This is Part IX 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.)
...Jim Puplava: What would cause you to change your position on deflation? What would you like to see before you would change that position?
Robert Prechter: If the major benchmarks that were pushed up by credit make new highs, then I'll say somehow these brilliant directors of our financial life and economic life have won the inflation game. That would mean if real estate went to a new high above its 2006 peak, the stock market averages went above their 2007 highs, and the commodity indexes went above their 2008 highs, I would probably have to conclude that they must be printing money faster than credit is imploding. I have been arguing from the beginning that outstanding credit is already there and it can implode faster than anybody can monetize. We'll just have to see.
JP: If I were to summarize your views: The greatest part of the economic and market downturn lies ahead of us. ...
RP: You've nailed it.
JP: Once this bottom is reached, is that when you see hyperinflation kicking in?
RP: Well, that's when it would be politically possible. Maybe I should even say financially possible. I don't think it's possible now, because we have so much outstanding debt. If the debt market collapses and bonds are no longer any good, then at that point Congress could make a political decision to get its hands on a printing press and start printing notes. Right now, it doesn't have that ability, and the Fed is somewhat of an independent bank. I don't think it really wants to own the worst debt on the face of the earth to back its notes. It generally tries to buy things that it believes will hold value. That behavior hasn't changed. But it might later.
JP: Under your scenario, how would you be positioning your portfolio? You've talked about the most secure cash type of instruments such as Treasury bills. Anything else you would own?
RP: That’s the most important question, so I'm glad you're bringing it up near the end of our discussion. Now, you know that we try to call markets all the time, so we have services for people who want to trade, who want to get in the dollar, get out of the dollar, get into the stock market, get out of the stock market, or maybe sell short for certain declines. But typical investors in my view should not be in any financial market. They should be in cash and safe cash equivalents.
The people who have been holding cash occasionally look around and say, “Look at the big bull market I'm missing; I'm missing this whole move in oil,” and so on. But the people who bought oil futures believing that oil was going to go up forever got killed. They got slaughtered. The people that bought real estate: same thing. There are stories of people in Las Vegas or Florida that had 24 homes, which they had pyramided one on top of the other; all was credit, all was collateral for more credit from banks. All it took was a 20% downturn and they were wiped out. They have no money left.
Even though there will be bounces in some investments, whether it be commodities, or oil, or gold, or stocks, or whatever, by the time this whole process is over it'll be the people like Bernard Baruch, who went to cash somewhere in 1928 or 1929 and stayed out of the way, allowing their cash to be worth more and more, who come out winners.
For example, the dollar is now worth twice as much “house” as it was in 2008. I think more and more of that is going to happen. The people that are holding onto cash are eventually going to find bargains in consumer prices as well. Consumer prices are the last prices to turn, so they really haven’t had much of a turn yet. Their rate of change is still near zero, but I think eventually deflation is going to affect consumer prices. We've recently seen Wal-Mart and some other discount stores cutting prices. How could that possibly happen in a hyperinflationary environment? I think the pressures are already there.
In hyperinflation, what's the classic scene in your mind? It's people with wheelbarrows full of marks and Zimbabwe dollars, or whatever they call them, trying to get rid of them in whatever way they can. Today, it's exactly the opposite. People are out there scrounging for dollars. They can't get them from banks; banks are stingy and won't lend. The stores want dollars from the customers, but the customers don't have the dollars to go in and buy the stuff, and that's why you're seeing bargains appear. People are trying to find jobs, but it's very difficult to get an employer to part with a salary because he's trying to cut corners. Dollars are hard to come by now despite all of the inflation, despite all of the stimulus, and despite all of the stupid government programs, which are actually making things worse.
To me, the reality here, even though it's not really severe yet, is the opposite of a hyperinflationary environment. People are trying to get hold of money; they're not trying to get rid of it.
[Part X is now online: Prechter explains why, "whether you’re a deflationist or an inflationist, you need to get your escape hatches built now, and you need to have your plans in place because its going to be a tough ride."]