Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression

The Burst Bubble: Precursor to Economic Depression

Stock prices have not regained their January 2000 peak, but talk of the so-called "new economy" continues to percolate among economists and the media. Few believe that a longterm downtrend is even possible, simply because they have never experienced one. Despite this widespread mindset, stock market crashes do occur, and a big one is on the way.

To understand why, you must know a little about Wave Theory. First, the stock market is a very good barometer for the mood of the public (euphoria breeds rising stock prices, and worry produces a bear market). Contrary to popular belief, economic contraction and expansion are not reasons for a bear or bull market; they are caused by market activity.

Wave theory recognizes that the market as a whole acts somewhat like a living system, one with predictable patterns of behavior. Furthermore, the graph of stock prices is a fractal — it takes on the same shape no matter the length of the time period studied. So, by carefully examining stock prices graphed over time, it is possible to predict future market activity by figuring out where we are in the predictable pattern.

The bull market that reigned from the early 1980s to 2000 was the fifth wave of a rising wave cycle. Rising wave cycles are always followed by declining wave cycles. Expanding the time scale, it is also clear that the overall rising trend in stock prices from the 1930s to 2000 is the fifth wave in a much larger-scale rising wave cycle, one that has lasted since the birth of America. So, the coming downturn will definitely be the worst since the Great Depression of the 1930s, and possibly the worst in American history.

Monetary Defl ation: A Mythical Beast Made Real

Most people equate infl ation with rising prices, and therefore assume that defl ation means falling prices. Price fl uctuations, however, are only symptoms of the fluctuating volume of money and credit. The price of goods rises when the supply of credit and money increases, making each unit of money worth less. Conversely, prices fall when the money and credit supply shrinks, making each unit of money worth comparatively more.

Historically, depressions in the U.S. have been preceded by an expansion of available credit in the banking system. During the recent bull market, the U.S. experienced an unprecedented expansion of this type. Banks are willing to loan to almost anyone, and nearly everyone feels confident enough to take out large loans to satisfy their consumer desires. Buyer optimism abounds.

At some point this huge mass of debt will be unable to sustain its own weight. When that tipping point is reached, once again, psychological trends will create economic trends. Lenders will suddenly become unwilling to lend to anyone but the most creditworthy borrowers, and people who are currently struggling under a large debt load will either rush to pay off their debts or default on their loans. These two reactions will feed each other in a downward spiral, and the result will be a defl ationary crash as the volume of available credit contracts rapidly and the public mood changes to conservatism and pessimism.

Most economists, if not all, are more concerned about infl ation than defl ation. The U.S. Federal Reserve Bank has recently decreased its interest rates to historically low levels, purportedly to reduce the risk of runaway infl ation. Of course, the Fed cannot decrease interest rates below zero, which is where rates are headed. Unfortunately, almost no one is taking precautions against defl ation, simply because they don't believe it can ever happen.

U.S. bank depositors have been lulled into a false sense of security by the existence of federal deposit insurance. But this insurance, which is paid for by the banks themselves, will not protect depositors when the defl ationary crash arrives. And worldwide, global central banking has also made the worldwide supply of credit topheavy and ready for collapse.

Safe and Unsafe Investments in Preparation for the Crash

Remember two things when arranging your financial affairs: first, even in times of great financial crisis such as the Great Depression, the majority of the population is not reduced to destitution. Second, those who prepare for bad times during good times are bound to be ridiculed. Be patient and you will be rewarded. For this reason, be skeptical of conventional investment wisdom, because it was formed during a spectacular bull market and is not at all appropriate for investing in a defl ationary depression. Avoid these investment ideas:

• Bond investing — This is a prime example of conventional wisdom that will go wrong during a recession. Graphs that appear to illustrate the safety of high-grade bonds during bear markets actually refl ect only the bonds that maintained their high ratings; the vast majority of bonds are downgraded during a depression, and many default, resulting in total loss of investment principal. Government bonds, though they may be tax-exempt, are also risky, because governments often default on their obligations during a crisis.

• Real estate — This is risky because real estate is highly illiquid. American consumers are over-leveraged and have tapped out their homes' equity. In a crash, banks will foreclose on thousands of mortgages. If you're tempted to take out that home equity loan to pay for something else, ask if it is worth losing your house — that may be the ultimate price.

• Collectibles — Invest in collectibles for pleasure, not for profit. In a defl ationary depression, no one will have enough money to buy Beanie Babies at infl ated prices.

• Stocks — Investors should have learned about the perils of the stock market from the bursting of the Internet bubble. However, many believe that the Fed will manage the economy well enough to prevent further market declines; that simply isn't true. Therefore, holding long positions in stocks is extremely risky. Experienced investors can consider short-selling stocks or perhaps investing in mutual funds that specialize in short selling. Remember, though, that during a marketwide panic, the trading system may break down or be suspended, affecting shortsellers as well as other investors.

• Commodities — Graphs of commodity prices during the Great Depression illustrate that commodities are as risky as stocks. Unless you actually own an oil company or a cotton plantation, you don't own something physical when you buy commodities, but rather a futures contract, which is nothing more than a paper promise to deliver.

Here, on the other hand, are essential items for a secure investment portfolio:

• Cash — Currency on hand is the only asset that doesn't suffer price declines during defl ation. With interest rates at historical lows, no one wants to put large amounts of money away into savings accounts or CDs today. But during a defl ationary crisis such as the one experienced by Japan, cash actually appreciates in value as all other asset values plummet. If you don't want the 2% annual interest gain on your CD, you can take a 30% loss instead by investing in stocks, bonds or commodities.

• Precious metals — You can physically own this hard asset. Even if the price of gold and silver drops, it will never drop to zero, as stock prices may. Therefore, precious metals (in hard form, not futures contracts, ownership certificates or asset-backed bonds) are a crucial part of a survival-oriented investment strategy.

• Safe cash equivalents — Most people consider money market funds to be the same as cash, but not all money market funds are the same. The safest funds hold only shortterm U.S. Treasury debt. You can skip the middleman (the fund) and simply purchase Treasury bills. Direct ownership takes more time but may offer more safety.

Finding Companies You Can Trust with Your Money

Whatever investment vehicles you choose, be confident in the professional advice you are getting and in the ability of the companies you're working with to continue to operate in the worst economic times. Most importantly, choose a safe bank, investment company and insurance company. This is more difficult than it sounds — big-name companies aren't necessarily the safest.

Because banks are no longer required to keep deposits on reserve for withdrawal, it won't take very much to precipitate a major bank run, because the banks will quickly run out of money to satisfy depositors if just a few more than expected wish to withdraw their money. Many banks have unwisely invested in derivatives. In addition, recently banks have been lending money to anyone with a pulse and thus loan portfolios are weaker than they might appear. Seek banks that keep large cash reserves on hand.

Many large banks in the U.S. satisfy this requirement, and the safest banks in the rest of the world are in Switzerland and Singapore (not coincidentally, these countries' government-backed debt is the safest).

Investigate the possibility of cashing out your retirement plans. The possible tax penalties may be a bargain compared to the cost of letting the government seize all pension assets (as happened in Argentina recently). Take a hard look at your insurance policies. Is the insurer sound? Is it over-leveraged by unwise investments in speculative securities and derivatives? Find out before the insurance company goes bankrupt so you can move your policies.

Social unrest always increases in economic hard times. When people are confused and scared, crime rates go up, riots occur and society becomes polarized along many different axes (social class, gender, race and religion, to name but a few). For example, the September 11 terrorist attacks were actually symptoms of a global economic downturn, not the cause of the recession in the U.S., contrary to widespread popular belief. One major repercussion of these facts is that elected officials nearly always lose their jobs, even though they have little or no control over the economic trends in their countries.

Elected leaders set themselves up for their own ousters by acting as if they have power over the markets (through institutions like the Fed, which, as we have seen, is powerless to control social mood and, therefore, economic mood).

In the worst case, a government may experience a coup d'etat, so keep an eye on the political situation in your country as the depression worsens. Conversely, leaders who are elected during the downward slide or at the bottom automatically get the credit when the economy inevitably ameliorates — though, once again, they usually have little to do with the recovery.This political instability, which reveals the lack of economic power governments actually wield, should be enough to convince you not to trust any government to protect your assets, job, bank deposits or even your physical safety during times of economic distress.

Buying Low, Selling High

Consider how your strategy should change as the depression bottoms out and the economy eventually recovers. If you have cash or cash equivalents, you can buy hard assets when their prices drop. Massive foreclosures will result in a glut of real estate being sold at bargain prices, as happened during the Great Depression. Many kinds of assets will go on sale as desperate investors seek cash. Having prepared, you can cash in on these deals.

If you own a business or have an entrepreneurial bent, positioning your company properly at the bottom of a depression will virtually ensure prosperity for years to come. Similarly, if you have political aspirations, run for office at the bottom of the depression and ride a surge of popularity on the way back up .

Some Good Quotes From Book

“What would you say if you discovered that we have not had anything near a New Economy, that all that talk is a lie?"

“People are often prepared for the past but rarely for the future."

“Wake up now, while there is still time, and actively take charge of your personal finances."

“Given the evidence, I think it would be financially suicidal to bet on an extension of the bull market and a requirement of even moderate prudence to prepare for a major reversal."

“Those of us dedicated to objective financial analysis aren't always right. But those who rely on extra-large helpings of trust, faith, hope and 'gut instinct' always regret it."

“For many people, the single biggest financial shock and surprise over the next decade will be the revelation that the Fed has never really known what on earth it was doing."

“In a bear market, both international and domestic tensions increase, and the resulting social actions can be devastating."

“Economists as a group have an unbroken record of failing to predict economic contraction."

“Most of the time, you could divide stock prices by the price of pickles and have a more reliable indicator [than the price/ earnings ratio]."

“If the issuers of your tax-exempt bonds default, you will have the ultimate tax haven:”

“Currencies today are utter fictions, but few realize it. Sometime this century, people will question the validity of the fiat money system."

“For the Fed, the mass of credit that it has nursed into the world is like having raised King Kong from babyhood as a pet. He might behave, but only if you can figure out what he wants and keep him satisfied”