With
less than a year to go before the bottom of the 60-year Super Cycle many
investors are wondering how the coming months will play out. There are at least two major possibilities
that need to be discussed: the soft landing and the hard landing.
The
effects long-term 60-year cycle, which answers to the economic long wave
(K-Wave) can be seen in the fact that commodity prices and inflation are unusually
low given the extraordinarily high levels of central bank and government stimulus
in recent years. Despite $85 billion in
monthly asset purchases by the Federal Reserve alone, the oil price – one of
the most sensitive inflation indicators – has actually been declining in the
last couple of months.
Its
effects can also be seen in the fact that the job market remains an issue for
central banks. The labor participation
rate has dropped steadily in recent years as many unemployed have given up seeking
work. And as we looked at in my previous
commentary, money velocity has been steadily declining despite record amounts
of liquidity being created by the Fed.
All these indicators are symptomatic of a major deflationary
undercurrent. The Fed is well aware of
this structural problem and this is why it has steadfastly maintained a
continuous flow of liquidity, for without this life-giving stimulus deflation
would surely have its way altogether.
The
long-term deflationary cycle has both a malevolent and a benevolent
aspect. The negative attributes of this
cycle are well chronicled and have been witnessed in recent years. The most obvious manifestation of this
deflationary cycle was seen in the throes of the credit crisis of
2007-2009. The painfully slow nature of
the job market recovery since then is a lingering reminder that deflation’s
work is not yet done.
Yet
deflation can also be quite beneficial for consumers if allowed to take its
course. In Japan deflation was a huge
benefit to the country’s aging population for some 20 years as low consumer
prices helped the elderly and underemployed get by during times when the
economy was sluggish. With the advent of
Abenomics, Japan is finally starting to see signs of inflation after more than
20 years of falling prices. Just as
Japan was the first major nation to feel the effects of the long-term
deflationary cycle, it’s also first to emerge from the long-wave deflationary
winter. What is now happening to Japan
is instructive, for it will also happen to the U.S. once the cycle has bottomed
next year.
Stock
prices have greatly benefited from the Fed’s asset purchases and low interest
rate policy. They’ve also benefited from
the low commodity prices of the last couple of years, as can be seen in the CRB
commodity index shown below, since profit margins are higher when input costs
are lower. There’s a possibility the
stock market can dodge the proverbial bullet next year as the long-term cycle makes
its final descent, thereby resulting in a mild bottom. If this happens, however, the danger to the
economy will be acute in the years immediately following 2014.
By
refusing to let prices fall continuously since 2008, the Fed’s intervention has
artificially boosted retail prices to an extent that the next inflationary
long-term cycle that begins in late 2014/early 2015 could easily create runaway
inflation. That is, prices and interest
rates could go through the roof once the new cycle kicks into high gear. This is where Japan’s experience will be most
instructive.
Another
thing to watch for as we enter the final months of the cycle is China. Note that China’s stock market, as reflected
in the Shanghai Composite Index (below), has been in a downward trend since
2009. China’s economy has also been
showing signs of weakness at various times in the past two years. A truism of the 60-year cycle is that the
bottom must manifest somewhere. If it
doesn’t produce severe effects in the U.S. next year, it will surely do significant
damage to another area of the globe. The
most likely candidate is China.
With
China’s government significantly curtailing real estate growth over the past
year, the risk of an economic crisis will increase with the added pressures of
the deflationary cycle bottom in 2014.
China is another problem area to watch as we enter the final months of
the cycle.
