How to enjoy an economic depression

The depression is alive and well!

Unemployment claims just came in higher than expected.

And new house sales in January were at their lowest ever. Pundits were quick to blame the snow. But sales were off even in areas that had better-than-usual weather.

Household income has gone nowhere in 10 years. Stocks have suffered a lost decade too. And now Ben Bernanke says we’d better be careful…because the recovery ain’t no sure thing.

The Fed chief has no idea. But average people know what’s going on. They know how hard it is to find a job. If you’re in the building trades…or you have only a year or two of college…you’re pretty much out of luck. You may have to retire before you ever start work again.

That’s why there was such a big drop in consumer confidence.

But look on the bright side. Building more houses for people who couldn’t afford to live in them was not exactly the greatest business strategy. And all those people who were appraising, mortgaging and selling houses can now find more useful work. Real jobs. Doing something more useful. What are those real jobs going to be? We don’t know yet. But it could take a long time to find out. And in the meantime, we have a depression on our hands…

So, let’s enjoy it…

How do you enjoy a depression? Well, the first thing is to make sure you’re not in its way…

Dear readers may not know this, but in addition to writing The Daily Reckoning your editor also has a serious job…

Yes, in the morning he is a moral philosopher…gratuitously insulting public officials, whole professions, and entire nationalities. He is grateful to them all…they make life so entertaining! Imagine what kind of world we would have if people minded their own business and got on with their lives… People would be richer and happier, we don’t doubt it…but at whom could we point a finger and laugh?

No, dear reader, the world needs its bumblers, fools, politicians (are we repeating ourselves?), grifters (sorry…we did it again!), and megalomaniacs. It needs someone to challenge the gods from time to time. Otherwise, the gods wouldn’t have the fun of whacking them. And we wouldn’t have the fun of watching.

But getting back to the point…what was the point? Oh yes, the point is we have a serious job to do too. In addition to writing about the world of money, we actually have to live in it.

You see, we have a Family Office…a little group of researchers and analysts that actually has to make decisions… In the afternoon, we have to decide. What to do? Long or short? Buy or sell?

One thing we need to be on guard against is allowing our emotions to take over. For all our deep thinking and cynical detachment, we’re human too. We get emotionally attached to our own ideas. Then, we’re very reluctant to give up on them…no matter how bad they turn out to be.

We remember…sadly…our own feet dragging after the bull market in gold of the late ’70s. We didn’t want to sell. So we delayed…we hesitated… By the time we realized how wrong we were we didn’t have to sell. The bear market in the yellow metal was over! Gold had hit bottom. Gold was down 70% from the top. Much more in real terms.

But there’s nothing like a 20-year bear market in your favorite asset class to sharpen your wits. We realized that we needed a better way…

When you’re investing real money, you need some discipline…and some rules. At the Family Office, we’ve developed a methodical approach that let’s us choose investment themes very carefully – after much thought, consultation and deliberation. And then it prevents us from making any changes…again, except with much reflection and discussion. We also have our own timing index, which would practically take an act of congress to override. If the timing index says to get out…we get out.

Why are we telling you this? Because you need to follow some rules too – or you’re going to suffer in this depression along with everyone else.

What’s the number one rule in a depression? Conserve cash. In a depression, cash goes up. Everything else goes down.

Almost everyone loses in a depression. All assets go down. Against what? Against money…cash. So, the thing to do is obvious. Get rid of your investments. Cut your expenses. Sit tight. Do nothing. When you’re given an investment opportunity, just say no. Wait until the depression has run its course.

If Japan is any indication, this could go on for another 10 to 20 years – with generally sinking prices for just about everything, but particularly for stocks and real estate.

It’s going to be hard to sit out a downturn that long. You’re going to be tempted to speculate…to get back in… You’re not going to want to be left behind.

And yet, in a real depression, getting left behind is the best you can hope for…

A year or two ago, we would have thought that you couldn’t increase the monetary base so dramatically without grave inflationary consequences. Inflation – with a lag of about 18 months – was a dead certainty. Now that we’re closer to the situation, we see that inflation may be hard to avoid…but it’s hard to summon up too. Japan couldn’t do it. And now the Bernanke Fed can’t seem to do it either.

Central bankers are talking about increasing their inflation targets from 2% to 4% in order to give themselves more flexibility to deal with situations such as the crisis of the last 2 years. But they are dreaming. They can’t really control inflation that perfectly. Maybe they can’t really control it at all, except in the grossest, clumsiest way. They have tripled the world’s monetary reserves in the last 7 years. Prices for gold and oil have responded more or less in line with the monetary base. But most consumer prices are heavily dependent on capital investment in China…housing prices in the US…and a million other things that the economists at the Fed can’t begin to control.

Of course, in extremis, as Ben Bernanke once told the world, a central bank can always create un-controlled inflation. They “have a technology known as the printing press,” he said. Crank up the presses…and let people know that you are cranking up the presses…and you’ll have price inflation lickety split.

But the financial and economic costs of cranking up the presses are so great that very rarely is any central bank…and certainly not any major central bank of a civilized nation…reckless or bold enough to do it. It’s the nuclear option of the monetary world. You have to be very desperate to take the nuclear option. We don’t think Bernanke and crew will get there…not for a long time.

That said, there are also conventional weapons…such as those being used now. One in particular…quantitative easing…packs a lot of firepower. It’s not nuclear. But it can still make one helluva mess. Stay tuned.

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