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Deflationary Spiral Signals More Stock Market Declines Ahead

Wednesday, December 24, 2008 by: Barbara L. Minton
Tags: stock market, health news, Natural News

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(NewsTarget) Everybody in America is excited about the new president. We tend to think that as soon as he is inaugurated things will get better and a new era of prosperity will begin. We are so excited that we are even putting money into the stock market again, buying at what we think is a bottom. Yet the recent action by the Federal Reserve is sending a signal that some time around inauguration day, the stock market may begin to head south at a rapid rate.

Signs the U.S. has entered a major deflationary period are everywhere

On December 16th the Federal Reserve effectively lowered its target for the federal funds rate (the rate at which banks lend to each other) to zero, a move that sent cold chills down the spines of those who remember the collapse of the Japanese economy in the early 1990's. This is the lowest rate on record. It is the end of Fed easing and an announcement that from here on out, we are on our own.

On Main Street the signs of price collapse are everywhere. The Fed even suggested it would use whatever means it could to lower the rates Americans pay for mortgages, car loans and business loans. At the mall 50% to 60% off signs signal retailer desperation, as merchandise continues to sit on the shelves. U.S. households lost $647 billion in real estate in just the third quarter of this year, along with $523 billion in mutual funds, $653 billion in life insurance and pension fund reserves, and $128 billion in private (non-corporate) business interests. The total destruction of wealth for Americans in 2008 is $7.2 trillion, more than ten times the amount of the $700 billion bailout package.

This destruction of wealth has been sharp and swift. Most people stood no chance against it. Although a few big companies will receive bailout money, the work of the Troubled Asset Relief Program (TARP) is like trying to empty a sinking ship with a teaspoon. Countless small and medium sized companies are rapidly going bankrupt and there is no money to save them. There are also the state and local municipalities that have run out of money, the situation in California being just the tip of the iceberg.

The continuous release of statistics underlines the trauma, with producer prices falling at an annual rate of 26%, and overall commodity prices getting hammered by 70% from their bubble heights.

The evidence is clear. The U.S. has entered a dreaded deflationary spiral that threatens to engulf every aspect of the economy. And we do not know how to act or what to do because there is no precedent in recent times to teach us. The last major deflationary period was from 1929 to 1932, and those few old timers who are still around tell tales that make skin crawl.

Talking heads say Buy, Buy, Buy

Markets never move in straight lines. Every bull market has periods when prices decline, and every bear market has periods when prices rise. One of the main forces behind the periodic price rises in bear markets is the concerted effort of manipulators to con the unsophisticated into putting more money into the market so they can take if from them. Nothing has been put in place to stop the downtrend of the market. The uprick rule has not been restored. Yet fresh meat must be tossed into the lion’s den periodically. Wall Street calls these maneuvers sucker rallies.

Sucker rallies are characterized by fast changes of tune. The same groups of investment gurus who a month ago were telling us we were all doomed are now saying the bottom is in and its time to buy. This sudden buying sentiment is almost universal, and cloaked in complete denial of what is in front of their faces. These are people whose living depends on selling financial products of one sort or another. They are not people given to rational interpretation of data and the ability to see things objectively. They are simply acting from self protection when they tell us that the bottom is here. These are the same people who have been saying buy, buy, buy as the Dow Jones Industrial Average dropped from 14,000 to 8,000.

Financial experts appear nightly on the news to tell viewers that as long as they are relatively young, they should continue investing most of their 401K or IRA money in stocks regardless of market declines. The majority of pundits maybe even believe what they are saying. But that does not make it good advice.

Experts told everyone to keep buying and holding stocks during the Great Depression

Brokers in 1930 were advising their clients to hang on to their stocks for the long term and ride it out, the same message we are hearing today. But the results of their advice were devastating. If you bought the average stock in 1929 and held on until 1932, you wound up with about 10 cents for every dollar you had invested, at least if you bought stock in companies that survived. It you did not, you were left with absolutely nothing. Even if your companies survived, it was not until 1954 that your stocks again reached the levels you paid for them, that is if you were able to stick it out that long.

Most people gave up in despair some time along the way. They lost their jobs or were at risk of losing their homes and had to use what little money they were able to recoup from their investments. They had no choice but to sell out at huge losses.

Americans have been conditioned to expect stock market gains

We have been sold on the wonders of investment in the stock market. Almost everyone had something to gain from convincing us that stocks were where our money should be. Employers wanting to shed their obligations for employee retirements talked them into 401K or other retirement accounts by telling them it was through such investments that they could reach a golden retirement. They showed us charts to illustrate the magic of compounding, and we were hooked. Our employers made money from convincing us to accept these accounts as our retirement benefit. The companies that sold the investment products bought by people with retirement accounts also benefited. Even the government got a piece of the action since losses in these types of accounts are not tax deductible like they would be in non-regulated accounts.

It was the money of hardworking Americans pouring into the stock market since the creation of such accounts in the 1980's that caused the level of stock prices to rise. This is the simple law of economics that says when demand increases, prices rise. And as prices rose, it became even more inviting to add to our investments.

Now, as companies file for bankruptcy and people lose their jobs, the steady influx of retirement money will no longer be there to support the market even if everyone who still has a retirement account makes the decision to keep putting money into the market.

Previous hard times are the only guides we have to determine where we stand

Between 1965 and 1980, America went through a prolonged period of stock market stagnation characterized by debt difficulties, credit crunches, financial failure, house price declines, recessions and bear markets. For a decade and a half, most investors lost money in the stock market. The only thing that got the market going again was the invention of the retirement account.

Today's financial crisis has already shown itself to be far worse that what went on during the 1965-1980 period. The level of debt held by almost everyone is far greater today than it was in the earlier period, and the number of bankruptcies is higher. The nationwide bust in housing prices is much deeper than anything ever experienced before. A reasonable conclusion would be that the experience of investors would be at least as bad as, if not worse than, that experienced during the 1965-1980 period.

The fall of the Japanese economy, the second largest economy of the modern world, began in 1990. It has lasted for 18 grueling years during which the Nikkei Average (the Japanese counterpart of the Dow Jones Industrial Average) went down 82% from its high, and has not rebounded. However, the crisis that struck Japan in the 1990’s was nowhere near as severe as the global crisis we are now facing. When the Japanese economy declined, Japan was a nation of savers. Almost every Japanese citizen had money socked away. But when American entered the current financial crisis, they were already in a mountain of debt and had no resources to draw upon.

The great investors of the world are united in thinking that when the risk of loss is greater than the opportunity for profit, it is not the time to invest. Even the current cast of market gurus tells us the market hates uncertainty. But it is just such uncertainty that we are facing. We do not know how far stocks will fall, where the bottom is, or how soon prices will recover. We do not know how many banks, insurance companies, brokerage firms, service industries or manufacturers will go bankrupt. We do not know whether government intervention will make the problem worse, better, or change its direction. We do not know how deep or long the commercial real estate collapse will be, or how low the prices of houses will have to go before willing and able buyers emerge.

If you are a gambler, the door is always open at the casino. If your desire is to consistently build wealth for your family and your retirement, a certificate of deposit at a 5 star bank will allow you to hold on to what you have and let you get a good nights sleep too.

Most of us will be affected in some way from the financial collapse of the U.S. There is no way around that. It will be important to make the best financial decisions you can so you have the resources to see yourself through this crisis. Maintaining your health and keeping stress to a minimum should be your paramount concerns.

What about gold?

As Natural News predicted, gold has outperformed other investment classes during this early part of the financial crisis. It is the only asset that has not fallen significantly in value. From this point on as the deflationary spiral deepens, the chance is greater that it will join other assets that have fallen in value and may remain at depressed levels until the threat of inflation is ignited.

It is true that massive amounts of money have been printed by the Federal Reserve with the stated goal of stimulating the economy. Eventually, this increase in the money supply is bound to cause a burst of inflation greater than was seen coming out of the desolate economic period that ended in 1980. But before this can happen, the deflationary forces must exhaust themselves, and it appears that this will be no time soon. If you have an interest in gold as hedge against inflation, now is a good time to establish a relationship with a company you can trust to treat you well when the time for buying gold arrives, but look to buy it when deflation has run its course, at substantially lower levels.

Source for numerical data:

Martin D. Weiss, Ph.D., Deflation strikes hard! What to do... Money and Markets

About the author

Barbara is a school psychologist, a published author in the area of personal finance, a breast cancer survivor using "alternative" treatments, a born existentialist, and a student of nature and all things natural.

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