Posts Tagged ‘Paul Volcker’

How do we prepare for a possible economic crisis?

Sunday, June 29th, 2008

We will continue with some of our readers’ questions from our previous article, What is a crack-up boom?:

My comment/question is how do you plan, as a family, for an event that is this big and catastrophic and that could happen any day over the next 10 years, or take place ?slowly? over months or years (or really is happening already at some rate)? Buying gold it seems is a good investment strategy, but not a complete preparation by any means.

Is another great depression an inevitable event that will occur sometime in the near future? Can it be AVOIDED or at least, the effect minimised with any sort of human intervention? My main concern would be that I am still in the early stage of my career and have not yet accumulate sufficient wealth to withstand any significant recession/depression.

Personally, I think it would be great (if you have the time) to see an article explaining why it’s unlikely; and perhaps explaining how – given the stark possibilities we’ve been shown – it will be possible for the US (and the rest of the world) to NOT enter an inflationary or deflationary recession.

To be honest, we do not really have all the answers to these questions. This is because what we are experiencing today is unprecedented in the history of humanity. Therefore, history can only be a limited guide to what is to come. As we said before in Epic, unprecedented inflation (remember, that was written 12 months ago, when the bear market had not yet arrived),

Today, the world is experiencing an unparalleled inflation of asset prices. This is the first time ever that the world is experiencing asset price inflation in all asset classes (e.g. property, bonds, commodities, stocks and even art!) and in all major nations (e.g. US, China, Japan, Australia, UK, Russia, etc). We will repeat this point again: never before had such a universal scale of asset price inflation ever happened in the entire history of humanity! Today, even artwork is also in a ?bull? market (if you consider artwork as an asset class)!

Since 1971 (when President Nixon severed the final link between gold and the US dollar), this is the first time in the history of human civilisation that the entire world is using freely fluctuating and pure fiat money (see What should be your fundamental reason for accumulating gold? for the meaning of what fiat money is).

Therefore, we must impress upon you that we do not know what the future holds and hence, are not making any predictions. Understanding what is to come lies outside the realm of economics and finance, into the realm of psychology, politics, sociology and so on. The latter group are outside our circle of competence. As such, this topic is full of Black Swans. As we said before in Failure to understand Black Swan leads to fallacious thinking,

For this reason, that is why we delve more on the big picture and economic history and get mired less on minute statistics and detailed numbers. In technically philosophical terms, it means we are taking on a meta-view i.e. we are taking on a view of our view. At times, this means we have to expand our circle of understanding and venture outside of finance, investing and economics into fields such as psychology, politics and history. The broader our circle of wisdom and experience (that includes borrowed experience from a study of history), the less vulnerable we will be to being caught out like that turkey.

Thus, your guesses of the future are as good as our guesses. Here are some of our thoughts…

A lot will depend on the level of law and order if/when the epic economic crisis happens. In the United States during the Great Depression, there was still a functioning government, with law and order still functioning. We can think of modern examples of countries that are not so lucky: Rwanda, Yugoslavia, Somali, Congo, and so on. If anarchy reigns, we doubt money in any form would be useful- guns, food and survival equipment may be better bets. On the other extreme, we can imagine a potential demagogue secretly practising his incendiary orations in some back rooms today, to be used tomorrow to seize absolute power and authority- a case if ‘too much’ law and order.
As David said, buying gold may be a good idea. But gold ownership was outlawed in the United States during the Great Depression. Currently, Vietnam is banning gold imports (see Vietnam Suspends Gold Imports) as price inflation surges to 25%. This is another example of Black Swans. For our United States reader, this is one thing to bear in mind.

Can an economic catastrophe be avoided, or at least be minimised?

Firstly, the coming ‘catastrophe’ may not happen in a way that we expect, in a manner that we may recognise today as a conventional ‘catastrophe.’ Would life under the coming ‘catastrophe’ be some form of hellish tribulation or just a very difficult disruption of the life, as we know it? The answer may depend on the context of which country/currency/region you live in. The Middle-East is the place we would like to avoid. Australia, the “lucky country” may be a safer place. There is a possibility that we may have to revert back to a much simpler lifestyle (e.g. cycling to work, planting our own vegetable gardens, no television at night, etc). Maybe the financial markets as we know it, will be completely different and much simpler under an overhauled system (e.g. a gold standard)? Some may welcome this while others may fear it. For those who live in the third-world countries, it may not be any difference.

Who knows, perhaps another Paul Volcker may take on the helms of the Federal Reserve? As we said before in Peering into the soul of Ben Bernanke,

In a way, Paul Volcker, the chairman of the Fed in the 1980s, is the anti-thesis of Ben Bernanke. He was credited with ending the US?s stagflation crisis in the 1970s by crushing the economy into the worst recession since the Great Depression. To do this, he had to raise interest rates to unbelievably high levels, to the point that in 1981, interest rates charged by banks exceeded 20 percent (Note to Australian readers: the Labor was often blamed for the super high interest rates of the 1980s. Now you know where such high interest rates come from- such high interest rates was a global phenomenon). Paul Volcker crushed severe inflation by crushing the growth of money supply.

If such a person heads the Federal Reserve today, you may want to consider selling your gold straight-away. On the other hand, with the United States mired in so much more debt than in the early 1980s, can such a harsh medicine work without killing the patient?

Can an inflationary/deflationary recession be avoided?

Well, how do we see ‘avoidance?’ Back in 2001, the United States briefly dipped into a very shallow recession before the economy bounced back into growth. But did it really avoid a recession? Or was it merely postponed? Back in November 2006, as we said before in How will asset-driven ?growth? eventually harm the economy?,

In 2001, when the US economy was faced with a threat of recession, the Federal Reserve embarked on an expansionary monetary policy (aka ?printing money?) in an attempt to prevent it from happening. We believe this policy does not prevent a recession?it merely postpones it, in which the upcoming one will be more severe instead.

So, if the world manages to ‘avoid’ another severe recession, will that be setting itself for an even larger one down the track?

With such a colossal amount of debt owed today, the consumption of the present generation will consign the future generation to slavery paying off what was owed by their parents. If Peak Oil is true, how can the future generations have the capacity to do so? Who knows, perhaps a new technological breakthrough is about to happen, bringing us to a new paradigm shift? This looks to be the only way for both inflation and deflation to be ‘avoided.’

Are young people more vulnerable to an economic crisis?

We believe that having a large nest egg is no guarantee as much as having a minuscule one. When inflation strikes, the purchasing power of any nest eggs will be severely eroded very quickly in no time. For example, say you had accumulated 1 million Zimbabwe dollars for your retirement. But today, that nest egg is worthless through hyperinflation, unless you have a foresight to convert that to foreign currencies or gold BEFORE it happens. Our point is, to protect yourself against hyperinflation, it is not how much you accumulated that makes the difference. It is what you hedge it with that means the difference between the poorhouse and a much better life. With deflation, no matter what amount of nest egg you have is useless if your counter-parties (e.g. bank, superannuation fund) default on their liabilities to you. See Should you hold gold or cash in times of deflation? for more details on this.

For young people, you have one advantage that the old folks does not have- the energy and drive to learn new skills and embark on useful enterprises/projects that may be far more useful and relevant in a tougher and different economic scenario. In that sense, retired people are far more vulnerable than young people.

What are your thoughts on how to prepare for an economic crisis? Share them at this forum!