The War on Deflation

France is at war. Wars cost money.

More police on the streets. More money on defence spending. More government. More debt.

With a public debt level that is rapidly closing in on 100% of GDP, the last thing France needs is more government expenditure. However, public debt and deficit is not a problem unique to France. Governments around the world are spending far more than the taxes they collect.

Budget deficits as far as the eye can see are worrying in normal times. But in a world teetering on the brink of deflation, they’re downright dangerous.

Yet share markets shrug this off and instead focus on when the cheap money tap is likely to be turned off.

Wall Street is far more concerned with the Fed’s plans in December than anything IS has planned. It’s all about will they or won’t they raise interest rates?

Earlier this year my money was on US rates remaining untouched. The weakness in the global economy did not warrant a rate rise.

Now I’m not so sure rates will stay on hold.

I think the Fed will move the dial up 0.25% in December. Not because the economy is getting stronger…quite the opposite. It’s because Fed Chairperson Yellen has played this ‘yes we will, no we won’t’ game for too long. Yellen needs to look decisive, and therefore will raise rates.

Not that a 0.25% increase in interest rates is that decisive when compared to Fed Chairperson Paul Volker.

Volker took the Fed Funds Rate from 11% in 1979 to 21% in 1981…a 10% rate increase in two years. Back then Volker was fighting inflation.

Imagine if rates rose 10% today? With the world sitting on a US$200 trillion debt pile, interest payments alone would increase by US$20 trillion — more than the entire value of US GDP.

One thing we can say with relative certainty is we are not likely to experience Volker-like rate increases anytime soon. The world would go broke long before the interest rate needle moved up a few percent. Over-indebted households, corporates and governments cannot afford interest rates to rise much more than a percent or two, at the most.

Interest rates are going to be tinkered with at the margin — and more likely moved into negative territory — because we are in a deflationary world. The opposite of what Volker was trying to tame.

The deflationary clouds continue to gather on the horizon.

Japan’s Cabinet Office officially announced that Japan is in recession — again. Third quarter growth in Japan shrank by an annualised 0.8%. Add this to the previous quarter’s negative growth and Japan fits the technical definition of a recession.

It also fits the not-so-technical definition of an economic basket case.

Remember Prime Minster Abe’s grand plan to produce inflation — the three arrows of fiscal stimulus (government spending more yen), monetary easing (government printing more yen) and structural reform (government making more hard decisions).

Abe fired the first two arrows, but the third arrow is more like a dart…never really had much size to it.

The recession announcement shows the two arrows and the dart were all firmly shot into Abe’s foot.

Where to from here? More printing? More government buying of shares and bonds? More ‘tough’ decisions? Probably.

Even though the three-pronged strategy is a proven failure in every country it’s been used in, policymaker logic dictates that this is not a reason to abandon it. But to rather to double-down on the strategy…go even harder for even longer.

In reality what we’ll see in Japan is more deflation.

Even those perennial overstaters at the IMF issued a global growth warning over the weekend at the G20 leaders meeting.

In an environment of declining commodity prices, reduced capital flows to emerging markets and higher financial market volatility, downside risks to the outlook remain elevated…

The OECD chimed in with its own dire assessment. World trade slumped to 2% growth for the year.

China’s slowing economy is the primary reason both institutions are painting a not-so-bright outlook for 2016.

The interdependency between the indebted east (producer) and the even more indebted west (consumer) to buy and sell things to each other in a slowing world has created a deflationary loop.

When you add the continued encroachment of technology into the supply chain of nearly every good and service, you have another powerful deflationary force in the global economy.

For example my former industry, financial planning, is on the cusp of a technology revolution.

In 5 November 2015 The Sydney Morning Herald reported ASIC chairman, Greg Medcraft, saying ‘…computer-generated financial advice, or “robo advice" could slash investment costs and eliminate conflicts of interest in the maligned financial planning industry.

What is a ‘robo-advisor’? These are websites that use sophisticated algorithms to make programmed decisions on where best to invest your money. Apparently they are proving very popular overseas.

Swiss research group, MyPrivateBanking report there is already US$14 billion invested with robo-advisors. Within five years its forecast assets under management will grow to US$255 billion.

Apparently NAB are looking at introducing automated advisers into its financial planning network. With the recent scandals involving planners associated with banks, an automated advice service may assist in restoring some credibility.

Initially robo-advisors are aimed at investors with low dollar amounts and fairly simple investment needs. Over time the lessons learned from real-life interactions between clients and the machine will no doubt improve the algorithms exponentially.

With ultra-low fees, 24 hour access to reporting, auto re-balancing of asset allocations and access to robo-advisory services NOT owned by banks, there’s a lot for customers to like about this disruptive technology.

High priced planners are either going to have to improve their skills and justify their fees OR get out of the industry.

This situation is not unique to financial planners. There are so many industries — mining, banking, accountancy, retail, cargo handling, aged care — that are adopting disruptive technology solutions.

We’re even getting in on the act here at Port Phillip Publishing. Jason McIntosh’s Quant Trader is an automated ‘black box’ trading system that has seen market-beating results for his subscribers in the year that it’s been operating.

Collectively these kinds of innovations will drive costs down (deflation) and unemployment up (rising government expenses).

The speed of technological innovation is gathering pace, and financially strapped governments are ill-prepared to cope with the coming changes.

Governments, worldwide, have been fighting the war against deflation for nearly seven years.

Their arsenal consists of zero interest rates, money printing and asset purchases — directly or indirectly.

These weapons are proving to be ineffective against too much debt, demographics — such as ageing baby boomers — and technology.

Governments may instruct the central bankers to launch an all-out assault on deflation.

However, Japan’s all-out effort to generate inflation is proof these weapons are not winning the war.

The real world war is against deflation. Governments are losing this battle. Unless they opt for some unknown nuclear economic option other than the tried and failed stimulus strategies, deflation will be the victor.


Vern Gowdie
For Markets and Money

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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