This is Part III of our multi-part series of questions and answers with Robert Prechter, the world's foremost authority on Elliott wave analysis. (Excerpted from an hour-long June 19, 2010, interview with Jim Puplava's Financial Sense Newshour.)
We will be posting a new part every business day, so come back to elliottwave.com tomorrow for more. (Here are Part I and Part II.)
...Jim Puplava: You know, unlike the '30s when there were other currencies, even in the ‘20s during Germany's hyperinflation, there were other currencies that were backed by gold. But say we live in a fiat world where all currencies are fiat, what's to stop the process of competitive devaluations where countries keep devaluing against each other during that period of time; the one benchmark that rises is, let’s say, the value of gold?
Robert Prechter: Well, they can't devalue, because their currencies are not pegged to anything. The only way that a country can effect something like a devaluation is to print money. So they can't simply devalue and say, “Well, now our franc is worth so much gold, or now our dollar is worth so much gold.” Everybody already knows what gold is trading for in dollar terms, so there's no decree that could devalue the currency. It has to be valued to something before you can devalue it. And I don’t see what they would accomplish by establishing a new, false value.
JP: All right, let’s take the situation like the Fed last March, where they said, “We're going to monetize $1.7 trillion.” People thought the ECB would be steadfast, and they came up with their trillion-dollar equivalent rescue package. What's to stop them from saying, “All right, we're going to this time to try and monetize three or four million dollars?”
RP: Nothing! theoretically. But I think eventually social mood is going to stop them in their tracks. People are already upset at the government and the Fed, and they're going to start throwing congressmen out who keep acting this way. At the moment there are no restrictions on the Fed from monetizing. But even its own governors are arguing about the amount of monetization that they've already undertaken. I think there's internal resistance to the idea of doing far more. Even if they did another five trillion, there's a quadrillion dollars worth of bad debt over the entire world, and they can't monetize it all. They're not going to the local courthouse and buying these bad mortgages, are they? They bought some through Fannie and Freddie that were more or less guaranteed by the Treasury. I just can't see the Fed saying, “Yes, we're going to buy everybody's rotten IOUs.” If they said that, people would start writing IOUs, wouldn’t they? I would.
There are going to be limits. There’s more bad debt out there than the Fed could possibly handle. And not only that, I want to make one more point: Even if the Fed monetizes old bonds that people thought were good, that doesn't change the net supply of money plus credit. It simply changes credit into money, so I don't think that that necessarily creates inflation. Under a robust economy it does, because those dollars can be re-lent. But if nobody wants to borrow, if nobody can borrow, there's still no net inflation. That's why you can have a year like 2008 and early 2009 despite trillion-dollar bailout packages by the government and the Fed.
JP: I want to come back to government spending, but first I want to move onto the stock market. In your last two Elliott Wave Theorist issues, you laid out a scenario that would put the Dow and S&P, which in your opinion may have peaked on April 26, as the top from here. You feel that this top is the biggest top formation of all time, a multi-century top and we could head straight down in a six-year collapse that would end in 2016 that could see a substantial portion of the S&P and the Dow wiped out in a similar way that we saw between 1929 and 1933. Let's talk about that and the reasoning behind it.
RP: Yes, you're exactly right. I did a lot of work on technical forms, cycle forms and Elliott wave forms in April and May and put them in a double issue. Let’s talk about the cycles first.
The 7¼-year cycle has been quite regular since the first bottom in 1980. The next bottom was at the crash in October 1987. The next one was November 1994, which is when the economy went through four years with lots of layoffs; it was a recessionary period throughout until that cycle bottomed. The next one was between September 2001, which was the 9/11 attack, and the October 2002 bottom. And the latest one was at the low in March 2009. All those periods are 7¼ years apart, so we are in the uptrend portion of the 7¼-year cycle.
However, notice for example that in 1987, the market went up until August of that year and then bottomed in October, just a couple of months later. So the decline occurred very, very late in the cycle. This time it occurred a little bit earlier in the cycle, topping in '07 and bottoming in '09. In the current cycle, prices should peak the earliest of all of them. It's what we in the cycle prediction business call “left-hand translation.” The market’s already gone up for about a year, and I think that's just about enough. I think we're going to spend most of the cycle going down. ... It's going to be a very long decline. It's going to be interrupted by many, many rallies, just as the decline from 1930 to 1932 was. And every time it bottoms and rallies, people are going to say “OK, that's enough; it's over.” But it won't be over. It's just going to be a long, long process. I think you and I will probably be talking a few times during this period.
One of the interesting aspects of this process is that optimism should actually remain dominant through the first three years of the cycle. That will carry us into 2012. Even though prices will be edging lower, most people are going to think it's a buy, and you shouldn't get out of your stocks, and recovery is just around the corner, probably for the next three years. And then, for the final half of the cycle, the final three years, that's when you'll get the capitulation phase when everyone finally gives up.
[Part IV is now posted. Topic: government interventions]