Zulauf: Marching Full Speed into Calamity

Felix Zulauf sees problems ahead in North America and Europe because of private sector debt. Consumers are “spent out” and “cannot continue to accumulate debt”. Expansionary fiscal policy and deficit spending have allowed the real economy to cope while expansionary monetary policy has helped asset prices.

Zulauf sees a pause in this dynamic. But when the inevitable relapse occurs, he believes the response will be aggressive because he believes austerity measures will not be tolerated in a democracy. In his view, expansionary policy will resume and this will lead to an inflationary depression over the next 3 to 5 years. He recommends gold as a currency to hedge against these events. This will be good for stocks over the medium-term. However, he says stocks will not be spared by the inflation because he sees the S&P trading down to book value of about 500 before the secular bear market is over. That is over 60% below present levels. Stock picking and rotating between risk and safety at the appropriate times is very important in this environment.

The main difference between today and the 1930s in his view is that we had a gold standard during the Great Depression whereas we have a fiat currency system today. Zulauf believes this will be a buffer against the extremes we saw in the 1930s.

(click for audio)

Audio of Felix Zulauf here.

Source: McAlvany Weekly Commentary 06 July 2011 (hat tip Barry Ritholtz)

  1. Tom Hickey says

    Just how is it possible to have an inflationary depression (deflation)? Isn’t that an oxymoron?

    1. Edward Harrison says


      If you look back at the two great secular bear markets of the modern era (1929-1949 and 1966-1982), one was deflationary and the second was inflationary. Zulauf seems to believes the differentiating factor was fiat currency which affords governments the ability for more policy stimulus and thus reduces the possibility of a deflationary outcome.

      It’s an interesting view that is predicated on his thinking of likely policy responses. Here’s how I would interpret Zulauf’s commentary:

      Government deficit spending has been the only thing supporting the real economy. Monetary policy has added recovery by supporting asset prices. However, this assistance will not arrest the fall in asset prices which is the central threat to over-indebted consumers for whom government spending is substituting.

      What we are witnessing now is that the pullback in policy stimulus reveals the underlying weakness of the real economy. Eventually, this weakness will be so great that more stimulus will be forthcoming. In fact, policymakers will be lothe to withdraw stimulus even when inflationary tendencies begin. We can see that most acutely in emerging markets like China. The boost to global aggregate demand will eventually cause inflation (from commodity prices and emerging markets are two places to look) such that we will eventually see much higher inflation coupled with high unemployment in the developed economies.

      I don’t think this view is at odds with MMT’ers complaints that economic slack and excess labour supply mean muted inflation in developed economies. Rather, inflation would come via imports and commodities.

      Personally, I still think the primary forces are deflationary at present. But I agree with Zulauf that the ability to add stimulus will be met with willingness if the consequences of debt deflation are too much. The question then is whether the outcome is inflationary.

  2. Chad Kiernan says

    Tom it would be deflationary, except the Federal US government doesn’t want prices to fall. Prices, specifically in housing are falling and should continue to do so for the next 2-3 years. However, to combat this the Fed, as you know, is stepping in and devaluing the dollar. Every commodity and global business transaction in the world is primary denominated in dollars. When the number of dollars increase while the supply of wheat, gold, oil etc stay for the most part limited, this will cause more dollars chasing the same amount of goods, causing inflation. While structurally unemployment is 18-20% and will stay that way. But the top earning companies and rich maintain their wealth Becuase they have liquid assets to seek gains while poor are just making ends meet with the rising energy n food prices. At the same time 45M are on food stamps in the US compared to 22M in 07 I believe.

  3. Chad Kiernan says

    Edward good article. This is good information. I appreciate your work. I randomly came across your blog and am interested in following your thoughts on a consistent basis. Zullaf is correct in stating their is a buffer vs 1930s gold standard. However the two parallels that really matter are the US’s persistence in interventionist policies, specifically by propping up prices. The US gov did some ambitious things under Hoover and FDR. Unfortunately, Mr. Obama is equally ambitious in intervention. I always like to remember the original Boston Tea Party was over a 3 cent tax, today people accuse the modern Tea Party of being too radical while $110k of debt looms over every tax payees head. History is a great thing.

  4. Richard says

    I am so sick-and-tired of this “inflationary depression” nonsense. If you can’t force employers to pay people more money, how can you “create” inflation which is nothing other than people paying more for goods and services??? Yes, people pay more for gas. Yes, people may pay more for health. Yes, people may pay more for education. BUT THEN THEY HAVE TO PAY LESS FOR OTHER THINGS. And that is the point that is lost on everybody.
    The reason everyone “wants” to see inflation is because the alternative – deflation – is just to ghastly for people to contemplate. Therefore they “hope” that by yelping INFLATION! every ten minutes, it will somehow make it happen.
    Not gonna happen, folks… We are all going to suffer the ravages of deflation, whether you like it or not.

    1. David Lazarus says

      I agree. Asset prices are grossly overvalued especially property and stocks. I think that 500 for the S&P will be likely. It might take time. What will happen in the meantime is that more and more people go bankrupt forcing defaults on the banks, though overall living standards will plummet. Current Fed policy is creating the problems to be dragged out. I suspect that if Obama is ousted in 2012 things will get worse much faster.

      The depression that started in 2007 has only be stalled and until debts are cleared the prospects for recovery are very dim. So I have to agree with Zulauf that we will have a horrendous decade in the west.

  5. Anthony says

    Well said, Richard. Without increasing wages, inflation dies in its crib. Higher fuel and food prices — when combined with falling wages, rising unemployment, and falling house prices — equals declining real wages for wage-earners and margin compression for the businesses they patronize. Those are DEFLATIONARY. Viewed in context, higher food and fuel prices in the short run actually buttress the case for deflation, at least in the U.S.

    1. fresno dan says

      I would say that is a very good point.
      I would also point out that “inflation” and “deflation” are really two sides of the same coin. If the idea that deflation is so horrible because debt stays at its nominal value while wages and assets decrease, I would agree with that. However, the idea that inflation gets us out of that fix because debt is reduced in real terms – well, that is great and I’m all for it. Just one question: where is the wage inflation? Where is the scarcity of workers, forcing compensation higher? The surreptious adjustment of the economy through inflation doesn’t work if income isn’t rising.
      And being an old codger, I remember that thing known as “stagflation”

    2. David Lazarus says

      Well US median income has been stagnant for 30 years so in that respect we should not have had inflation for 30 years. It was because of ever increasing demands on households that meant that both parties in a household had to work to survive, now even that is a dream. The Fed wants inflation because it is better than deflation yet they are just wiping out the middle classes. US inflation is as a result of external influences. Asian demand to some extent has boosted oil prices but the majority has been down to Wall Street speculation. As you stated margin compression has been the result on US businesses. Yet much of the Dow do not care about the US any longer as they get the bulk of their earnings overseas.

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