Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 25-Jan-05
A change in thinking about the economy

Web Log - January, 2005

A change in thinking about the economy

Stocks fell again yesterday, as they have steadily since December 31.

Stocks fell despite generally good earnings reports in the last few days, but as one commentator described the situation, "Investors are looking for reasons to sell, not for reasons to buy."

If you're looking for reasons to sell, you won't have any trouble finding some. Oil prices are back up, reaching $50 a barrel today. Alan Greenspan and the Fed are on a tear, planning to raise interest rates steadily throughout the year. Stocks are still overpriced by a factor of two, according to perfectly standard price/earning ratios. American public debt is so high, and growing exponentially, that Japan and China are in a trap: They buying huge amounts of America's debt, for fear that if they don't, all three economies could collapse.

And the collapse is coming, according to more and more analysts. A lengthy 10-year analysis of the economy by Chris P. Dialynas, Managing Director of PIMCO, begins, "Today, the global economy is on the threshold of upheaval."

Peter Schiff, CEO and chief global strategist of Euro Pacific Capital, says in an interview with Forbes, "We are going to go through one of the most trying financial times in U.S. history, including the Great Depression." He says that, "We are a society that has lived beyond its means for a long time," adding that while the trend has been evident for two or three decades, "in the last five years, it has gone off the deep end." Americans are relying on foreigners more and more to produce goods, rather than producing them themselves.

And Stephen Roach, the Chief Economist at Morgan Stanley was privately telling clients that America has no better than a 10 percent chance of avoiding "economic Armageddon," according to a Boston Herald news report.

I personally have had a change of thinking in the last year in the nature of the coming financial crisis. I alluded to this change of thinking a few weeks ago when I wrote that the stock market might lose 50-75% of its value, possibly in a single day.

This change has been bubbling in my mind for many months, but what really firmed it up was the tsunami disaster in the Indian Ocean, for reasons that will soon be clear.

Dow Jones Industrial Average -- 1896 to 1940
Dow Jones Industrial Average -- 1896 to 1940

Early in 2002, when I was first developing Generational Dynamics, I concluded that it implied that we would have to be entering a new 1930s style depression. At that time, I speculated that the path of the depression would be similar to the 1930s, as shown in the adjoining graph.

Notice that stock prices fell gradually from 1929 to 1933. I've been assuming that something similar would happen now, following the 2000 Nasdaq crash.

However, the path since the 1990s bubble has been quite different:

S&P 500 index, 1950 to present
S&P 500 index, 1950 to present

This graph shows the explosive bubble that began in 1995 followed roughly the same upward path as the 1920s bubble. But the downward paths have different. A lot of the reason for this is the near-zero interest rate policy that the Fed has followed; this prevented massive bankruptcies and homelessness in 2000 and 2001, but it transformed the stock market bubble into a more unstable credit bubble.

So what's going to happen when the bubble bursts?

Now, here's an important change. I speak to a lot of people, and I've learned something remarkable: Evidently many, many investors are aware that "something is wrong" with the stock market, and they plan to sell "soon," but they think that they can get out in time.

Even those who've already lost money in the 2000 Nasdaq crash seem to have no fear. They're certain that they'll be "smarter" this time around, and get out fast when they see the warning signs.

I just spoke to an investor today who said, "I can't sell now with the market down. I'll sell in a couple of months when the market is up again." Gulp. What if the market doesn't come up again?

DJIA, Jan 24 2004-2005
DJIA, Jan 24 2004-2005

Look at the graph on the right of the DJIA for the last year. It's as addicting as a roller coaster ride. It even looks like a roller coaster ride.

This leads to an obvious apparent logical contradiction. We know that "getting out in time" is a zero-sum game, and that only a few people will actually succeed at doing that. Therefore we know that most of the people who believe they can get out in time will not be able to do so. It therefore follows that the next collapse won't take four years, as it did in 1929-1933, but will occur so quickly that almost all investors will be unable to react in time.

Thus, I see two possible scenarios:

Either way, we're going to return to the bankruptcies and the homelessness of the 1930s.

Things have gotten so bad in the world economy, that it's only a matter of time before something triggers a collapse. The trigger could be almost anything -- a word from Japan or China that they won't purchase as much American debt, an unexpected bankruptcy, a terrorist act, or any of a million other possible random, chaotic events that can cause a panic.

There's no way to predict this with any certainty. Maybe the stock market will continue its wild roller coaster ride for another year, and will go up and down five times before then. But with price/earnings rations so high, and with public debt so astronomically high and growing quickly, there is no possibility that the current situation can continue.

The depressed economy will be with us for a long time, since we'll be seeing a "reverse bubble" effect. That is, people in the 1990s were irrationally exuberant in making unwise investment decisions, while people after the next crisis will be irrationally subdued, and will be overly cautious in making new investment decisions.

Expect a severely depressed economy until the 2015-2020, when the new biotechnology revolution will begin to take hold.

A lot of people ask me about investing in gold. My view is this: The economy is in a long-term deflationary period right now, which means that gold is more likely to fall than rise. But if it falls, it won't fall much, and there's a good chance that gold will spike upward for a while. So gold is a good bet, since the worst that will happen is that you'll lose very little.

Another choice is Treasury bonds. Ten-year bonds are paying a little over 4% a year, which is pretty good these days, especially since you might lost 50-75% in the stock market.

You could put your money into banks, because your money will be insured -- but if you have a large bank account, make sure that you don't exceed the bank's insured amount. Or stuff your money into the mattress. It'll be safer there than in the stock market. (25-Jan-05) Permanent Link
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