday brought reports from Hong Kong and Russia, both of whom announced higher inflation rates. And in the United States, Merrill Lynch (NYSE:MER) reported that the cost of Thanksgiving had risen nearly 8% – or more than twice the official inflation rate – from the year before.

Oil rose to a new record over US$97…gold shot up to US$798…the dollar fell to a new record low against the euro…and even the rich are having to cut back their spending, says Bloomberg.

While the rich are trimming their sails, the poor are positively sinking. They can’t pay their bills. An article in today’s International Herald Tribune tells us that the number of people who rely on food banks and homeless shelters if rising sharply. New York City food programs are serving up 24% more grub this year than last, says the piece.

And the middle classes are caught between the hurricane of rising living costs…and the doldrums of falling asset prices. They have less money to spend…and more ways to spend it. The unstoppable force is bearing down on them from one side. An immovable object blocks their retreat. They’re going to get clobbered.

They are the ones that own houses and mutual funds…and they are the ones that owe too much money…and whose living expenses have gotten away from them.

They may have substantial salaries…but they have very little margin. Everybody is already working full time…or more. After paying the mortgage, the car loan, the kids’ tuition, their health insurance…and other regular expenses…they have less left over than their parents had. Is that progress or what?

We’ve argued that the “progress” of this generation of Americans is largely an illusion. They earn more. They have more gadgets. Their houses are said to be worth more. But they have actually less real wealth than the generation that preceded them.

Nobody cared when the assembly line workers lost ground. If they were too stupid or too slow to get an office job, said the middle classes, they deserved what they got. But now people in the middle classes are beginning to feel like losers too.

You are either a contrarian, or you are a victim – especially in a credit deflation. When prices fall on most assets…you have to be a contrarian to own the few things that aren’t going down. And when the basic financial formula that has guided a whole generation of Americans breaks down, you have to be a contrarian to find a new one. Since 1980, more or less, Americans have saved less and less of their earnings. Buy a bigger house…buy another car…burn more fossil fuel…spend more money. This spendthrift culture helped to speed up economic growth in Asia. Americans would buy anything, whether they needed it or not. The Asians began to make things, sell them to Americans, and bank the profits. As this process intensified, Asians ended up with more and more money…and more and more of the world’s industry. In other words, America’s middle class spending funded the rise of its most potent competitor. And now the US lumpenhouseholder is in a fix.

The obvious contrarian solution was to NOT do what the US middle classes were doing: Don’t spend; save. Don’t borrow; lend. Don’t consume; make do with what you’ve got. Don’t buy a big house far from your work; rent a little house nearby. Don’t live large; live small. Don’t buy stocks; buy gold.

During the past 27 years, doing these contrarian things was as unappealing to most people as a cheap hair transplant. They felt a little ridiculous driving around in an old car…or having a kitchen with linoleum on the countertops.

But fashions change. Maybe thrift is about to make a comeback.

Bill Bonner
Markets and Money

Bill Bonner

Bill Bonner

Since founding Agora Inc. in 1979, Bill Bonner has found success and garnered camaraderie in numerous communities and industries. A man of many talents, his entrepreneurial savvy, unique writings, philanthropic undertakings, and preservationist activities have all been recognized and awarded by some of America’s most respected authorities. Along with Addison Wiggin, his friend and colleague, Bill has written two New York Times best-selling books, Financial Reckoning Day and Empire of Debt. Both works have been critically acclaimed internationally. With political journalist Lila Rajiva, he wrote his third New York Times best-selling book, Mobs, Messiahs and Markets, which offers concrete advice on how to avoid the public spectacle of modern finance. Since 1999, Bill has been a daily contributor and the driving force behind Markets and Money.
Bill Bonner

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2 Comments on "Inflation, Deflation Collide, Exposing Warren Buffett’s Naked Swimmers"

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Half a quadrillion dollars, that’ll buy a lot of icecreams.

Alice Cook

Check this story out:

Revealed: how UK banks exploit charity tax laws .

UK Banks have been using “charitable status” to offload mortgage debt from their balance sheets. Moreover, the amounts are huge.

Where is the outrage?


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