Expect lower equity prices, higher gold prices, a far deeper recession and deflation

The market ascribes specific reasons as the cause of the latest market declines in equities as well as the rise in gold prices above $1,000 per ounce. But these and other longer term trends are likely to persist for basic reasons, long after the latest presumed justifications, such as the threat of bank nationalization, are forgotten. The real reason is that the global economy and financial system are in close to free fall despite the desperate and seemingly aggressive efforts of governments around the globe to deal with mostly the symptoms rather than the causes of the problem.

The economic decline is so pervasive that it is bound to inevitably lead to outright deflation for consumer prices, as it has already produced pronounced deflation in producer prices, commodity prices and home prices. Though the consumer price index (CPI)was up in February, the rise is an aberration. Even with this monthly CPI rise, February consumer prices were unchanged (0.0%) from February last year. This compares with a 0.1% year-over-year rise in the CPI in January and down sharply from a 4.3% year-over-year rise in February a year ago. Thus, consumer prices are already on the threshold of outright deflation. In coming months the desperate efforts of retailers to survive will further cut the prices of a broad range of consumer products. That should lead to year-over-year declines in consumer prices, a pattern that should persist for a considerable length of time.

That deflation prospect has broad adverse implications for the equity market. It strongly suggests that as prices are cut to stave off failure and bankruptcy, corprate profits will decline still further. That and the continued erosion of dividends will lead to significantly lower lows in equity prices.

The coming deflation reality in all price indices will also help keep Treasury bond yields low despite misplaced concerns that the large step up in Federal budget deficits and Treasury borrowing will lead to an early spike in inflation. While inflation will eventually reappear, that is unlikely to occur for an extended number of years, perhaps five years or more. There can be no reflation until the global recovery has been underway for a considerable length of time. It will take years before there is a sustained global recovery. The Administration's estimate that the recovery could begin in the third quarter this year should be dismissed as merely boosterism. An economic recovery in 2010 is possible but by no means assured. Even then, the recovery is more likely to be sluggish than robust. Even in a recovery from a typical recession, and this is far from a typical recession, there is an extended period, often years, before the excesses of unused productive capacity of manufacturing, mines and labor are used up enough to reestablish pricing power. This time that period will be far longer than typical. That points to years of deflation, followed by more years of very low inflation. That virtually assures a long period of low Treasury bond yields, because inflation expectations are a prime determinant of Treasury bond yields.

At this point many of those reading this will point out that the rise in the Federal budget deficit and consequent increase in Treasury borrowing demands will vastly increase the supply of Treasury debts marketed far beyond the increase in a typical recession. That argument has led to widespread expectations that this Treasury debt expansion would require a substantial increase in Treasury yields. However, the decline in private sector borrowing and the increase in Fed and other purchases of Treasuries will keep Treasury yields low or move them still lower. The rise in gold prices reflects a flight from currency,economic and equity market uncertainties and fears , which are likely to persist, even if inflation is not a realistic near term prospect.

Expect next weeks revision of fourth quarter real GDP decline to exceed 5.0%, a far deeper decline than the 3.8% drop originally reported. But, the first quarter real GDP decline, to be reported at the end of April will be as large or larger, probably between 5.0% and 6.0%. The next employment report for February, released March 6, is likely to reveal a 600,000 or larger decline in nonfarm payrolls and a further rise in the unemployment rate judging by the high 627,000 weekly rise in initial claims for unemployment benefits in recent weeks.

The US Treasury attempted to reassure the equity market on Friday that it intends to preserve private ownership of the US banking system. The Treasury also leaked indications that details of its plan to solve the banking system's profound problems would be released over coming weeks. These efforts were an attempt to quash market fears that at least a temporary nationalization of major banks may be required. Such fears were ignited by comments by Senator Dodd and former Fed Chairman Greenspan indicating that nationalization of some banks may be required. That in turn led to market fears that bank equity values would be completely wiped out in the nationalization process even if temporary. If the US Tresury is considering nationalization, it could achieve many of its objectives without nationalization if it would quarantee deposits regardless of the size of the deposit.


The next economic and finance report will be posted in two weeks, dated March 6, following release of the projected horrendous February employment report.

Philip Braverman, President
Braverman Economic and Financial Consulting
One Hewitt Square #249
East Northport, New York 11731

Email Address: philipbraverman@ Gmail.com