Wednesday, March 11, 2009

EW perspective on financial crisis

Each week Elliott Wave International sends out recommended "content" to affiliates like AllAllan. This week's article was especially worthwhile.


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6 Questions You Should Be Asking About the Financial Crisis
(And 6 Must-Read Answers)
March 11, 2009

Elliott Wave International, the world’s largest market forecasting firm, receives thousands of questions every year from web site visitors and subscribers on their free Message Board.

Here the company shares 6 of the recent critical questions on the financial crisis and 6 answers provided by their professional analysts.

For more free questions and answers or to submit your own question, visit Elliott Wave International’s Message Board.

Q: Can increased government spending help stop the crisis?

What do you think about the new mortgage bailout plan – or bailouts and proposals for additional government spending in general? The opinions on whether or not this will ultimately work seem so divided...

Answer:

In Ch. 13 of his Conquer the Crash, “Can the Fed Stop Deflation?”, Bob Prechter writes; quote: "Can the government spend our way out of deflation and depression? Governments sometimes employ aspects of' 'fiscal policy,' i.e., altering spending or taxing policies, to 'pump up' demand for goods and services. Raising taxes for any reason would be harmful. Increasing government spending (with or without raising taxes) simply transfers wealth from savers to spenders, substituting a short-run stimulus for long-run financial deterioration. Japan has used this approach for twelve years, and it hasn’t worked. Slashing taxes absent government spending cuts would be useless because the government would have to borrow the difference. Cutting government spending is a good thing, but politics will prevent its happening prior to a crisis. ... Prior excesses have resulted in a lack of solutions to the deflation problem. Like the discomfort of drug addiction withdrawal, the discomfort of credit addiction withdrawal cannot be avoided. The time to have thought about avoiding a system-wide deflation was years ago. Now it’s too late. It does not matter how it happens; in the right psychological environment, deflation will win, at least initially."

Q: In deflation, what's best: to have no debts or preserve capital?

During a deflationary period, if you had to choose one or the other – debt reduction or preservation of capital – which one is MOST important?

Answer:

In Ch. 29 of Conquer the Crash, "Calling in Loans and Paying off Debts," Elliott Wave International’s founder and president Bob Prechter writes; quote: "Being debt-free means that you are freer, period. You don’t have to sweat credit card payments. You don’t have to sweat home or auto repossession or loss of your business. You don’t have to work 6 percent more, or 10 percent more, or 18 percent more just to stay even. ...the best mortgage is none at all. If you own your home outright and lose your job, you will still have a residence." Of course, one could pay off some debts AND keep some capital – it all depends on an individual's risk appetite and tolerance.

Q: Which news and events can move the market and which can't?

I've noticed that a lot of times, the stock market does the opposite of what the news suggests it should do – or does nothing at all. Can you make a distinction, if there is one, between news that does not move the market and the news that does? I'm talking specifically about the news and anticipation of another bailout plan plus stimulus package that is supposedly rallying U.S. stocks right now.

Answer:

The subject of the news is almost irrelevant. What IS relevant is the state of investors' collective mood at the time of the news release. If they feel bullish (or bearish), they will interpret just about any news story as bullish (or bearish) too. (Or "dismiss the news," as financial commentators often put it.) If you need a good example, just compare the February 6 horrific U.S. jobs report with that day's rally in the DJIA. Or, contrast the February 10 passage of the "$838 Billion Economic Stimulus Package" with a 300+ drop on the Dow. The important thing to keep in mind is that while the news can cause short-term price spikes, it has no effect on the longer-term trend; only social mood does.

Q: If this deflation deepens, will the US dollar crash?

Bob Prechter’s Conquer the Crash and your monthly publications like Bob’s Elliott Wave Theorist, you've been saying that in deflation, "cash is king" as the value of the dollar rises. But won't the U.S. government's spending spree cause the dollar to crash instead against the euro and other currencies?

Answer:

It's very important to make a distinction between the dollar's domestic and international values. In a deflation, the value of any currency – the U.S. dollar, in this case – rises domestically: As asset prices fall, each unit of currency buys more domestically-available goods and services. "Cash is the only asset that assuredly rises in value during deflation." – Bob Prechter, Conquer the Crash, Ch. 18. However, the USD's international value (as represented by the U.S. Dollar Index) in a deflation can rise OR fall relative to other currencies. If, for instance, the euro is deflating faster than the dollar, then the dollar's value relative to the euro will rise, and vice versa.

Q: Won't government bailouts turn deflation into inflation?

Trillions of dollars in bailouts "injected" into the economy – won't they reverse deflation and turn it into inflation instead?

Answer:

Here is a quote from Bob Prechter’s October 2008 Elliott Wave Theorist: "Believers in perpetual inflation think that the government can keep assuming others’ bad debts infinitely. But it can’t. The only reason that Congress has gotten away with issuing this latest blizzard of new IOUs is that society is still near the top of a Grand Supercycle, so optimism and confidence still have the upper hand. But as pessimism and skepticism continue to wax and the economy contracts, the bond market will figure out that the Treasury will be unable to fund all these obligations with tax collections. Then Treasury bond prices will begin falling as if they were sub-prime mortgages. A collapsing bond market is deflation; it is a contraction of the outstanding credit supply. Recent bailout schemes will not reverse the deflationary freight train. They will serve only to confuse the marketplace and hinder the efficient retirement of bad debts, thus exacerbating the crisis and aggravating investors’ uncertainties and thereby falling right in line with the declining trend of social mood."

Q: When will recession end – and DEPRESSION begin?

When do you think the economic DEPRESSION will officially begin?

Answer:

It took mainstream economists over a year to recognize the "official" start of the recession! Because a depression is a much bigger and rarer event, the delay with its "official" recognition will likely be even greater. Not to mention the fact that, interestingly, there is no "official" definition of a depression; even if there were one, ours here at Elliott Wave International would probably differ. Rest assured, though: We intend to update subscribers on any "progress" in that direction.

To read 30+ additional questions and answers on the financial crisis, investing, capital safety and more, visit Elliott Wave International’s free Message Board.

Elliott Wave International (EWI) is the world’s largest market forecasting firm. EWI’s 20-plus analysts provide around-the-clock forecasts of every major market in the world via the internet and proprietary web systems like Reuters and Bloomberg. EWI’s educational services include conferences, workshops, webinars, video tapes, special reports, books and one of the internet’s richest free content programs, Club EWI.

3 comments:

Anonymous said...

Should someone send this to the president and Congress and let them know...

"Raising taxes for any reason would be harmful. Increasing government spending...simply transfers wealth from savers to spenders, substituting a short-run stimulus for long-run financial deterioration...Slashing taxes absent government spending cuts would be useless because the government would have to borrow the difference. "???

Thanks.

Anonymous said...

From Wikipedia:


"In economics, inflation is a rise in the general level of prices of goods and services in an economy over a period of time. The term "inflation" once referred to increases in the money supply (monetary inflation); however, economic debates about the relationship between money supply and price levels have led to its primary use today in describing price inflation."


So using the old standards of inflation Prechter's statement is probably correct.

And he's correct when he says that currencies can fluctuate against each other in times of deflation and inflation, sometimes almost counter intuitively.

But a key issue is that the US is now a net consumer. Without a counterbalancing mechanism, using any standard of currency you want, prices will rise for a good number of imported items in the US relative to what they were in terms of dollars.

This is inflation as most of us will feel it.

So you have a contracting money supply and rising prices. Not a good situation.

I don't think trading will be affected that much (other than there's probably a lot less of a shot for large upside trades), but long term investments will be. Which is not good. So people will probably sit on their cash as their cash starts to decline in value.

I really don't know what will happen. Prechter could be 100% correct. I feel that it's more likely that governments will flail, print (actually print) more money, and you'll have a very steep inflation for a number of years and then the existing debts are wiped out and somehow the cycle starts again.



--VJ--

Dave said...

--VJ--

Very good points indeed. As for the long term investor, they say that buy and hold is dead. I think that the buying and holding of individual stocks may certainly justify a rethink, or at least better exit plans than most have. I do believe that if you do your homework and find an actively managed mutual fund with a good (and most importantly adaptive) manager, that long term investing can pay-off. Of course a combination of investing and trading can be even better with the right tools and constitution.