Deflation 101

This is not my post, but it so closely mirrors my thoughts on our economy right now that I'm going to post it here. For those of you that think the economy crashing is a conspiracy, stop reading here and go to the next ~when are we going to march~ post.

(shamelessly cut/pasted from another forum... the thread itself is a wonderful read. )

http://www.godlikeproductions.com/forum1/message503140/pg1

Here's how I think it will all end. To wit:

Unfortunately, the glut of baby boomers is now moving into the years approaching retirement. The leading edge of the boomers already HAVE retired. While the baby boom generation spans many years, it is a fact that people who approach retirement become more conservative. They shun risk. They take measures to preserve capital. They absolutely CANNOT afford to "invest for the long run" because for them there IS NO long run. This changes the entire psychological make up of the market, as risk aversion soars and patience for volatility evaporates. We can see risk premiums soaring everywhere, from health care costs, to tighter lending standards, to bond insurance. The baby boomers, as they pass into a new retirement psychological state, have triggered an avelanche of systemic change. Long term yields are so low because boomers are increasingly holding their cash in safe places for the LONG RUN. The yield curve conundrum isn't at all perplexing, Mr Greenspan -- it's smart boomers battening the hatches. They realize that social security & corporate pensions cannot be trusted, PARTICULARLY if the economy heads south. The most alarming part is that they have just started. The 50 year "buy and hold" mentality instantly becomes invalid.

The greatest problem of all is that the wealth of many baby boomers is tied up in equities. Worse -- MUCH WORSE -- it is tied up in the SAME EQUITIES. The vast majority of boomers with 401k plans, personal investments, IRAs, etc own Intel and GE. They own the same S&P stocks. Everyone owns AAPL and GM. There are 77 million baby boomers, and the bulk of their equity holdings are in approximately 600 stocks -- the S&P 500, DJ 30, and the Nasdaq 100. This is a fantastic oversight that almost NO ONE recognizes or appreciated. The greatest crime of the century has been to encourage a glut of 77 millon people to own the SAME THING when they retire at the SAME TIME. This is a financial planning gaffe of massive and devestating proportions.

The systemic market risks lie in too many people being on the same side of the trade. That's effectively what causes a bubble to deflate. The tech bubble of the 90s deflated because EVERYONE had YHOO, AMZN, INTC, JNPR, ARBA. And everyone tried to sell those same small number of stocks at the same time.

So what we have now is a group of 77 million people who own the same 600 stocks, and who are becoming risk averse. It doesn't take a rocket scientist to realize that if you have 77 million people who own 600 stocks and are attempting to preserve capital that you're going to have a problem of massive proportions.

The markets are down 10%+ already this year and the boomers are sweating. Their fingers are hovering above those sell buttons. It will take just take a tiny fraction of those anxious people to crack open markets. That in turn will create wave after wave of panic as the 77 million boomers try to preserve whatever they can of those 600 stocks. Because of their concentration in the same stocks, bids will crumble, indices will tumble, and selling will accelerate.

There has been an argument that boomer retirement selling will be spread over many years as they slowly and leisurely retire. That's in a fantasy world. In the real world, someone approaching retirement in a chaotic market takes the money before the other 77 million people take it. It's the prisoner's dillema (a Nash equilibrium problem) in full effect. As risk soars, individuals take the money while they can. As people take the money while they still can, risk soars. Who the hell cares about a 15% tax penalty if it means you avoid a 90% value meltdown in a long protracted crash?

You end up with 77 million sellers on 600 stocks, with no one on the other side of the trade. Will the baby boomer's kids be on the other side of the trade? No way in hell, since they're up to their eyeballs in debt. What about the Chinese? They're on the brink of their own bubble crash too. In effect, there is NO ONE on the other side of the trade. The earnings power that gave us stable bids in the 80s and 90s and managed to make the 87 and 97 "crashes" irrelevant no longer exists. Crashes now are serious because there is no guarantee that they will bounce back.

There is also one other major reason why this will be deep, fast, and hard: tech bubble. Many of the more wealthy boomers have painful memories of the tech bubble crash of 2000, and will not be nearly as willing to "ride it out" this time. They know first hand and in fresh memory that sometimes a market doesn't bounce back and that "buy and hold" is a fallacy. This is critical to understand as a psychological underpinning of the coming crisis.

I predict that over the coming few months we will continue to see a staggering and relentless crash in the markets. Also, a crash doesn't have to be a 1 day event. We will start seeing it get pounded into submission as boomers panic and smart money lets them panic. 77 million people on the same side of the trade with no one on the other side has never occurred before, but it soon will. And since even after a crash tens of millions of people will be severely underwater, there will be no bounce back, as rallies will be sold into. This will indeed be a crash that will result in a long, deep depression.

p.s. If you are smart and understand how Wall Street works, you will know precisely why this meltdown began on January 1. It is no coincidence. There is a very good reason why January 1 was the perfect day for it all to begin, and the reason completely validates and supports my theory above.

The boomers created this monster, and now they will kill it.

Currently the Federal Funds Rate is now 3 percent. These low rates have been killing the dollar. So what's a Federal Reserve Goon to do? Lower the rate further and vaporize the dollar, or raise and vaporize the entire housing industry as well as lending institutions.

Unfortunately for the believers of hyperinflationary jackpot scenario rates can't keep dropping forever like they have been. Once they hit near zero they will have to rise...or game over.

But if they rise game over.

So just game over.