The Good Oil on Deflation: COVID–19 the Match that Lit the Debt Tinder

Dear Reader,

Oil price plunges to record lows into the negative. Virgin Australia in voluntary administration…16,000 jobs hang in the balance. NAB warns profits to fall…sharply.

But don’t worry, all this bad news is (apparently) good news. There’s going to be a V-shaped recovery. Sharp down and (a not so) sharp up.

Everything will be pretty much back to normal this time next year, at least that’s what the market wants you to believe.

However, recent action on Wall Street suggests that people (in the know) aren’t really buying the market’s BS.

These ‘recoveries’ are called ‘sucker’ rallies for good reason. If you buy the market’s story, then more fool you.

Getting your head around changing trends can take time. Adjusting to (yet) another ‘new’ normal doesn’t happen overnight. And by the time the mob wakes up, it’s too late.

We become so conditioned/accustomed to something operating in a certain way, that its existence in our lives is taken for granted.

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Each and every one of us has been conditioned to believe there’s one absolute constant in our lives: inflation.

Over the past 70 years (with the exception of a few flirtations on or below the zero line), inflation has been ever present.

Sometimes higher. Sometimes lower.

The Rum Rebellion

Source: Trading Economics

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Decade after decade of inflation has developed ingrained expectations.

Higher wages. Higher prices. Higher asset values. We come to accept this as part of everyday life.

Inflation is a central bank creation

Very few people realise that inflation is actually NOT normal. Inflation is a central bank creation.

Prior to the US Federal Reserve Bank being legislated into existence in 1913, the US experienced virtually NO inflation.

The Rum Rebellion

Source: Business Insider

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In the pre-1913 era, market forces sorted things out. Periods of high inflation were offset by deflation. The end result — over a 138-year period — was a zero-sum game for inflation.

A dollar issued in 1775, could (more or less) still buy the same basket of goodies in 1913. Then came the Fed with its meddling. Slowly at first, but it gathered pace as the decades progressed.

Over the past century, the buying power of that 1913 dollar has been eroded to a few cents.

An inflationary world is the one we’ve all grown up with. But what if the future is not going to be the past? What if deflation — not inflation is in our future? What if the central banks idiotic pursuit of growth at all costs has pushed us well beyond the edge of the economic envelope? What if markets are primed to correct a century of imbalances?

Impossible? If recent times (should) have taught us anything, it’s that the impossible is entirely possible.

Trends can and do change. The dreaded ‘D’ word is getting a little more airtime these days.

Why Deflation Is Poison for Virus-Plagued Economies

Bloomberg, 20 April 2020

How Deflation Could Doom the Economy to a New Great Depression

CCN, 10 April 2020

And, even in the land of the perpetually rising deficits and debts…

Oil Plight Could Drive Japan’s Inflation Below Zero in April

Bloomberg, 15 April 2020

Deflation is kryptonite to the growth at all costs super economy.

Inflation pushes wages up, which in turn increases borrowing capacity. Inflation diminishes the value of debt. Inflation provides higher tax revenues (increased GST, income tax, CGT). More taxes equate to even more political handouts.

Deflation does the complete opposite. Here’s a simple graphic from YouTube:

The Rum Rebellion

Source: YouTube

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Consumers stop buying things in anticipation the prices will be lower tomorrow. The prices fall — as anticipated — so consumers hold off some more. Jobs are lost. The vicious circle keeps spinning.

COVID-19 will cop the blame for taking us to this tipping point, but the root cause of what really ails our economy is too much debt.

Australia’s inflation rate trending down over a decade

Artificially inflating the economy and asset prices with debt put us in a vulnerable position. COVID-19 simply exposed the flaws, complacency and hubris in the system.

In spite of our nation’s love affair with debt, Australia’s inflation rate has been trending down for more than a decade.

Competitive global labour markets. Excess capacity in global production. Increased use of AI and robotics. Mortgage stress. All these factors have combined to suppress wages and inflation.

When the air escapes out of our debt bubble, it’s not going to take much to tip us over. We are teetering ever so close to the deflationary edge.

All those highly leveraged factories in Asia will be pumping out ‘product’ (supply) to a world with less demand. Sustained downward pressure on prices is coming.

This change in trend and the looming threat of deflation is something I’ve been alerting readers to for some time.

The Daily Reckoning, 6 August 2016:

There’s a horse named “inflation”.

This horse is flat on its stomach with legs spread eagle.

Every three days for the past nine years one of the world’s central bankers dresses up as a jockey. They mount the horse and flog it with the whip marked “lower interest rates”.

On Tuesday, our resident jockey, Glenn Stevens, sat astride the deflated mount and hit it with a 0.25% cut.

The inflation horse is supposed to respond to these whippings by suddenly springing to life and galloping towards the furlong marked 2­–3% inflation.

No one seems to have told these jockeys they’re flogging a dead horse.

Which is why I wrote a few years ago [in 2012] — when our cash rates was above 4% — that we would eventually see our rates fall below 2%.

In hindsight that prediction looks positively conservative. However, at the time it was at odds with the mainstream economists who were talking about rates eventually rising.

The Gowdie Letter, June 2018:

In providing the extraordinarily low interest rate and easy money conditions needed to create the “everything bubble”, the central bankers have set us up for a massive deflationary fail.

When the everything bubble bursts, it means everything — shares, property, cryptos, artworks and debts — will deflate in price.

Stimulus gives way to sedatives.

Investors will be walking around in a stupor…wondering what the hell has happened and questioning what sort of future lies ahead for them.

With tens of trillions of dollars wiped off global asset values and debt levels, people are going to be a lot poorer.

People with a mindset of being poor do not spend OR borrow…except to keep food on the table and a roof over their heads.

We haven’t seen potential social and economic consequences on this scale since The Great Depression.

The title of the 28 September 2018 issue of The Gowdie Letter was On Balance a Depression Is Coming’.

There’s a natural balance in life. The balance is not always delivered on an evenly weighted scale. Droughts can last for years before flooding rain saturates the earth. Long-lasting despot regimes are eventually overthrown by a revolution. Bull markets can endure for years before bear markets correct the imbalances. For every yin there’s an inevitable yang.

Unless the natural equilibrium of life has been permanently altered, we know a bear market is coming.

the coming depression is most likely going to be deflationary. Cash will be king.

However, in saying that, there’s going to be a time when the deflationary pressures exhaust themselves and asset prices cannot be discounted any further. It’s during this phase that cash needs to be deployed to income-producing assets.

Assets that will, in due course, benefit from the “green shoots” of the inevitable recovery phase. The time when the “rains of healthy debt” starts to reinvigorate a barren economic landscape.

The serious imbalances in the system need to be corrected by an equal and opposite force.

Being bunkered down in cash is the safest place to be while the financial system undergoes this rebalancing process.

When those articles were written, the use of the ‘D’ words (depression and deflation) was considered alarmist and hyperbolic.

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These days, both words are being used widely in the media.

ABC News, 21 April 2020:

The Rum Rebellion

Source: ABC News

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And the IMF, 14 April 2020:

The Rum Rebellion

Source: IMF

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People say to me ‘this is only happening because of COVID-19, otherwise all would be OK.’ Wrong.

COVID-19 was the match (more like a flame thrower) that lit the debt tinder. The fact is, this debt pile was always going to combust at some point.

Recognising that fact and then identifying what the effects would be when this happened, is what long-term wealth creation is all about.

Cricket Australia’s ill-fated foray into the share market (with its cash reserves) is a glaring example of how society believed the permanency of the trend.

Trends change. And the deflationary change that’s coming is going to catch the vast majority by surprise.

Cash is king…for now.

However, in due course — when central banks have thrown way too much at the deflation problem — you’ll want to be an eager buyer of deeply discounted assets.

Stay tuned for tomorrow, when I share with you a chart that’ll show just how severe this crisis is likely to get.


Vern Gowdie,
Editor, The Rum Rebellion

Vern has been involved in financial planning since 1986.

In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognised in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

In 2005, Vern commenced his writing career with the ‘Big Picture’ column for regional newspapers and was a commentator on financial matters for Prime Radio talkback.

In 2008, he sold his financial planning firm due to concerns about an impending economic downturn and the impact this would have on the investment industry.

In 2013, he joined Fat Tail Investment Research as editor of Gowdie Family Wealth. In 2015, his book The End of Australia sold over 20,000 copies and launched his second premium newsletter, The Gowdie Letter.

Vern has since published two other books, A Parents Gift of Knowledge, all about the passing of investing intelligence from father to daughter, and How Much Bull can Investors Bear, an expose on the investment industry’s smoke and mirrors.

His contrarian views often place him at odds with the financial planning profession today, but Vern’s sole motivation is to help investors like you to protect their own and their family’s wealth.

Vern is Founder and Chairman of The Gowdie Advisory and The Gowdie Letter advisory service.

The Rum Rebellion