Saturday, May 16, 2009

Why would it be different this time?

This is the question I find myself asking over and over again whenever I hear about this new proposal or that new "stimulus." Why would people believe that government intervention changes the primary trend? Why do people believe Bernanke, Obama, or Geithner can do anything besides screw things up even more?

Governments don't stabilize economies, economies stabilize governments. Now that our global economy is unstable, government is powerless to fix it in a meaningful way. Yes, they can borrow and tax more, but this simply turns a severe recession into a depression. And in case there are some who don't believe it, yes, another economic depression has already begun. Everyone has this vision of people starving in the street, bread lines, etc., which is only true for a proportion of the population. However, these things have already begun. Do you not think that tent cities developing around California are a modern-day equivalent? If not, ask yourself why. How is it different this time? What about soup kitchens and shelters overwhelmed by the volume of folks showing up and having to turn people away?

But I am primarily interested in the investment side of things for the purposes of my blog. Why do people think that we won't have a vicious 19 year bear market like Japan is in now? Look at this chart of the Nikkei Index, Japan's rough equivalent to the S&P 500, since 1970 ("borrowed" from, a great site for historical information):

Why do people think this can't happen in the U.S.? Is it because we're smarter? Harder working? Because our government takes on more debt? Because our government is creating the same zombie banks Japan did but the end result will be different because, dammit, we're America?!

How about an example from the good ol' USA? Look at this chart from the late 1800s to now for the Dow Jones Industrial Average (also from

And why am I so sure that we're heading for a deflationary depression? The bond market, which is usually (not always, of course) smarter than the stock market (again from

Notice the long, sort of sine wave pattern of bond yields and notice how long we scraped along the bottom last cycle before turning back up into a new Kondratieff spring, heralding the return of inflation. We're not going to go from a 1% yield to a 15% yield in the T-Bill in one year. The one exception to this statement is a geopolitical event that abruptly dethrones the U.S. Dollar. This is why I hold most of my cash in the form of Gold, since the yield on the T-Bill doesn't adequately compensate for the risk of this type of event. Additionally, banks and other financial institutions aren't trustworthy custodians of cash at this point in the financial cycle, as they are BANKRUPT. People who don't understand Gold is money don't believe Gold will hold its value during a deflation, but it has already shown that it can and will during a brutal deflationary wave (i.e. the last year proves it!).

Governments cannot stop this cycle from playing out, but they can prolong it by increasing public debt in the midst of a debt crisis. Japan has been doing just that for some time now. We in the United States have also started down this road vigorously, ignoring the lessons of generations past and doomed to repeat the same cycle of a prolonged economic depression.

The word depression conjures up emotional reactions from people. It isn't all bad for everyone. Savers who can manage to keep a modest revenue stream/income (I am not saying this is an easy task in an environment where unemployment will probably double from current levels) will be able to purchase more goods with their savings. Deflation lowers prices. A perfect example is cars. Think about how much cheaper cars will be in a year. With GM and Chrysler going out of business, credit hard to come by, and unemployment and uncertainty running high, cars may be 20% cheaper next year. Housing prices have fallen 50% already in some areas and are still falling aggressively.

What is clear is that those who insist on being bullish despite overwhelming fundamental evidence that this is a bad idea are going to lose a lot of money. A LOT of money. Stocks, corporate bonds and commodities aren't coming back any time soon. Yes, there will be bear market rallies like the one that is ending (or already ended) as I type this, but the trend is down and we are not even close to being out of the woods yet.

The ways to make money in this environment are:

1. Preserve capital. This is a better option than most people think. If you can manage to hold onto your $100 (or my preferred $100 worth of Gold) for another year or so, you'll be able to buy twice as many stocks or twice as much real estate with that money, which is the equivalent of buying a stock or piece of real estate and then having it turn a 100% profit!

2. Trade the bear market. It's hard, trust me. But a time like right now is a wonderful shorting opportunity if one has the patience to wait for the inevitable payoff to play out and one uses risk management principles.

3. Buy Gold stocks. Perhaps not right now if one is a trader, as many senior Gold stocks are closer to an intermediate-term top than a bottom, but I believe this fall will provide potential life-changing (in terms of finances) opportunities in the Gold mining sector. Those with a buy and hold mentality in this sector can simply dollar cost average into the only decent nascent bull market in town. Remember, Gold miners thrive during deflation for those who haven't looked at how Gold mining stocks did during the last deflationary depression in the 1930s.

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