Investing with the Moon

Why deflation is a blessing

Posted by Danny on June 30, 2014

Average wages are stagnant in the developed countries. Which also means that consumer spending is stagnant, because in the longer term people can spend only as much as they make. So, the economy stays weak. What is the solution? Central banks are trying to create more inflation, as if that will somehow wake the developed economies out of a coma. But will it? More on that below.

Let’s first have a look at the Nasdaq (click for larger chart):


Not much has changed since our previous look at the Nasdaq. The market has climbed another 50 points, but the market is still bumping into overhead resistance from the dashed grey line. And the bearish divergence continues in the Earl indicator, while the Earl2 is now clearly turning down from a top. These indicators tend to be a bit early (which is why I called them Earl), so it doesn’t mean the market has to drop immediately, but the odds for a further rise are not good.
We will also enter a new lunar red period tomorrow, so chances are we will see weakness start in the next weeks. My current estimate is for a pullback to take the Nasdaq down to ~3900 by September. What would invalidate this picture? Well, a new upside acceleration with the Nasdaq surging above 4500 would point to the start of a blow-off peak phase, and that has probably some 10-20% chance at this point.


So, our central banks are trying to create more inflation. Whenever there are new laws or stated policy goals there is always one important question to ask: “Who will get any better of this?” Will it be you and me? Or somebody else? Whose purposes are being served?
Suppose they succeed in creating more inflation. E.g. Prices of food and computers start going up. Does that make things any better for you? Doesn’t that mean consumers will have little choice but spend more on those items, and thus have a smaller portion of their family budget left for other purchases? That would be bad news for companies in those other sectors. We always see the same reasoning when gasoline prices go up: it will leave consumers with less money for other products. It is true, but then why would it suddenly be good news if it are e.g. food and computer prices that go up?
If they succeed to create more inflation it will depress consumption. As an example we can look at Japan already. They finally managed to drive annualized inflation up to 3.4% in May. What most news reports failed to mention is that Japanese household spending simultaneously dropped by 8% y/y , much worse than expected. Why does that surprise anybody? The Japanese are already used to see their real income decline. Now they also start feeling that life is getting more expensive (thanks to a weaker Yen and higher taxes). So, their response is to try to save even more, because that stash of Yen they always kept in the bank suddenly doesn’t look sufficient anymore to meet their future retirement needs if cost of living keeps going up like that. It’s a normal reaction. So much for stimulating the economy with more inflation. Letting prices deflate would do more good than trying to prop prices up by artificial means like QE.
Then why are central bankers so much against it? Well, they are not serving the population, they are serving the bankers and the government, and those are the entities that benefit from inflation more. Deflation is simply a sign of progress. If technology advances we can make the same product cheaper, or produce a better product for the same price. Letting deflation happen means that the benefits of those productivity gains (coming from technological progress) are spread evenly among all the participants in the economy. Everyone enjoys cheaper products, leaving him with more money to spend on other products or new products. What’s not to like? Well, bankers don’t like it. They can profit more in an inflationary environment. They have figured out that by creating inflation, the ongoing productivity gains of the economy can be made to flow mostly into their pockets. The consumer meanwhile, finds it ever more difficult to maintain his standard of living, because inflation always seems to push prices up more than his wage goes up. He then needs a loan, another mortgage, or an extra creditcard, just to keep up… And over time that pumps a significant portion of his income straight into the banker’s pockets, in the form of interest payments. What’s not to like for the banker? From his perspective, letting deflation happen is like letting his business die.
That’s why we continue to hear that higher inflation is needed. It would be terrible if the cost of living went down for the average consumer, isn’t it? These middle class people wouldn’t need loans anymore. And imagine the protests in the third world if food and housing started to become cheaper for them as well, leaving them with money for the education of their kids. What a catastrophe that would be… Noble institutions like the IMF and UN would start feeling useless…

Our society and economy has become so perverted it is probably going to be beyond belief for future historians who study our period. Our governments punish creativity and productivity with high taxes, while rewarding doing nothing with social security payments. It is as if the biggest crime in this world is to make money, because we use large fines (taxes) to discourage it. And cost of living going down (deflation) is considered bad, our economists prefer cost of living going up (inflation) and successfully promote that as being more desirable, all the while millions are lining up for soup with food coupons.
What if we did just the opposite:
1) reward creativity and productivity ( = zero or negative income taxes )
2) punish doing nothing ( = tax on money hoarding )
3) embrace the deflation that comes with improving technology

There would be no jobless and no debt. There would also be no profits for banks. Just call me crazy.

Stay tuned,


14 Responses to “Why deflation is a blessing”

  1. Elias Throckmorton said

    That’s Crazy Talk! Just stop! lol. kidding. Its also a values problem. I notice when folks do get cash, they spend it on silly status stuff, bigger cars, tv etc. I live in a poor area, so I also see the long lines at the drug corners the day the ‘checks’ come out. I don’t pretend to know the answer, but to have a conversation about it is certainly a start.

    thanks for the site, love reading it.

    • Danny said

      Thanks for the thumbs up. It’s true what you say about values, but of course in other parts of the world they have problems with different sets of values. For example, in Japan or Germany folks get cash and what they do is put it in the bank, even at 1 or 0% interest rate. That too can become a problem because when the money doesn’t flow the economy doesn’t work. This makes the issues very complex because a policy that could help in one part of the world (or country) may turn out to be worse than doing nothing in another part.


  2. There has been no real deflation for the last two years. Look at the food index for this year alone. If you add up food, gas, utilities and insurance there has been no deflation for 3 years. All Kabuki for the general population.

    • Danny said

      Indeed, there has been no real deflation because policy makers have not allowed it to happen with various rounds of QE among other things. The question I see rarely asked: where would we be now if we had just let the chips fall where they fall, let the deflation clean out the economy, and see what happens…? No doubt there would have been more bankruptcies without QE and bailouts. But people with savings would have picked up the pieces that were worth picking up. And we would probably be in real recovery already. Now our economies continue to struggle with the fallout and hangover from these policies, that were mainly designed to save the banks in the first place. We would have created new banks after these old banks failed… and they would have started with a clean sheet.


  3. “Just call me crazy.”

    Crazy like a fox. But Cody Willard, who linked to this post at MarketWatch, I’ll simply call crazy.

    P.S.–The Lunatic trading strategy is all the more remarkable for the fact that the S&P 500 increased by 5000 percent during the interval you consider. Kudos to you for providing open-minded investors with a rigorously back-tested method for timing the market.

    • Danny said

      I guess it’s OK as long as there is a system to the madness ;-)

      I think the lunar strategy has kept working for so long because there are enough investors who immediately discard it as “astrology”. I think the lunar phases work because they affect some people’s sleep :
      If a significant portion of traders trade differently when they are not well-rested and perhaps more irritable because of a few nights with poor sleep, then this can be enough to explain the long term lunar effect. Maybe they panic quicker when there is “news”. Maybe the lower levels of melatonin make them less optimistic (lower melatonin is connect to depressions.)..

      Cody Willard showed that open-mindedness by linking to my piece. It takes courage to be crazy enough to link to a piece of “financial astrology” on Marketwatch. Kudos to him.


  4. Correct me if I’m wrong but the performance tab is not technically a back tested sample. My understanding is that the record was established only after the site went live… so real time observation. Minor detail since it’s probably easy enough to model as far back as you like… but I like the idea of the ‘model’ reflecting your actual experience if that’s the case.

    As provocative and even more Austrian your commentary is on deflation, I can’t agree with it in its entirety. By your example we would witness the collapse of the financial system (which we may witness anyway), and by your solution surely inflation accelerated by a multiplier gone wild.

    Wonderful insights nonetheless Danny and a great job on the site.


    • Danny said

      Hi HVA,

      That’s right. The performance page is a so-called forward test. I update it in real time at the end of every green or red period.
      As you point out, creating a model that works well in back-testing is always easy, especially with the fast computers we have nowadays. You can put a neural network to work and it will always crank out a model that does very well by shuffling with inputs and parameters until it finds a combination that *would* have done very well with the given sample data. So, it doesn’t really matter what data we feed into the neural model, could be the lunar phase, the temperatures in London, the daily sunspot number, the number of tweets that Beyonce posts,… the model will find a way to use these data to “predict” the data you want to predict, in this case stock prices. There is always a way. It becomes a case of overfitting:
      But, of course, such a model will typically stop working as soon as we start using it in real time. That doesn’t mean it will start losing money immediately, most typically it will just do what throwing a coin would do: lose some, win some…but go nowhere in the longer term.
      That’s why forward testing is very important. We find some idea/model that does very well when we test it on historic data. But maybe that was just a lucky streak. We will find out by forward testing: if the results continue in the same vein it becomes likely that the result was not a case of good luck but rather some valid principle… if not and the results start dropping off, then it becomes clear that the model was rubbish.
      There is no shortage of such overfitted stock trading models being sold on the internet, showing you great equity curves with almost no draw downs. Alas, when it looks too good to be true it usually is.
      To find something that keeps working in forward testing is much more difficult, and that’s why I keep track on the performance page. That’s the only way to be honest with readers, and with myself. And if some day the lunar phases stop working, for whatever reason, we will start seeing it on this tracking page.


  5. despe906 said

    More or less I agree, but I would be against taxing money hoarding. let’s say that in a free economy environment (something that doesn’t exist on planet earth) an inversor is sick and prefer to be out of the game for 3 years. Why punish him? Or someone doesn’t see opportunities for him, why to push him into something by force? In a economy where there is no central banking, monopoly and totalitarian state interference, there will be a natural money flow. By the way : today money hoarding is taxed by inflation and ZIRP. The governements/central banks want to revive the dead by punishing prudent savers and those who have money. It’s not savers’ fault that it doesn’t pay to work or invest, as all activities are taxed.

    • Danny said

      Hi Despe,

      The “gestalt” of the economy changes when deflation is allowed to happen and money hoarding is punished with a form of tax. Remember, all other forms of tax are replaced with just a tax on currency holdings. Nobody is being forced to keep his savings in the form of a large pile of currency. The result is that the currency circulates, as it should, and facilitates a lot more economic activity and exchange than it otherwise would (velocity of money is currently very low).
      This system was actually used in the high middle ages (1000-1200), which was a period of unprecedented progress and high prosperity: From time to time all gold coins were called in to mint new coinage with image of new king or so. And that’s when the local gvmt would keep 10 or 20% for its treasury. So, it was a form of tax on money hoarding. The result is that people used their money to improve their tools, invest in new property, rather than keep more coins than they would need in the short term. This is the era when most cathedrals in Europe were built, the people did it in their spare time with their spare cash! Even cripples could find a job, and musicians(troubadours) made a living traveling from town to town. Money circulated very fast.
      More recently there was the miracle of Worgl, an experiment in Austria that somehow solved extremely high jobless rate within a year: Even the French prime minister made a visit to see it. The secret? They used a form of scrip money that was designed to punish hoarding. People used the scrip as soon as they got any, and within a year everything was repaired in the village as well new bridges and roads built. The Austrian National Bank killed off the experiment (it worked too well I suppose):


      • despe906 said

        OK, let’s say I am convinced. I went long China on a technical signal after your suggestion. It’s doing good, If I caught the low, that would be a story, I never tried to catch the low ;)

      • Danny said

        Yes, China is quietly climbing and now coming at the point where it can break out to the upside. If Shanghai Composite gets above 2100 then it can rise another 10% very quickly as it has some catching up to do with other markets.And that would probably start pulling in more investors as Chinese market has been grinding down for so long already…
        Best of luck with the low you caught. Maybe you will start liking it ;-)

  6. mike said

    Nasdaq catipults anther 50.00+points today when will it crater? it has been 3 yrs since a 10% correction. I remember a newsletter I can’t remember the name he wrote about the Plunge Protection Team & Hindenberg Omen & if there were clusters market poised to fall. Has there been any hinedenberg omens recently I can’t read charts.

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