Bear Market Race to the Bottom - Week 91 - Negative Interest Rates & InflationPublished: July 11, 2009 by GoldSpeculator The 1929 & 2007 Bear Market Race to The Bottom Week 91 of 149 Negative Interest Rates & Inflation: CinC & CPI Models Short Term Interest Rates Have Fallen Down & Can’t get Back Up S&P 500 Dividend Problems Continue Mark J. Lundeen mlundeen2@Comcast.net 10 July 2009 Color Key to text below Boiler Plate in Blue Grey New Weekly Commentary in Black Below is my BEV chart for the Bear Race.  Remember, this chart uses weekly data, the below Step Sum’s BEV Chart uses daily data. Examining the above weekly data chart, the DJIA appears to be losing steam. Typically, Bull Markets on the rise have sharp breaks to the downside to shake out the week hands in the markets before going back up. This market is just hanging on, doing nothing drastic to drive the Bulls away. I sense danger. It has been two months now since anything exciting has been seen on the up or downside. The gap between the Great Depression Bear and our Bear is growing. I guess that’s good, but then maybe not. Fundamentally, what’s changed since last October or March? America’s foreign creditors are making angry sounds. The consumers are as heavily in debt as before, but now housing prices are even lower. Government’s debt load has exploded with a bunch of TARP and stimulus spending. Both actions by the Government will prove harmful to the economy and markets. Our governments are managed by people who couldn’t get a job in the private sector. I see California may pay the bills for the Michael Jackson’s memorial. Why is a bankrupted California even considering picking up that bill? The State of California is managed by incompetent people! It was reported that the police providing security for the event were supplied with box lunches from a restaurant 90 miles from Hollywood. What, LA doesn’t have restaurants? How much extra did that cost? I don’t know, but probably less than if the US Treasury was involved. We may see some catching up to the 1929-32 Bear this Autumn. Below is my 8-Count & DJIA BEV Chart  Volatility is really low. That should be helping the Bull, but it’s not. I expect to see the 8-Count at zero again next week. If the Bear is intent upon going away, we should see it in the chart below. Bear markets are easy to isolate as 2% days pile up in the 200 Day Moving Average. The magnitude of the 2007-09 Bear is easily seen below! It peaked at 84, 2% Days in the 200 Day Moving Average, but is coming down now.  The 2007-09 Bear is its own Bear. Other than being a very intensive Bear, it has little in common with the 1929-32 Bear. In the chart below, we see a side by side view of the 2007-09 Bear rise in 2% Days in the Volatility’s 200 Day Moving Average along with the 1929-32 Bear.  The 2007-09 Bear’s rise in 2% Days came up from nowhere and kept going until it hit 84, 2% Days in the Volatility’s 200 days in the M/A. That didn’t happen with the Great Depression’s Bear. Eighty years ago, the #1 DJIA Bear Market went up in stages before it peaked. So what is next? Does the number of 2% Days in the Volatility’s 200 Day Moving Average decline to less than 5, and the market’s volatility return to normal? Or are we going to see a decline, and pick up in 2% Days similar to the Great Depression Bear? We are all going to have to wait to see what happens. But my guess is that this Bear has much work still to do before we see another Bull Market rise up from its ashes. TARP is a tasty treat for a Bear!
The 2007-09 Bear is the second worst DJIA Bear since 1885, and all that damage was accomplished with 23 net down days from 09 Oct 2007 to 09 March 2009. INCREDIBLE!  I can’t forget watching Bernanke asking Congress for “new tools” last October, as the DJIA became a -40% Bear and the credit crisis was peaking. Congress gave Bernanke what he asked for. But Bernanke and Congress never said what the “new tools” were, or how they were to be used. If you think about it, Bernanke admitted the Fed and Treasury found the old tools used in the markets insufficient. So the DJIA’s second worst Bear since 1885 found its -53.78% bottom with only a net 23 down days. There is something wrong here. Here is the DJIA’s Step Sum from 1980 to 2009.  I don’t want to be accused of being a conspiracy theorist, but I don’t want to be gullible either! When I look at these Step Sum charts, and remember the political importance the stock market has for Washington, I’ll risk the conspiracy theorist label. It’s becoming apparent the prices I see for the DJIA, Gold, Silver, Oil, Interest Rates and anything else on CNBC are not real prices, but “policy statements” from wishful thinking Washington bureaucrats who’ve usurped control the economy. Do I think this Bear Market is over? Heck no! If we see new all-time highs in the DJIA a year from now, I’m still a Bear because I think the “regulation” of our “free markets” is a fraud. But as I’ve said before, during Bear Markets, there are good corrections that are tradable. We just saw a dandy from March to May, so the next logical thing for the DJIA to do is go down. But Doctor Bernanke has new and unspecified tools to control the markets, so I’m careful making predictions for what the next few months will bring. This will end badly, but it might be a long time before it comes to that, and then it might be next month. I think it will take a market or non-market event, something beyond the control of the “policy makers”, before they are overwhelmed and ready to call it quits. What that may be, I haven’t a clue. An act of terrorism? Our foreign creditors dumping their US assets? With Obama and the socialists in control of Washington, something bad is going to happen between now and 2012. It’s a Bear Market. Bad things happen in Bear Markets. When the “policy makers” are hit by a rogue wave, watch out below! The Step Sum is an indicator of market sentiment. When the underlying sentiment is bullish, the Step Sum will rise. When bearish, it falls. Think of the “Step Sum” as the sum total of all the up and down price “steps” in a data series over time; an Advance – Decline Line for a data series derived from the data series itself. Logically, bull markets will have more net up days, while bear markets will have more net down days. Understanding the Step Sum is no harder than that. Negative Interest Rates & Inflation: CinC & CPI Models Prices for goods and services are determined by supply and demand factors within an economy. Supply is simple to understand; supply is the goods and services created within the economy to satisfy demand. How do manufacture and service companies know there is demand for what they are supplying? People contact these companies to purchase what they are selling. It’s on the demand side of the formula where things become confusing. The mere want of goods and services do not create economic demand, unless socialist politics interfere in the economy. While everyone may want a fine Swiss watch, Switzerland is only paying attention to people with the money to pay for one. In an economy without a Central Bank controlling the money supply and setting interest rates, prices are determined by producers and consumers. In such an economy, producers also consume and consumers also produce. In other words, people go to work, satisfying the needs of others to earn a paycheck that allows them to call on others to satisfy their needs in return. Central Banking is a political institution that enables social elites to create demand (money) for products, without having to first produce anything. It’s called counterfeiting, when private citizens do it. The creation of money without production, whether its source is Central Banking or counterfeiting, is the actual basis for broad spectrum price inflation. As Central Banks control the money supply, it’s a simple matter to “print money” for purchasing government debt. This funds a government’s operations without direct taxation. But the taxpayers still bear the burden of government through future inflationary losses in their savings, wages and income, as well as the burden of the debt taken on in the public’s name. This is why inflation is a hidden tax.  Banks also benefit from Central Banking’s inflation. A bank’s ability to tap into a Central Bank’s inflationary money flows, not only frees banks from dependence upon saving deposits, but allows the banking system to convert savers, which banks formally paid interest to, into debtors who now pay interest to the banks. Frequently; until the day they die. Because Politicians, the Federal Reserve, and the Banking System have converted the US dollar from people’s assets into their liability, Americans will experience a drastic reduction in their standards of living sometime in the future. The Federal Reserve’s defenders claim the Fed is actually an inflation fighter.  Their theory is, as long as the Fed keeps interest rates above the rate of inflation, it’s possible to keep inflationary price increases suppressed. The implication is that, yes, the Fed does create money that increases demand without increasing supply, but as long as the Fed keeps interest rates higher than the rate of inflation, their “monetary policy” is price neutral or possibly even deflationary. The flip side of this argument is that if the Fed keeps interest rates below the rate of inflation, price inflation will result, as too many created dollars are chasing too few produced goods and services. My personal opinion is that the creation of the Federal Reserve, by Congress in 1913, was one of the worst acts ever perpetrated by Washington against people who get up in the morning to go to work. But I’m willing to put that aside, and examine how well the Fed has managed interest rates and inflation by its own standards. So using the Federal Reserve’s own data, let’s see how often they have kept their Discount Rate above and below the rate of inflation since 1921. In the chart below, we see CPI & CinC’s annual increase plotted with the Fed’s Discount Rate from 1921 to the present. I’m someone who believes inflation is an increase in the money supply, so I use Currency in Circulation (CinC) as my inflation index. CinC data allows us to see the Federal Reserve System increasing money over the years. M-1&2 might be better as they take into consideration the increases in money by bank credit, but CinC is good enough for my example. The Consumer Price Index (CPI index) uses price changes to measure inflation. Prices are important. But I see CinC as the inflationary action while price changes are the inflationary or deflationary reaction to CinC inflation.  If you look above at 1933, the difference between using CinC or CPI is very evident. In 1933, CPI fell 10% while CinC increased by 50%. Whether you understand the 1930s as a time of deflation, or inflation all depends upon what you’re looking at: deflating prices or inflating money supply. As I blame the Roaring 20s and Depressing 30s on the Federal Reserve’s mismanagement of credit in the United States, I focus on what the Fed is actually doing with the money supply. But if you accept that “inflation” is caused by rising prices and “deflation” is caused by falling prices, and don’t care why, then CPI is for you. But you’re ignoring the 800 pound gorilla, and his money printing press in the room! As the swings during the 1930s & 40s in these plots are so severe, I’ve made another chart starting in 1950 to better show our current era’s inflation and interest rates.  Negative interest rates (Discount Rate below the rate of Inflation) are inflationary. This means that interest rates are below the rate of inflation, and inflationary price increases are building either in asset valuations or CPI prices in the economy. Look at it this way. A consumer has $500 a month excess income and intends to purchase a new car. If inflation is 10%, but a car loan is only 5%, it makes economic sense to purchase a car today with a bank loan, (the loan created by fractional reserve banking) than saving $500 a month for 4 to 5 years and pay cash. The concept of negative interest rates does make sense. Lending money to consumers and business at a rate below inflation should increase inflationary price pressures. Give my second chart above a good examination. Note how frequently the Green Plot (The Fed’s Discount Rate) is above CPI’s Blue Plot. That indicates the Fed has maintained higher interest rates than CPI inflation. If CPI is an accurate indication of inflation, then from 1950, the Fed has maintained a fairly tight monetary policy, constraining inflationary price increases in the past 59 years. But if you take the Red CinC Plot as an inflation index, the opposite argument can be made, that the Fed has been very loose in its monetary policy since 1950. Below is a table comparing how many weeks of negative interest rates the Fed has allowed since 1950 using both CPI and CinC as an inflation measurements.
Currently the Fed’s Discount Rate is at 0.5%, while the latest data published in Barrons’ has CPI at -1.25%. CPI has interest rates at a positive 1.75% above the rate of inflation. So CPI would have us believe that the Fed has inflation under control as the Discount Rate is above CPI. However, using CinC as our inflation model tells a completely different story! Taking the Discount Rate of 0.5% to the annual increase of CinC of 10.35%, as of Barron’s 06 July Issue, we see that the Fed has its monetary policy operating with its Fed Discount Rates 9.85% below the growth in CinC. So using CinC as an inflation index, the Fed’s Discount Rate is almost a negative 10% below the inflation rate! So which inflation index, CPI or CinC is right? I suspect the academics compiling CPI are understating price inflation, so I’m leery of CPI. But if you keep your grocery receipts and utility bills in your records, you can see which measurement of inflation is correct in the next year. If CinC is correct, and if the current trends continue, we will see our income lose about 10% of its purchasing power in the next 12 to 18 months. All the data I use is published weekly in Barron’s. You may want to follow up on these inflationary developments on your own. Short Term Interest Rates Have Fallen Down & Can’t get Back Up I follow international short term interest rates by taking a simple average of the Foreign Prime Rates listed each week in Barron’s Money Rate Page.I also toss the US Prime Rate into the mix. Since May, my average of Foreign Prime Rates has hit a 22 year low of 1.50%.  Below is the BEV Chart for the above data.  Barron’s started publishing Foreign Prime Rates in Dec 1987, so I don’t have much of a historical perspective on international rates. Below is a chart of the US Prime Rate going back to 1921. I’ve included the Foreign Prime Rate Data (Red Plot).  The world has the same problem as the United States. Their banking systems made too many loans to bad credit risks during times of rising asset valuations. As financial and real estate booms became busts, job losses rose and many people can’t pay back their loans. If they raise interest rates, they will cause even larger credit defaults in their economies. So just like the US, they are keeping interest rates low, while attempting to stimulate their economies with high money growth. Call it the economics of seeking pleasure and avoiding pain. Like the United States, their credit addiction has caused them to seek further “injections of liquidity” to avoid the pains of credit withdrawal. It will end badly. I’m expecting worldwide tsunami waves of inflation in the next few years. That will be good for commodities in general and excellent for gold and silver. S&P 500 Dividend Problems Continue Since the 30 March 2009 issue of Barron’s, the S&P 500 has been paying $3 in dividends for every $1 dollar in earnings.  I’m curious to see how long this abnormal situation last and what the government is going to do about it! Dow Jones -40% Declines From 1885 to 2008 is the article that inspired this race of 1929 & 2007 Bear Markets. You may want to read that article to understand my “BEV Chart.” Dow Jones Industrials Average Market Volatility is the source for my volatility studies. The Lundeen Bear Box and Step Sum is the source for my Lundeen Bear Box and Step Sum Chart Note For the Record: Mark Lundeen does not want a devastating bear market in the next two years. However, in full view of Congressional Market Oversight Committees and under the supervision of Government Regulatory Agencies, things were done that I believe will make a historic bear market inevitable. If you have a problem with this bear market, contact Washington, not Mark Lundeen.
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