When almost everyone believes that the Fed's interest-rate policies will eventually create awe-inspiring inflation, it's difficult for other voices to get heard. Bob Prechter argues that the real effect of the Fed's "extra-credit" policies will be deflation -- and that's what will hamper an economic recovery. He went into the lion's den recently to talk with the managing editor of the Daily Crux, a financial website that mainly focuses on the inflation side of the argument. In this excerpt from the interview, which runs in full in the June 2010 Elliott Wave Theorist, Prechter talks not only about why the Fed's action won't create inflation but also about what might come after we have walked through the valley of deflation.
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Excerpted from The Elliott Wave Theorist by Robert Prechter, published June 18, 2010
The Daily Crux: OK, so you don’t think the Fed will go that far. But what if the government got involved and tried to inflate its way out by issuing massive amounts of Treasury bonds to the Fed? Wouldn’t that create inflation?
Robert Prechter: If the government tried to do that, bond holders would get spooked, and interest rates would go up and stay ahead of the printing. At the same time, other credit prices—municipal, corporate and consumer—would implode. When the supply of credit is far bigger than the supply of money—and it is by a huge margin—the value of old credit can contract faster than new bonds can be printed. The net result would still be deflation.
But this is not the most likely scenario. Have you noticed that even the Fed chairman has been telling Congress it needs to stop spending and borrowing? The Fed doesn’t want this to happen any more than other creditors do.
If the Treasury’s interest rates do soar, it will not likely be due to inflation fears but to fear of government default. If the government is forced to pay higher and higher rates, it will become a black hole for money. Spiraling Treasury rates would suck money from other sources, causing banks, municipalities and companies to fail, ruining all of their debts, which would be deflationary.
Crux: Will hyperinflation ever happen in the U.S.?
Prechter: It certainly might. But it could only happen after the bond market implodes, not before. Then, if politicians get hold of a press, they might decide to print. But this is political conjecture, not monetary analysis. First we have to cross the deflationary valley, and this could take longer than almost anyone thinks.
Crux: So what you’re saying is that inflation is possible, but that it can’t happen until deflation has run its course. What would you be looking for to indicate that deflation was over and that inflation was beginning to become a danger?
Prechter: A banking crisis, in which thousands of banks shut their doors. Thirty-three percent unemployment. A ruined private and municipal bond market. And a panic in government bonds. If all those things happened, then you would have to be on the lookout for legislation allowing the government to take over the printing of money or to force the Fed to monetize new federal debt at a rapid rate. I think we will have to see all these things before hyperinflation will become possible. If all of this happens, trade all your greenbacks immediately for gold and raw land.
Crux: Are there any scenarios that would change your mind, that would make you think you may be wrong and that inflation is becoming a threat?
Prechter: If the S&P index, real estate and the CRB commodity index all take out their price highs of 2006-2008, it would probably be enough to indicate runaway inflation. We keep a very close eye on all the key markets and will try to be ahead of any such development.
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