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Hyperinflation Worries Laid to Rest, Part II
There is one major difference between Zimbabwe and the U.S.
Low Rates Hint at the Outcome
As I mentioned in Part I, the main catalyst of the out-of-control money printing in Zimbabwe was their loss of the ability to borrow money abroad. And that remains the main difference between Zimbabwe and the U.S. This country continues to retain its global creditors, and does so at a very low cost: Currently, the U.S. pays only 3.4% on a 10-year bond. Since bond yields are close to a 60-year low, there is still demand for the unprecedented issuance of Treasury debt.
Look at it this way: During its ongoing battle with deflation, Japan retained its global creditors, as seen by its low rates, which allowed its debt-to-GDP ratio to balloon up to 200%. The U.S.’s debt-to-GDP ratio is expected to end 2009 at around 50%. As we wrote in the June issue of EWI’s Global Market Perspective, “The U.S. government is in a similar position [to Japan], because 32% of U.S. government debt is due in less than one year, and short-term interest rates are minuscule. Such low funding costs mean that cash is available.” Therefore, because 2-year rates are only at 1% and T-bills are at 0.05%, the U.S. is not at panic levels. Although we disagree with the policy of deficit spending and quantitative easing, it looks to us that our politicians and the Fed are more likely to have a battle with more deflation first.
Don't get me wrong -- hyperinflation could happen in the U.S., just not over the next few years, while deflation takes its toll. In fact, as Bob Prechter writes in Ch. 13 of Conquer the Crash (Ed.: The 2nd, expanded, edition is available now),
"At the bottom [of the deflationary depression], when there is little credit left to destroy, currency inflation, perhaps even hyperinflation, could well come into play. In fact, I think this outcome has a fairly high probability in the next Kondratieff cycle."
(Make sure to also see Chapter 18 of the book for Prechter's description of "one defense works for both a deflationary crash and a local hyperinflation.")
Similarly, notice that Zimbabwe’s inflation really turned higher AFTER their economic problems led to the withdrawal of foreign credit. What would the signs of that happening here look like, you ask? One of the first signs of credit withdrawal would be a sell-off in the 10-year T-bond. Its yield is now 3.41%, and, in my opinion, it would take a push back above 7% to raise concerns about hyperinflation. (Ed.: Stay tuned to EWI's monthly Elliott Wave Financial Forecast for regular updates on the U.S. bond and other markets.)
Will other markets provide us with indicators? Currency markets will provide much less of a clue towards inflation because many countries are in a similar position to the U.S. The equity market will provide some clues: Once the Dow reaches its Primary-degree wave 3 bottom (which remains our forecast), inflation risk will increase. Ironically, that would also be the point when most mainstream financial experts will likely be worried about continued deflation -- that is, after it will have occurred.
Investors would be well-served to be able to recognize the difference between hyperinflation and deflation. If the evidence changes (e.g., a new all-time high in the Dow, among others), we at EWI will re-examine our opinions, too. But you can be sure that we won’t be swayed by the emotions that will surface concurrent with market direction.
A chance reading of a book on technical analysis and the Austrian school of economics eventually led Jason Farkas, CMT, to Elliott Wave International. Prior to joining EWI Jason worked for 14 years as a futures, options and equity trader. Jason has been tutored by some of the best investment minds, including legendary trader Dick Diamond. You can read Jason's Weekly Insights regularly in EWI's intensive Currency and Interest Rates Specialty Services.