The Daily Reckoning Presents... April 7, 2015 Archives | Unsubscribe Deflation's Still the 800-Pound Gorilla Jim Rickards explains why deflation's still the 800-pound gorilla in the room... Will interest rates be raised? Maybe… but we're still betting it's not likely... Then, Chris Mayer reports on Japan's deflation from Tokyo... This will blow your mind [LEAKED VIDEO] If you are looking for a way to collect real income from your investments... Then you need to check out this "leaked" video. By the way, some people are making over $10,000 per month using this... but... the weird part is it's a safe and conservative strategy. It's so safe, in fact, even the federal government says you can use it in your IRA! ==> This will blow your mind [LEAKED VIDEO] Baltimore, Maryland April 7, 2015 Dear Reader, Deflation is still the 800-pound gorilla in the room. The deflation coming from lower oil prices, reduced drilling activity, oil patch layoffs and collateral consequences has barely begun to show up in reported data. Fed models exclude energy and food prices from so-called "core inflation" that the Fed watches most closely. But this exclusion assumes energy price volatility is temporary and mean reverting. As discussed yesterday, this oil price decline looks more permanent, probably lasting several years, because it is being dictated by global fundamentals that show no signs of reversing and by Saudi Arabia, which is the only producer in the world with the right combination of low costs and high potential output to dictate world prices. Deflation has other sources as well, including massive debt, deleveraging, technology and demographics. The deflation story has created a conundrum for the Fed. They say publicly that they have goals of lower unemployment and higher inflation. This is based on an old model called the Phillips curve. In fact, the Fed is concerned almost exclusively about hitting its inflation target. They assume that if they hit the inflation target, the employment situation will be along for the ride and heal itself. Inflation is the Fed's holy grail, because without inflation to reduce the real value of the national debt, the U.S. is headed for bankruptcy. But what if inflation and employment do not move in sync? But what if inflation and employment do not move in sync? What if job creation remains strong, but deflation persists because of energy prices, oversupply, demographics and other factors? The tighter labor markets may induce the Fed to raise rates on inflation fears. Yet the higher rates may make the dollar stronger and cause more deflation -- the exact opposite of what the Fed wants. The jury is still out on a Fed rate increase this year. I don't expect a rate increase based on weak growth data. But the Fed may move anyway if there's strong employment data or because of flawed models. If they do raise rates, it will just make the deflation worse. For now, you should focus on economic growth and not read too much into employment data. Deflation still has the upper hand, which lowers expectations about price increases in consumer goods and major assets such as housing. This game is not over, however. At the end of the day, the government has to get inflation. They're not getting it. They've been trying to get inflation for five years and haven't succeeded. At present, deflation is a greater danger. But what I try to explain to investors is, you shouldn't think of one or the other. Don't think we're definitely going to have inflation or we're definitely going to have deflation. Think of it as a tug of war where two forces are pulling against each other and, at any point, one side is winning. At writing, deflation is winning. But sooner than later, inflation might start to win. And what I try to do in Strategic Intelligence is help you understand that dynamic, keep you informed and give you portfolio suggestions so you can win either way. [Chris Mayer writes to you from Tokyo, below, with lessons from Japan's deflation…] All the best, Jim Rickards for The Daily Reckoning Peter's editorial note: We recently received the craziest email we've ever seen. We read each and every piece of mail we get. Most times, you wouldn't believe the messages we're sent. Conspiracy theories... pyramid schemes... weird technologies... insane rants... We've seen it all. So when I say that this is the CRAZIEST email we've received, you shouldn't take it lightly. You can see the contents of this email for yourself by going here. As you'll see, this email involves a mysterious $1.5 trillion event. From the minute I read it, I knew he was on to something. Again, click here to see for yourself. Free Presentation: World's Best Places To Live Well For Less In the United States and elsewhere, this is shaping up to be the retirement era of scraping by and making do. But not everywhere. In key spots around the world, not only can you maintain the standard of living you enjoyed during your hard-working years... you can improve it. In these 10 places, you can live better... for less. You owe it to yourself to find out how. Click here to see the free presentation. The Daily Reckoning Presents... "That chill in the air?" wrote Chris Mayer in February. "This is what deflation feels like." He reports from the capital of deflation, Tokyo, on the future that might be in store for the U.S.... ****************************** Notes on Deflation From Tokyo by Chris Mayer I arrived in Japan on Friday and have been exploring Tokyo with my 16-year-old son, Calvin. Earlier this year, I wrote to you about the deflationary chill affecting U.S. and European markets. I used the metaphor of an ice age, borrowing from the late Barton Biggs. And I focused on the experience of what it's like to live in a financial ice age and how to invest in one. [If you missed my recommended strategy then, please click here.] Well, Japan is ground zero for studying how a deflation upsets all the normal economic assumptions we have. Take money. The Japanese currency is the yen. (Which, I've learned, the Japanese pronounce as "en.") I've been reading David Pilling's Bending Adversity: Japan and the Art of Survival. And Pilling has a great example where talks about a family that stored yen notes in an envelope in their fridge: "Because of the deflation that had been gnawing at prices since the mid-1990s, the crisp notes could acquire more goods the longer they remained in their frozen vault. If, for example, someone had stashed 100,000 yen in the fridge in 1995, by 2012, its purchasing power would have risen to 112,000 yen." It is a strange, topsy-turvy world where the value of currency appreciates. No American would think stuffing $10,000 in their fridge for 17 years would be a good idea. In Japan, this has been a good idea for a long time. No wonder they sock away yen. There is no feeling of entitlement about getting an annual raise in Japan. Pilling writes that one economist figured out that as much as $300 billion worth of yen notes "roughly the economic output of Denmark -- had simply vanished in people's cupboards and under their futon mattresses." In a deflationary chill, you would also come to expect that your income might not change in nominal terms. There is no feeling of entitlement about getting an annual raise in Japan. In fact, as Pilling writes, "a worker's wages might fall, but he or she could still feel better off." Deflation creates a disincentive to borrow, as falling prices (and possibly falling nominal incomes) make past debts more difficult to pay. An extended deflationary chill would also force you to rethink basic investing concepts, as investor Larry Robbins shows. Before I left for Tokyo, I read Robbins' annual letter to investors in his Glenview Opportunity Fund. (It is one of the best annual letters I've read so far this year, loaded with ideas. I'll share a link further down below.) Robbins spoke recently at the Japan Society about markets and investing in a world of deflationary pressures. The talk formed the basis of his letter. He writes about the other main feature of a deflationary chill -- extremely low, or even nonexistent, interest rates. In fact, they may go negative. Robbins points to some examples in today's markets: "Danish, Swiss and German government obligations all trade with negative yield through 5-plus years (Swiss all the way to 10 years)" "Nestle recently placed 500 million euros of bonds that traded at negative yields -- it is unclear if you get a Crunch bar to compensate you for your loss of principal on the investment" "A total of $3 trillion of debt in Europe and Japan trades at a negative interest rate." Such a bizarro world leads to "esoteric concepts that we can write about but are very difficult to actually comprehend." Suppliers, for example, have an incentive to push for later collection terms. Meanwhile, purchasers would have an incentive to prepay for goods. "Working capital management would be turned upside down," Robbins writes. Banks become more akin to storage units for currency. Valuing stocks and assets becomes harder, because many of the existing models won't work. Robbins writes: "All the formulas we learned in business school blow up. Good luck computing a dividend discount model [when the denominator is negative]… Obviously, growth could be pressured in a deflationary environment, but many businesses would retain absolute pricing power and have [theoretically] infinite value." Do you eat fruits and vegetables? If so, read this. It contains information from a report stamped "Confidential, Read & Destroy" by the U.S. government and reveals a killer threat inside 75% of our food supply. There's a good chance some of these foods are in your house right now. Click here to find out. The deflationary chill also means you have to think differently about economic statistics. People like to write about how Japan's economy has gone nowhere for 20 years. On the surface, that seems right. But when you account for deflation, you get a different picture. As Pilling writes: "Japanese incomes may have been falling, but the price of everything from newspapers to haircuts to housing and sushi have been stuck at 1981 levels." Pilling notes if you adjust for deflation, Japan does not look so bad compared against other countries. If you rebased the size of the economy to 100 in 1989, then Japan's economy is roughly at 127 today, compared with 137 for the U.S. and 144 for the U.K. over the same time frame. Besides, there are subjective factors at work. The Japanese enjoy a famously high standard of living. Crime rates, for example, are super low. "Dropped wallets are almost invariably returned, cash untouched," Pilling writes. Life spans are long, and the lifestyle is comfortable. I can tell you just in just my short stay in Tokyo so far, it is one of the comfortable cities in Asia -- or the world, for that matter. There are the taxis with the doors that open automatically. There are the machines that wrap your wet umbrella for you so it won't drip everywhere. There are the toilets -- soft, heated and with extra amenities such as the gentle spray of warm water that washes your behind. There are heated mirrors in the bathroom that don't fog up when you take a shower. ("Tokyo is a city of the future," a friend of mine told me before I left. I now see what he means.) There are other conveniences. There is no tipping in Japan. I knew that but forgot, and in my first taxi ride, the driver had to call out after me to give me my change. There are no beggars that I could see. There are no aggressive merchants trying to sell you stuff, as is common in Asia. Another feature common in Asia but missing here: the incessant honking of car horns. Another feature common in Asia but missing here: the incessant honking of car horns. I don't think I've heard even one yet. Tokyo must be one of the quietest large cities on Earth. Then there is the general sense of order. There are orderly lines everywhere. Even on escalators. It's remarkable how everyone stands to one side. There are trains everywhere that seem to run everywhere. You also don't have to worry about where you eat or what you eat. The Japanese are attentive to matters of hygiene and cleanliness. It makes you wonder. Maybe a deflationary chill doesn't have to be so bad after all. China, India, Brazil and other celebrated economies would be lucky if they ever achieved for their populations the widely enjoyed standard of living of the Japanese. I should also point out that Japan was not always caught in this deflationary ice age. The bright line on the Japanese financial timeline is 1989. It was then, on the last trading day of the year, that the Nikkei -- Japan's main stock index -- almost touched 39,000. After that, everything changed forever… The bubble burst in 1990, and Japan's markets have still not come close to that high. (The Nikkei currently sits at around 19,000.) The deflationary chill set in. It was an epic bubble -- a topic for another time -- and an epic bust. That bust triggered the deflationary trends that followed. And while there are many differences with the U.S., the episode begs a series of questions: Could 2007 be the bright line on the U.S. financial timeline? Could the 2008 crisis that followed mark the date when things changed forever? Could we be in the midst of our own deflationary ice age? And what about Europe? Are they turning Japanese? More another time. Until then... Regards, Chris Mayer for The Daily Reckoning P.S. During deflation, you want to go small. Smaller companies can grow faster in little niches than the giants. (There are exceptions, like Apple.) If deflation takes hold, you should consider owning companies that are growing fast or have the ability to grow fast. Click here for my favorite seven companies. P.P.S. On Saturday, Calvin and I watched sumo wrestlers train in a nearby stable. It was something to see. These big men work hard and make great sacrifices to their health to practice sumo. Training is serious business, and we had to abide by a list of rules. No talking. No showing the soles of your feet to the wrestlers. (It is sign of disrespect.) I snapped this picture: Chris Mayer is managing editor of the Capital and Crisis and Mayer's Special Situations newsletters. BE SURE TO ADD dr@dailyreckoning.com to your address book. Additional Articles & Commentary: Join the conversation! Follow us on social media: The Daily Reckoning is committed to protecting and respecting your privacy. We do not rent or share your email address. By submitting your email address, you consent to Agora Financial delivering daily email issues and advertisements. To end your Daily Reckoning e-mail subscription and associated external offers sent from Daily Reckoning, feel free to click here. Please read our Privacy Statement. For any further comments or concerns please email us at dr@dailyreckoning.com. 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