David Knox Barker is one of the
leading authorities on the economic long wave, otherwise known as the
Kondratieff Wave (a.k.a. "K Wave"). Barker has had an impressive
career both as a financial market writer and long wave analyst, as well as
being an entrepreneur in the emerging field of nanotechnology.
Back in the late 1980s and '90s,
Barker was known for his insightful and accurate views on the U.S. economy
and financial markets via his K Wave Report newsletter. Today he
shares his views on the global financial market and economic outlook through
his Long Wave Dynamics Letter.
Barker recently shares with me his
thoughts on what he sees ahead for the United States and the emerging markets
in terms of the inflation/deflation scenario. He also discussed the debt
crisis, China, and the oil price outlook among other topics of interest. What
follows is the transcript of that interview.
Q: David, where
are we in the inflation/deflationary cycle? Do you still expect a heavy
amount of deflation between now and the anticipated long-wave bottom in 2012?
Barker: Yes. I'm still in the
deflationary camp. [The cycle] might be extended out later than 2012 based on
quantitative easing and government stimulus expanding. I'm really looking for
a bottom in the long wave in 2013 based on what has been done in the way of
government stimulus since last year. If you look at $600 billion in
quantitative easing, in the long run I don't think it does anything but in
the short run it juices the cycle. Actually, in the long run the quantitative
easing makes the deflation worse than it would normally be.
Q: How so?
Barker: There's a big difference in
quantitative easing and printing money. With quantitative easing there's
always an offsetting debt created. Ultimately if you're a large tax paying
individual or corporation you know that ultimately someone has to pay that
debt, and it will likely be you. So it does have a dampening effect on the
economy.
There's another aspect to
quantitative easing that I don't think Bernanke appreciates and that's that
he's feeding deflation by keeping operators and manufacturers in businesses who probably should be taken out of business, which would
provide pricing power for manufacturers of any goods and services. But by
keeping the weaker operators in business it ultimately has a deflationary
effect.
Q: Lately we've
been hearing the financial press repeat the mantra "higher taxes are
needed" to get the U.S. out of its fiscal mess. Would raising taxes in a
recession be bad economic policy in your view?
Barker: Raising taxes in the long
wave is an absolute disaster. Maybe if this was going on in the early 1990s
you could make that case. We've tried spending and taxing and it's not
working. The only way to get out of this is a lower corporate tax rate. I'm
in favor of a fair tax but I realize that's unlikely to occur. The next best
thing would be radically reducing the corporate tax rate to stimulate job
growth and business investment. You're simply not going to get it without tax
rate reduction.
The irony here is that the media
focuses on people paying their faire share but my
argument for a lower corporate tax rate is not because I want to be kind to
the corporations. I want to be kind to the employees. The only thing that a
higher corporate tax gives you is higher prices and lower wages. At some
point we're actually going to have a politician that can articulate that.
It's not that complicated to figure out that if you raise taxes on
corporations they pay their employees less and they charge more for their
products.
Q: In your latest Long
Wave Dynamics Letter you wrote, "There comes a point with debt where
it reaches diminishing returns, and the developed world reached that point
some time ago." Would this explain why the Fed's frantic efforts at
providing liquidity have failed to revitalize the economy?
Barker: Correct. We're overproducing
everything and we're doing it with extensive debt. The whole point of QE
[quantitative easing] was ostensibly to create more borrowing and business
activity. We're overproducing everything we need right now from services to
manufacturing. What we need is whole new industries which come with long wave
innovation and lower taxes. But the stimulus simply isn't working and the old
phrase "pushing on a string" applies here. The hedge funds want to
borrow that money to buy commodities. The banks are taking that money that's
created and they're buying Treasuries. They're not creating economic activity
and true sustainable growth.
I think Bernanke believes in what
he's trying to do but it just simply is not working. He doesn't understanding
what's happening. He was testifying before Congress recently and he basically
said, "I don't understand what's going on with the economy." What
he doesn't understand is long wave theory. He doesn't understand that he's
pushing on a string and that what we need is to get rid of debt and we need
some austerity. The notion that we can get through this economic problem
without some pain is foolish; we need a painful adjustment to get us on the
other side of this.
That being said, the positive aspect
to this is the emerging markets. When you look at the whole
inflation/deflation argument you can see that the developed world is
basically deflation. The emerging markets with the growth of the middle class
and the demand for goods and services there is an offsetting inflationary
pressure on the global system.
Q: You also
recently discussed the possibility of a "soft landing" of the
current long wave. In your view, what are the odds for this and what is
required, politically speaking, to engineer a soft landing?
Barker: If you give me a 15 percent
corporate tax rate and you actually see some real spending, I think you could
actually engineer a soft long wave [bottom]. It would be painful for certain
entities. The problem we have is the large multinational corporations have
favorable tax rates because of their political clout. But the small entities
are paying much higher tax rates. For instance, I'm a large investor in a
small entity and I pay a 40 percent tax rate whereas the big guys aren't
paying that. The small guys can't afford to pay to get the exemptions in the
tax code. It's a criminal situation, basically.
I would support Obama if he would
reduce the corporate tax rate to 15 percent I'd say abolishall
loopholes. Why should a little company that's struggling and that has 10, 50
or 100 employees pay a 40 percent tax rate while the guys are paying nothing?
So bring the corporate tax rate down and abolish all loopholes and I think
you'd create a massive inflow of trillions of dollars into the United States.
And you'd trigger all sorts of investment and ideas and creativity in the
system and you would create a boom. And you would end up with a lot more tax
revenues.
Q: Have we seen
the end of the credit crisis or will the process of debt hemorrhaging and
deleveraging continue? In other words, was the 2008 crisis a proverbial
"shot across the bow" or was it a one-time situation?
Barker: It was a shot across the bow.
I think there's a bigger credit crisis coming. Most of your big U.S. banks
are insolvent. We don't have a liquidity problem, we have a solvency problem.
The Fed can liquify the system but they cannot create
solvency.
Q: Can you
explicate on that?
Barker: By dropping interest rates to
zero it's basically a massive hidden tax on prudent savers in this country
that's going to the big banks. The bailout is a lot bigger than people
realize. Grandmother Barker is getting zero percent on her savings. The big
banks are paying her zero percent and they're loaning to the government at
whether it's a three percent 10-year [bond] or with a blended rate and then
they're pocketing the difference.
There's a massive bailout going on
that people aren't talking about and it's destroying demand in the economy.
Interest rates would be low anyway, they just wouldn't be quite as low and
you wouldn't have the spread that the big banks are picking up. And that's
how the Fed is liquefying the stem. They're creating the income there plus
the income for the big banks. Their whole objective is liquidity, not
solvency. They're hoping the liquidity will solve the solvency problem but as
home prices and commercial real estate prices tick lower the solvency problem
is getting bigger. So at some point the solvency problem will overtake the
liquidity that the Fed is pumping into the system, and that's when the next
leg of the crisis and deflation hits.
Q: You've stated
that the only way out of the global financial mess is austerity. Could you
expand on that statement?
Barker: We've all spent beyond our
means. We have to pull in our horns here and we've got to focus on capital
formation and savings and investment. You can't solve a debt problem with
more debt. It's ludicrous.
Q: What are the
odds of a third quantitative easing (QE3) and if it's coming, when do you see
it coming?
Barker: I hope it's not coming. If
the credit crisis takes another big leg down and we see deflation in the
system I have to believe that Bernanke will be permitted to do additional
quantitative easing. I don't think it's politically viable that QE3 can stop
the deflation that's coming, though. The amount of [quantitative easing] that
would be required to stop the next leg of the credit crisis would create some
political issues for the Fed.
Q: Bill Gross of
PIMCO recently made headlines for his bearish outlook on U.S. government
bonds. Does your reading of the long wave tell you that Mr. Gross is mistaken
in shorting long-term bonds? Also, what is the general outlook for bonds in
view of where we are in the long wave?
Barker: Mr. Gross is a lot smarter
than I am but he obviously missed this call; bonds are still rallying and
interest rates are falling. I think this is the long wave weakness out there.
He's going to be right longer term but I think between now and 2013 the long
bond is going to rally. I think the U.S. is going to figure out its debt
issues and we're going to address them. That's part of why I believe the long
bond is going to continue to rally. In the developed world it's a debt
problem and a deflation problem. That means your German, your Swiss and your
U.S. bonds are going to rally in price and interest rates are going to come
down even lower because there's going to be even less demand in the system as
the credit crisis accelerates.
Q: Where do you
see the next trouble spot occurring in terms of the next global crisis? Will
it be here or abroad?
Baker: You could conceivably fix up
the debt problem for another year and just kick the can down the road. China
has to be at the top of the list in terms of the big problems that can
happen. If China's economy gets weaker as this long wave bottoms out into
2013, and I think it will, then that could be the next crisis. Or it could be
a big U.S. bank that gets in trouble. I wouldn't name any of them
specifically but there's a few of them where you have to wonder if the feds
can address the bank solvency issue.
Q: What in
particular do you see as the major stumbling blocks for China in the next 1-2
years ahead? Will they suffer a major recession or depression before the next
long-wave spring season begins?
Barker: They've been doing far more
stimulus than the U.S. has. You think we've been doing QE, China has done
even more. It's not specifically QE but rather aggressive fiscal and monetary
policies. They have a significant housing bubble on their hands just like we
did in 2006 that could potentially do some serious damage to the Chinese
economy. Plus their economy is still built on exports to the rest of the
world and as the U.S. consumer continues to pull in [spending] it will effect the Chinese economy.
Longer term I've very bullish on the
emerging markets and about the size and scale of the middle class coming into
the political system. I think it's going to be phenomenal. It's just that the
developed world's debt crisis we have to get over between here and there.
Q: In your view
does China need to shake off its Communist government before achieving true
national and international greatness?
Barker: Absolutely. It's going to
take a while but they need to shift towards a more Republican form of
government. Remember, the U.S. wasn't form as a democracy but as a republic.
Then hopefully China goes the direction of a republic as opposed to a
democracy. It's ridiculous when you think about it. They've got a communist
government running a central bank. People here complain about the Fed but
[China] is juicing its financial system like crazy. They put out all these
mandates about growth and they don't care how you get there. The China story
is real, don't get me wrong, and China's economic boom is real. And sure, the
communist model that they've created could still be productive - it's really
more a type of fascism or dictatorial system. Yet it has to convert to a
freer society, and I think it will, but I don't think we need to push it.
That's their internal issue. And I think they will slowly convert to a
non-communist system.
Q: Let's talk
about the U.S. government's recent oil release from the strategic petroleum
reserve. Was this another attempt to juice the economy or do you think there
was another motive for this?
Barker: My reading is that there's
panic going on in high places. They're asking, "Why is the economy still
weak?" And of course they're seeing that high oil prices are affecting
the American consumer, so they had to get oil prices down. So it was
definitely an attempt to boost the economy. I don't think that anything that
happens in Washington is political, per se. I think they're really just
trying to get the economy going. It's a sign of panic because at this stage
they thought they would see growth and improvement and so they're scrambling
to see what they can do to generate growth.
Trying to drop oil prices is
obviously at attempt at generating growth but it's kind of silly because
we've got a strategic petroleum reserve for a reason and that oil has to be
added back in there. So you're just taking from the future. They're going to
have to purchase from the future to put it back in there. It's just an
attempt to stimulate the economy.
Q: I know you're a
big believer in Fibonacci analysis as applied to not only cycle forecasting
but also to market trading. You recently created a new software product
called Market Cycle Dynamics (MCD), which you say is unique to any other
trading system because of its Fibonacci applications. What can you tell us
about it?
Barker: My whole approach to
technical analysis is price, time and sentiment. And I believe that Fibonacci
is the pricing mechanism of markets. And it's simply a tool that allows you
to more quickly uncover where a turn is happening in a market, either on a
short-term basis or on a long-term basis. There are a number of innovative
things about the software but one of the main things is the Fibonacci drill
down grid, where you can get down to a daily basis and see what's happening
in the market. "Quant X-ray" is what I call it. You've got the quantitative
analysts out there writing the code for the computer programs that their
using for the high frequency trading. And invariably they're using Fibonacci
ratios in their algorithms.
For the first time I think Market
Cycle Dynamics allows you to drill down and see where those turns are being
triggered. And that's relevant whether you're a long-term investor or a
short-term trader to see where those programs are going to kick in and either
trigger selling or trigger buying. And MCD acts as an X-ray to the market to
see where those grid structures are. It will startle people to see a level
three or level four Fibonacci grid on an intraday
basis where you see the market ticking and reversing on these grids.
So you use price, which is Fibonacci,
and then you use time, or the cycle approach, and
you use sentiment and for that I use stochastics.
And you just use this to find when you could have a market turn occurring.
The MCD software, which runs with MetaStock,
combines all three of these elements.
Q: For the benefit
of those unfamiliar with Fibonacci, could you give us a brief overview of how
it's important for understanding market turning points?
Barker: I believe that Fibonacci is
the pricing mechanism of markets. When you look at a decent presentation of
Fibonacci grids you realize that where the market turns, big turns, are
typically at Fibonacci key points in the market. The Italian mathematician
Fibonacci discovered the Fibonacci [numerical] sequence and Fibonacci ratios
are a function of those sequences. What they've discovered is that Fibonacci
appears in all natural forms of growth, whether it's pine cones or sea shells
or the ocean or the galaxies. We find that Fibonacci is in all natural
systems of growth and decay, and it governs growth and decay in natural
systems. I believe markets are a natural system of growth and decay and when
you use Fibonacci correctly it picks up the market's turns.
Note: More information on the Market
Cycle Dynamics software is available at www.longwavedynamics.com
Q: What's your
take on the recent stock market rally?
Barker: It looks like we got the turn
of an important Wall Cycle. It's a phenomenal rally, which makes you wonder
what's going on out there. But long term it doesn't change anything. Short
term, I think it's a function of all the liquidity in the system.
Q: How long can
the feds keep the economy at its current level before deflation makes its
presence known again?
Barker: I think we're in a window
where the deflationary pressures are overwhelming. I know everyone is
concerned about inflation but if you look at it, Bernanke is actually correct
to be scared of deflation. He knows what he's talking about and the
deflationary pressures are just phenomenal. It can overwhelm any efforts to
kick the debt time down the road.
With my whole cycle approach the most
important cycle is the business cycle, which I think ideally runs 42 months
short or long. The effect of this quantitative easing and lower interest
rates just makes the cycles run a little bit longer but it actually is
leading us toward chaos. Markets are complex systems and central bank
intervention messes with that system and fiscal policy messes with that
system. They can make the cycles run longer but they can't stop the cycles.
When they do make it run longer they have a tendency to push the system toward
chaos, not toward order.
You have bifurcation in cycles
sometimes. I think the 2002 to 2009 period was a doubling bifurcation within
in a cycle. Anyone who understands complex systems understands that the
doubling effect in a system leads to chaos, whereas halving bifurcation leads
to order. I believe that basically all the intervention is creating a system
that leans toward chaos. But it will be resolved and we will eventually move
into the next advance. I think we're on the cusp of a major global boom, it's just the disasters related to the debt bubble
we have to get past. I don't think the political will is there to
sufficiently juice the system to get past the deflation. So I think we're
going to have resolution to the crisis between 2012 and 2013 where we do have
a deflationary crack and a real debt bust crisis but then we're able to move
on to the other side.
Clif Droke
Editor, The Daily Durban Deep/XAU Report
Clifdroke.com
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