Deflation Warning: The Next Wave

The signs of deflation are now flashing all over the globe. In our estimation, the possibility of an associated financial crisis is now dangerously high over the next few months.

As we’ve been saying for a while, our preferred model for how things are going to unfold follows the Ka-Poom! Theory as put out by Erik Janszen of

That theory states that this epic debt bubble will ultimately burst first by deflation (the "Ka!") before then exploding (the "Poom!") in hyperinflation due to additional massive money printing efforts by frightened global central bankers acting in unison.

First an inwards collapse, then an outwards explosion. Ka-Poom!

We’ve been tracking the deflationary impulse for a while, and declared deflation the winner back in July of this year.

A Failed Strategy

What exactly do we mean by deflation?  Back in 2008 the central banks of the developed world, as well as China, had a choice:

  1. admit that prior policies geared towards encouraging borrowing at a faster rate than income growth were a horrible idea, or
  2. double down and push those failed policies even harder

As we all know, they chose option #2. And so here we are, just 8 years later, with nearly $60 trillion in new debt piled on top of the prior mountain -- while GDP grew by only $12 trillion over the same time period:


[Note:  Global nominal GDP is projected to be $68.6 trillion in 2015, virtually unchanged from 2013]

In other words, instead of saying to ourselves: Hmmm.... it was probably a terrible idea to pile up debt at 2x the rate of income growth, what the world did instead was to double down on that terrible idea and pile on more debt at 5x the rate(!) of nominal GDP growth.

Talk about not learning from your past mistakes....

At any rate, what all of that money printing, lower interest rates and new debt creation did was force capital over the globe to look for some place to go. Absent any really good and creative ideas, that money primarily chased yield. It piled into risk assets like stocks and junk bonds, often in bubble-like fashion (meaning, in haste), and without proper due diligence.

The only way the central bank “strategy” (and we use that word very loosely) could have worked was if very rapid economic growth emerged to justify the accumulated levels of debt, comprised of both old and new borrowing. Central banks were indeed hoping such growth would materialize and lesson the burden of servicing the interest on all that debt.

But that growth, quite predictably (as forecasted by us among many others), did not emerge.

Perhaps Japan’s experience should have tipped the central bankers off as to why not.  For several decades now, Japan has served as a warning: too much debt is the malady, not the cure.

So here we are.  What are we to make of it all?  It's our view that the financial markets are important to monitor because they will signal to us when sentiment has shifted, and let us know in advance that events will unfold at a faster pace.

Judging from the market action over the past month, we think that shift has happened. And we're increasingly concerned that this next ‘correction’ could be pretty rough for a lot of folks.

Bright Red Warning Lights

The global economy is downshifting fast, and there are lots of flashing red warning lights indicating as much.

Doug Noland has captured the emerging market pain caused by the hot money that is now flooding out of those territories, as well as provided a great explanation of the bubble dynamics in play:

The Federal Reserve is flailing and global currency markets are in disarray. Notably, the Brazilian real dropped more than 10% in five sessions, before Thursday’s sharp recovery reversed much of the week’s loss. This week the Colombian peso dropped 3.0%, and the Chilean peso fell 3.1%. The Mexican peso dropped 1.9%.

The Malaysian ringgit sank 4.5% for the week, with the South Korean won down 2.7% and the Indonesia rupiah losing 2.2%. The Singapore dollar fell 1.8%. The South African rand sank 4.4% and the Turkish lira fell 1.4%.

Notably, market dislocation was not limited to EM. The Norwegian krone was hit for 4.4%, and the Swedish krona lost 2.0%. The British pound declined 2.3%. The Australian dollar also lost 2.3%.

The global Bubble is bursting – hence financial conditions are tightening. Bubbles never provide a convenient time to tighten monetary policy. Best practices would require central bankers to tighten early before Bubble Dynamics take firm hold. Central bankers instead nurture and accommodate Bubble excess. It ensures a policy dead end.

As the unfolding EM crisis gathered further momentum this week, the transmission mechanism to the U.S. has begun to clearly show itself. While “full retreat” may be a little too strong at this point, the global leveraged speculating community is backpedaling. Biotech stocks suffered double-digit losses this week, as a significant Bubble deflates in earnest. It’s also worth noting that the broader market underperformed.


What does it mean when we see currencies in retreat across the globe?  It means that the hot, speculator money is rushing out of weaker economies and back towards the stronger center.  This is consistent with a liquidity crisis, one where all the borrowed money used to spark all those heady asset gains and falling yields on the way out do the exact opposite on the way back.

And Doug is exactly right – there’s never a good time to pop a bubble.  So the central bankers just sit, paralyzed, afraid to even raise rates by a token amount for fear that the daisy-chain of global bubbles will burst as a result. They needn’t fear: the bubbles will burst no matter what the Fed, et al., does.

A credit default swap (CDS) is a bit of insurance you can buy if you own a bond and are worried that the issuer may default on it.  In a stable climate, the cost of that insurance (measured in percentage points above the stated yield on that debt) is pretty flat. It's usually close to the yield of the bond in question.

So you might have to pay 1% to 2% (i.e. 100 to 200 basis points) above the yield on, say a Brazilian ten year bond, to insure it against a default.  As things begin to break down and become less certain, that cost will rise.

Now take a look at this chart of recent emerging market CDS 'spreads':


See those CDS ‘spreads’ blowing out to the upside? That’s the sort of thing I was tracking in 2008 that gave me a clear, early warning that things were about to fall apart.  While these levels are not (yet) flashing the same level of danger that we are seeing in the CDS paper for Glencore (which is almost certain to go bankrupt now), or for US shale drillers (tons of bankruptcies coming there, too), these are pretty serious warning signs to see in sovereign debt.

Why would the sovereign debt of Russia, Turkey, Brazil, and Malaysia be spiking right now?  Because the hot money is flooding out of those countries. There's now an elevated risk that they may default on their bonds in the future.

These emerging market countries are being squeezed from every direction. But the worst pain is being experience by those that borrowed heavily in dollars (or other stable currencies).  From the WSJ (Sept 29), we see the magnitude of the predicament for companies located in EM nations:

Developing-country firms quadrupled their borrowing from around $4 trillion in 2004 to well over $18 trillion last year, with China accounting for a major share.

Now, prospects in industrializing economies are weakening fast even as the U.S. Federal Reserve is getting set to raise interest rates for the first time in nearly a decade, a move that will raise borrowing costs around the world.

The burden of 26% larger average corporate debt ratios and higher interest rates come as commodity prices plummet, a staple export for many emerging-market economies.

Compounding problems, many firms borrowed heavily in dollars. As the greenback surges against the value of local currency revenues, it makes repaying those loans increasingly difficult.


So the afflicted countries are going to see vastly weaker exports, plunging currencies, and their local corporations unable to pay off dollar-denominated loans -- on borrowing that ballooned from $4 trillion in 2004 to over $18 trillion just 11 years later.  It’s an amazing statistic, one of many fostered by a cluster of central banks that know everything about blowing bubbles but nothing about ending them.

The punch line from the above article is this: That massive debt build-up means it is “vital” for authorities to be increasingly vigilant, especially to threats to systemically important companies and the firms they have links to, including banks and other financial firms, the IMF said.”

Decoded, that means that $18 trillion is a big number. If even a small portion of that goes into default, it could easily drag down whole swaths of the developed world’s financial corporate structure.  A systemic crisis that would begin on the edge but rapidly spread to the center.

Well, based on the DDBAX ETF which holds bonds priced in local currencies, we can get a sense of the pain those EM companies are feeling which have dollar denominated loans, but conduct business in their local currency:

Ouch!  Based on the above chart, the past year has been painful indeed for those emerging market corporations and governments. No sign of a bottom yet either.

Not So Fast There….

One so-called ‘bright spot’ in the world economy is the US, which supposedly is doing better than everyone else.  As you know, I consider US GDP statistics to be nearly useless because of all the statistical tricks and gimmicks that are now deployed (such as now counting ‘intangibles’ to go along with Owner Occupied Rent which records the price value of people not paying themselves rent, etc.,) to make things look better than they are.

So I’m having trouble believing that the US economy is doing well when our major trading partner to the south is struggling so much due to a huge drop drop in exports:

Mexico factory exports slump by most in over 6-1/2 years in Aug

Sept 25, 2015

(Reuters) - Mexico's factory-made exports slumped in August by the most in more than 6-1/2 years after uneven growth in the first half of 2015, data showed on Friday, while consumer imports rose.

Manufactured exports sank 7.2 percent in August compared with July, falling back after two months of gains, the national statistics agency said in a statement. It was the biggest month-on-month drop since December 2008, data showed.

Mexico exports mostly manufactured goods like cars and televisions and about three-quarters are sent to the United States.


It’s hard to imagine that the US economy is doing fine when a major trading partner who exports 75% of its finished product to the US is experiencing a deep export slump.

But it’s not just Mexico that's seeing a big decline in export activity:

For the first seven months of 2015, U.S. exports dropped 5.6% to $895.7 billion. The value of South Korean exports shrank a revised 14.9% in August from a year earlier, the sharpest fall in six years, as shipments to China dropped. Chinese imports in August fell 13.8% in dollar terms from a year earlier, after an 8.1% decrease in July.

(Source – WSJ)

If this keeps up, 2015 will see the worst global trade performance since…wait for it…2008.  For the US, 2015 will be the first year that exports have declined since the financial crisis.  Ditto for a number of other countries.

Beyond exports, the surveys of US manufacturing and service sector activity are also flashing recession warning signs.  In fact, the manufacturing survey has only been this low in the past during prior recessions. Maybe this time is different?


On the plus side for the US: reasonably robust housing activity, low initial claims for unemployment, and growing income and expenditures. But the data for some of these is suspect (nearly 100 million working-age adults are not counted in the workforce), and in other areas, not robust enough to hang too many hopes on.

Add it all up, and there are a number of signs that not only is the US economy is far from robust, it may even be teetering on the verge of a recession. But the global economic landscape is decidedly tilted towards contraction, not expansion.

Why is all this important?  Because seeing these signs early enough gives us a better chance to mentally, financially, and physically prepare for the next shock.  The press does a very good job of constantly painting everything in a rosy light, and that’s fine, but it’s not very helpful if it also misleads.

Lots of people are woefully unprepared for what’s coming next. For many it will be a shock.  Not because they couldn’t see it coming years in advance and made their own mental and financial adjustments on their own terms, but because they wouldn’t.  Preferring to avoid an unpleasant truth they put it out of sight and out of mind, hoping that somehow things would work out in their favor.

In Part 2: From Deflation To Hyperinflation, we detail out the likeliest progression of the unfolding deflationary rout and the inevitable tsunami of money printing that the central banks will respond with, unleashing the final hyperinflationary chapter.

Click here to read Part 2 of this report (free executive summary, enrollment required for full access)

This is a companion discussion topic for the original entry at

Are any of you folks attending Socap15 in San Francisco next week?  Would love to meet up for a beer on Oct 6th at the opening reception.

I've got to spend some time re-reading this, but just a few comments.  I have listened to Chris's Podcast with Erik Janszen a couple of times.  The deflationary buckling that is going on certainly is concerning, and with the craziness in the market last month, I wonder if Chris has any further analysis on how well the banks are doing now that American markets have evened out a bit.

I'm also wondering about Charles Hugh Smith's take on the most recent piece.  I have learned to not discounts Charles' point of view.  He was ended up being dead one a couple of years ago when he said the American dollar would actually strengthen, when many of us were screaming that inflation was obviously right around the corner.

Anyway, Chris's coming back to the Ka-Poom theory is noteworthy, as I think this is an idea he has mentioned a little more often lately.   Any chance of a follow up Podcast with Janszen?



While deflation is rampant on the left side of the balance sheet  (income and assets),  inflation–primarily through rising rent, property insurance, health insurance and health care–is raging on the right side (expenses and liabilities).
This is the worst of both worlds, resulting in the evaporation of discretionary income for a majority of working people and an ever weakening economy.

Have we recently begun the mother of all bear markets, one that will outlive us all?   If the market continues to lose value, asset deflation will likely accelerate as overall wealth shrinks.

I wonder if one of the few assets to increase in value in the future will be bicycles and other 2-wheel vehicles  (scooters, mopeds, e-bikes, skateboards, etc).   Think roi on a warehouse of bikes will prove to be better than that of the stock market.

…that before any Major Event (inflationary or deflationary) there will be a very publicly-occurring Trigger.  Something that everybody is aware of, even those that pay the economy no mind.  TPTB will be keen to slough blame and disapprobation onto some sort of scapegoat, and it's gonna have to be a doozy (given that the next lurch downward in everyone's standard of living will similarly be a doozy).  Think 9/11 (in terms of size/significance as a pivot point).  Whatever one's beliefs about What The Hell Happened on that day, we can all agree – can we not? – that the gears of history turned that morn (I watched the second plane hit live and in person and my next thought was "the world just changed!").  
This (seemingly) endless, keep-the-plates-spinning act will in fact come crashing down at some point, and IMO it will cost citizens of the West yet another thick slice of their civil liberties (along with a goodly chunk of the money they think they've put back against retirement, etc.).  

I am in a state of heightened watchfulness, as the Major Event could come from a number of spots at this point (ME?  Ukraine/Russia? [I do note with interest that the US is now potentially at loggerheads with Mr. Putin in two locations]  China collapse?  An emergent health crisis [remember Ebola?] could do it.)  

The conditions are ripe, but until I see an Event unfolding, I'm only on double-yellow-alert.  <smile>  The trick, I believe, is to be able to go to Red Alert without any major stress:  one has the various prep measures in hand, one knows what to do when Red Alert arrives.  Sure, there will be a frisson of adrenaline and the thought "oh damn – it's ON"…  But this is why we prep, and while I don't wish for it, when it arrives it'll just be a new way of being in the world.  

In addition to preps, I am more than quite certain that the robustness of one's social and biz network will correlate quite exactly with one's prosperity following the next downward ¡thunk!  (I find it helpful to think back to my ancestors [circa 1800s] – they had no health care, no guarantee of this'n'that, no IRAs or savings accounts etc.  But they made it.  I will do the same.)

In the meantime, I am building my business, putting goodies away for the future, studying Tai Ji rather intensively, and – in the rather salubrious company of my sweetheart, aggressively enjoying my recreational activities.  At the age of 50, I am learning to surf.  I'm terrible.  But I'm having fun.

VIVA – Sager 

The article is an illuminating discussion of intangible financial chaos. The tangible physical reality, however, is that industrial civilization is irreversibly using up the limited natural material resources as it irrevocably ages. Its operation is irrevocably disrupting natural operations including climate change and ocean acidification and warming. Money flow only affects the decisions made by people so hyperinflation is certain as money flow becomes impotent.

All is suspect in this era.  Watch the Jim Bruce doc, Money for Nothing a few times, the voting members have beliefs that must be proven because if they aren't true, their entire debt creating algorithm will stop.  The market action on Friday, October 2, was an absolute anomaly, right?  Or was it just a coincidence?  It was neither–it was intervention.  We recognize this same behavior over and over the last 2 years and it seems to be much more frequent.  Why did the S&P and the dow post "the biggest reversal in over 4 years" as stated by CNBC?  Only one unaudited entity has that type of influence on a day when ALL economic data was terrifying.  The most bizarre event was watching the T-bond yields fall dramatically as equity valuations rose dramatically.  This, of course, is a complete contradiction and violation of standard free market momentum.  And, all of this conducted with extremely low trading volume, or is that the only way the intervention will work?
For certain, it won't work for long because illiquid forces will only drive the problem further into fictional stress and the intervention will become more enlightened.  All thanks to deflation and leverage which will very soon be creating defaults that cannot be papered over.   

Aloha! One thing I learned from being a California Public Works contractor for 20 years was "public money" is on time delayed fuses. In other words the funds to perform contracts have to be secured for years in advance before a project can actually be launched. All the highway projects you see now and all the schools being constructed now have financing in place and unless there is some major financial collapse whereby states have to recall assigned funds the project will complete years later. A typical school project where a new school was built from the ground up had a construction duration of two years from bid to final punch list to grand opening ceremony. Those funds insured a structure, but never guaranteed much more than that. As an example, we opened libraries at elementary schools with no books. That has been resolved to some degree by allowing major tech companies like Apple and Microsoft and HP to deploy their products in schools virtually free of cost, however this is no altruistic act since these companies "brand" students for life. Once these students become adults it is highly likely they will continue to use Apple products once they become full fledged consumers. In the California school system Apple is dominant. If you want a leg up on the deflation prediction biz then follow public works start permits. When those dry up it's done!
Knowing this "delayed fuse" means it is harder to determine the exact year when deflation tips various cities and counties and states into depression. A majority of the community members need to be long term unemployed for us to see this effect in our daily lives. You see this effect in Detroit proper and eventually Chicago, but like dominoes it takes years to spread into neighboring communities. Some cities and states will fare better than others. For example the city of Signal Hill(near Los Angeles) is managed better and has direct oil revenues as opposed to other nearby cities like Long Beach or Costa Mesa. How do I know Signal Hill is managed better? First, I know the assistant mayor personally and I have seen businesses in Long Beach close up and move to Signal Hill. This same dynamic can be seen here in Texas. The survivors will exhibit more business friendly legislation than the competitors. Eventually the Fed funds will start drying up as more and more Detroits and Chicagos come to the surface. As an indicator you will be able to see the credit ratings crumble and CDS on munis go ballistic, just as Chris shows here with regards to major EM countries. Not every US state or city is created equal just as not every EM is created equal. I will guess that Singapore or Hong Kong will fare better than most mainland China provinces.

I add a chart for the Indonesian Rupiah to the mix. This currency was one of the wedges in the Asian currency crisis back in the 1990s. You can see the Rupiah is at the same crisis levels from 1997. Nothing makes CDS issuers more nervous than watching currency crumble. One of the ways around that was to peg the loans in US Dollars or so they thought. Problem now is a government or business operating inside Indonesia has to pay huge portions of its revenues to service USD loans. The short term mentality makes for some very critical issues in the long term. Of course the USA is not immune from this either and in fact short term mentality is a hallmark of the human condition so why shouldn't such a strategy be reflected in politics and business. 

Now what? The last "real" Great Depression more than 65% of Americans had a family farm to retreat to. Now less than 3% do. That means when the 3 day supply chain fails there will be around 300 million Americans desperate to find food and water. A lot of those will be in regions where there are low levels of free flowing water and even less food. We all bought into that "nanny state" strategy started way back in the 1960s by LBJ dubbed then "The Great Society"! Clearly that has failed. Whose farm do you retreat to? Look around your family … who has a farm? I would guess even followers here at PP will have to answer "no farm"! How fast can you run out and buy a farm or get one started. As a farmer myself the answer is "not fast"! The best most promising farmland will be gone first and fastest. Who wants to farm in the Mohave? That is why I think every square inch of windward land in Hawaii will be at record premiums because it is the only land I know where food and water can be found in abundance year round with little to no labor input. Yet, don't wait until the last moment because there will be push back against "last minute haoles"! You will have to be well established and known in the community. I would not be surprised if there would be some sort of state regulation against malihinis(new comers) from owning land. Maybe even a "malihini tax" on real estate transactions.

So who has Plan B? Plan C? D? E? F? Plan Z? Do not look to Washington DC because their Plan B is military action against US citizens. How else have the elite powers of prior Empires acted in such critical circumstances? Roman citizens were as expendable as Berlin and Tokyo citizens were. US citizens will be as expendable as Syrian ones are now. Does anyone here really believe US politicians are going to stand by and give up their power voluntarily for the good of We The People? Of course not. That is why they will need a World War soon. One with a draft! Those are the best ones! Historically, that tactic preserves the political elite for the victors, but at a tragic human toll. Question authority!

I found the article realistic, yet frightening.  And, all with interest rates at all time lows. It doesn't seem possible that trade could be this bad?
How long ago did Abe decide to go bonkers?  The affects of Japan's policies have had little if any in slowing down a decaying culture.  Looking at this scenario on a global frame–are we looking at homosapien peak?  Can the Fed lay claim to this phenomenon?  The trendlines in the article shout out disaster ahead.  The factory orders statistic has been down YoY now for 10 months, or so?  Not to mention Challenger data and commodity prices all run counter to everything we are being told by every media source in operation.  What makes all this trade and economic data so counterintuitive is the GDP report for all of 2015?  Why the contradiction?  How can gross domestic product be the complete opposite of nearly every other metric?  Is housing really that extraordinary?

I think a possibility that can conclude these questions is the argument that we are entering an era of peak manipulation.  The main stream is no longer an acceptable source and critical thinking is replacing the political simplicity of ad hominems.  The population has lost confidence in their own cultures and would not expect the problems to be resolved.  They will begin to look within themselves for answering questions.  They will not rely on social security or bailouts; they know they only have themselves for support.  I suspect the next 10 years will bring much more that resource degradation–it will be the second renaissance.

I have looked at it this way: while the prices of pretty much everything can and do wildly fluctuate up and down, the one thing that doesn't is middle class and low income wages. When it comes to inflationary environments, wages are the last things to go up, and in deflationary periods the essentials of life are the last things to go down in price – all because ultimately, it is the working middle class that gets screwed every time (almost every time – except the 1970's inflation which paid for the middle class' mortgages, causing great stress to the banking system); the working middle class creates the value from which all the other criminals and crooks in the economy steal.

I like the Exter's Pyramid explanation for the financial system which shows the entire financial system above gold essentially being created out of debt – future promises – which is one of the fundamental reasons why the economy must grow, to honor the promises saying that the future will be bigger than today (in other words ---->> the interest rate. Even if interest is zero today, the derivatives it spawns off that have taken its place for the insider banks are not zero return)


Each level up the pyramid can be thought to be derived from lower levels; not necessarily from the one directly beneath but the whole pyramid beneath. Each level up the pyramid you go, the greater the "edginess" becomes, meaning the more sensitive it is to growth, and generally the more amplified the swings in valuations become. And therefore, the greater the risk should become.

The whole inflation / deflation debate seems a bit misguided to me, and thanks to this site for putting it in perspective, since ultimately what financial crashes are, are higher levels of the pyramid crashing and vaporizing as credit money is destroyed, and capital / demand shifting to safer levels down the pyramid. This usually causes demand for dollars and Treasuries to rise, which is one reason why prices go down and deflation occurs (prices also go down because there are now less dollars chasing goods and services, plus people get scared and don't spend, so money velocity drops – all three reasons cause prices to drop).

But the problem now is that the economy can no longer grow so even Treasuries cannot retain any fundamental value when you factor in real inflation (absent deflationary forces from the upper levels crashing which would only be a temporary situation), because the supply of Treasuries is definitely not dwindling!!! They can only print them to offset deflation from higher up for so long. And when the CB goes about printing up phony dollars and Treasuries and injecting them into the upper levels of the pyramid to keep it from crashing, well you can see how the entire pyramid becomes at risk of crashing, which is where we are now.

I totally agree and was thinking about this today driving around. But I think it will have to be much more significant than a 9/11 event, because what's going to happen is that the dollar is going to crash and who knows if it will stabilize at a lower value or just enter hyperinflation, plus the US trade deficit is going to end, and that whole sector of the economy dependent on cheap consumerism will quickly end. People are not going to be happy, and I see zero chance that TPTB are going to let the truth be known about their own failed monetary policies. I can only see one way forward – a world war will be started. The issue I see is that any global war big enough to become a scapegoat has a very high likelihood of going nuclear and I think even the people in power know that in a global nuke war, no one wins. So I don't think they know exactly what to do.

When? I think we have at least a few months yet since the latest Oregon "shooting" seems to be another attempt to institute gun control on the masses (to make it easier for the military to exert totalitarian control when the dollar crashes) so it will take a few months for the ramifications of that and the new laws to be passed.

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