Conquer the Crash by Robert Prechter - Excerpts

Conquer the Crash: You can SURVIVE and PROSPER in a Deflationary Depression. Robert R. Prechter, Jr. 2002. ISBN 0-470-84982-7

EXCERPTS

If you follow the advice in this book and no financial crisis occurs, you cannot get hurt. In fact, you should profit nicely form most of these suggestions. Even if my outlook proves incorrect, the worst case is that your money will earn less than it otherwise may have.

… the largest stock-market collapses appear not after lengthy periods of market deterioration indicating a slow process of long-term change but quite suddenly after long periods of rising stock prices and economic expansion. A depression begins, then, with the seemingly unpredictable reversal of a persistently, indeed often rapidly, rising stock market. The abrupt change from increasing optimism to increasing pessimism initiates the economic contraction.

A bull market that has endured since the time of the Great Depression is definitely ending, and its termination could well mark the end of an uptrend of one degree larger, which has endured since the founding of the Republic.

… stock market advances and economic cycles must get weaker before they reverse. The final rise is where that weakness must be evident. Advances come in five waves, so the fifth wave is where the relative weakness manifests. The mechanism of that difference, I believe, is the immense optimism of major fifth waves, which encourages the populace to engage in financial speculation. Third waves are built upon muscle and brains. Fifth waves are built upon cleverness and dreams. During third waves, people focus on production to get rich. During fifth waves, they focus on finance to get rich.

A prime symbol of the deterioration … is the Federal Reserve System. Its manipulation of money and credit for the past 89 years … has been so destabilizing that it has transformed America from a production powerhouse into a society obsessed with dodging inflation and manipulating money and credit. A prime symbol of the deterioration in wave V … is General Electric, the oldest name in the Dow Jones Industrial Average. Through wave III ending in 1966, GE was one of the finest engineering and manufacturing concerns in the world. Its goods lasted for decades. In wave V, accountants took over the company and transformed it from a manufacturing concern into a financial concern. Today, its manufactured goods are mediocre and its vaunted company a cardboard edifice of credit services. It is the United States in microcosm.

If no dividend is ever paid, of what value is a share of stock? Do you really want to own a share of a super-successful enterprise that handsomely pays everyone involved in it except you, an owner?

Corporate earnings cycle with the stock market but with a 2-month to 2-year lag. Earnings do not begin to rise until well after stock prices have turned up from a bottom, and they do not begin to fall until well after stock prices turn down from a top. For this reason, the two trends often oppose each other. In contrast, book values and dividend payouts tend to be much steadier, cycling only on a very long-term basis with the largest economic trends, therefore providing a steady benchmark against which to compare stock prices to obtain a reliable relative valuation measure.

As I write this chapter, the “watchdog” of earnings, Standard & Poor’s, has just bowed to pressure to change the basis of its earnings reports to “operating earnings” rather than total company earnings so that the reported P/E ratio will henceforth be about half of what it really is.

The engine of high stock market valuation is widely shared optimism. The greater the degree of the advance that is to ending, the greater the optimism at its peak. Optimism also tends to remain strong in the early stages of a bear market … Bull markets, they say, climb a “Wall of Worry.” I like to add, “and bear markets slide down a Slope of Hope.”

To summarize, though my outlook may sound impossible, I am quite comfortable saying that the DJIA will fall from quintuple digits, where it is today, to triple digits, an unprecedented amount.

A pertinent observation with respect to our current concern is that a mania is always followed by a collapse so severe that it brings values to below where they were when the mania began.

Deflation requires a precondition: a major societal buildup in the extension of credit (and its flip side, the assumption of debt).

Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan generates the financial return that makes repayment possible. The full transaction adds value to the economy.

Near the end of a major expansion, few creditors expect default, which why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.

A high-debt situation becomes unsustainable when the rate of economic growth falls beneath the prevailing rate of interest on money owed and creditors refuse to underwrite the interest payments with more credit.

A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people’s desire and ability to lend and borrow. A depression is characterized in part by a persistent, sustained, deep, general decline in production.

Governments have often outlawed free-market determinations of what constitutes money and imposed their own versions upon society by law, but earlier schemes usually involved coinage. Under central banking, a government forces its citizens to accept its debt as the only form of legal tender. The Federal Reserve System assumed this monopoly role in the United States in 1913.

In 1933, President Roosevelt and Congress outlawed U.S. gold ownership and nullified and prohibited all domestic contracts denoted in gold, making Federal Reserve notes the legal tender of the land. In 1971, President Nixon halted gold payments from the U.S. Treasury to foreigners in exchange for dollars. Today, the Treasury will not give anyone anything tangible in exchange for a dollar. Even though Federal Reserve notes are defined as “obligations of the United States,” they are no obligations to do anything. Although a dollar is labeled as a “note,” which means a debt contract, it is not a note for anything.

The International Monetary Fund, the World Bank and similar institutions, funded mostly by the U.S. taxpayer, have extended immense credit around the globe. Their policies have supported nearly continuous worldwide inflation, particularly over the past thirty years. As a result, the global financial system is gorged with non-self-liquidating credit.

If the duration of recent past cycles is to repeat, then the falling portion of the current economic cycle would last another two years, and the depression would reach bottom in 2004.

The primary basis for today’s belief in perpetual prosperity and inflation with perhaps an occasional recession is what I call the “potent directors” fallacy. It is nearly impossible to find a treatise on macroeconomics today that does not assert or assume that the Federal Reserve Board has learned to control both our money and our economy. Many believe that it also possesses immense power to manipulate the stock market.

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. The spectacle of U.S. officials in recent weeks lecturing Japan on how to contain deflation will be revealed as the grossest hubris.

If people and corporations are unwilling to borrow or unable to finance debt, and if banks and investors are disinclined to lend, central banks cannot force them to do so. During deflation, they cannot even induce them to do so with a zero interest rate.

One example of action impelled by defensive psychology is governments’ recurring drive toward protectionism during deflationary periods. Protection is correctly recognized among economists of all stripes as destructive, yet there is always a call for it when people’s mental state changes to a defensive psychology.

The ultimate effect of deflation is to reduce the supply of money and credit. Your goal is to make sure that it doesn’t reduce the supply of your money and credit.

The ultimate effect of depression is financial ruin. Your goal is to make sure that it doesn’t ruin you.

The main goal of investing in a crash environment is safety. When deflation looms, almost every investment category is associated with immense risks. Most investors have no idea of these risks and will think you are a fool for taking precautions.

An added problem with owning government bonds is the political risk. Governments have a long record of stiffing their creditors in a crisis, and no government is immune from adopting that solution to its financial problems. A new regime especially may have little regard for previously squandered credit.

In the initial stages of a depression, sellers remain under an illusion about what their property is really worth. They keep a high list price on their house, reflecting what it was worth last year. I know people who are doing that now. This stubbornness leads to a drop in sales volume. At some point, a few owners cave in and sell at much lower prices. Then others are forced to drop their prices, too. What is the potential buyer’s psychology at that point? “Well, gee, property prices have been coming down. Why should I rush? I’ll wait till they come down further.” The further they come down, the more the buyer wants to wait. It’s a downward spiral.

Taking out a home equity loan is nothing but turning ownership of your home over to your bank in exchange for whatever other items you would like to own. It’s a reckless course, and it stems from the extreme confidence that accompanies a major top in social mood.

Owning an array of investments is financial suicide during deflation. They all go down, and the logistics of getting out of them can be a nightmare. There can be weird exceptions to this rule, such as gold in the early 1930s when the government fixed the price, or perhaps some commodity that is crucial in a war, but otherwise, all assets go down in price during deflation except one: cash.

Why do banks fail? For nearly 200 years, the courts have sanctioned an interpretation of the term “deposits” to mean not funds that you deliver for safekeeping but a loan to your bank. Your bank balance, then, is an IOU from the bank to you, even though there is no loan contract and no required interest payment. Thus, legally speaking, you have a claim on your money deposited in a bank, but practically speaking, you have a claim only on the loans that the bank makes with your money.

Some states in the U.S., in a fit of deadly “compassion,” have made it illegal for a bank to seize the home of someone who has declared bankruptcy. In such situations, the bank and its depositors are on the hook indefinitely for a borrower’s unthrift.

The estimated representative value of all derivatives in the world today is $90 trillion, over half of which is held by U.S. banks. Many banks use derivatives to hedge against investment exposure, but that strategy works only if the speculator on the other side of the trade can pay off if he’s wrong.

If the authorities in your country decide to disallow short selling, the bad news is that this option will be closed to you. The good news is that they usually take such actions near the major bottoms, so it will probably be about the proper time to cover shorts and start composing your “buy” list anyway.

If your government decides to confiscate gold, your country’s banks will be recruited in the operation. If it happens sometime in the coming crash, the reason will probably be “fighting terrorism.”

With the retirement setup in the U.S., the government need not be as direct as Argentina’s. It need merely assert, after a stock market fall decimates many people’s savings, that stocks are too risky to hold for retirement purposes. Under the guise of protecting you, it could ban stocks and perhaps other investments in tax-exempt pension plans and restrict assets to one category: “safe” long-term U.S. Treasury bonds. Then it could raise the penalty of early withdrawal to 100 percent. Bingo. The government will have seized the entire $2 trillion held in government-sponsored, tax-deferred 401K private pension plans. I’m not saying it will happen, but it could, and wouldn’t you rather have your money safely under your own discretion?

Bear markets engender labor strikes, racial conflict, religious persecution, political unrest, trade protectionism, coups and wars. In the area of personal behavior, part of the population gets more conservative, and part gets more hedonistic, and each side describes the other as something that needs reform. One reason that conflicts gain such scope in depressions is that much of the middle class gets wiped out by the financial debacle, increasing the number of people with little or nothing to lose and anger to spare.

Usually in a major bear market, you are less likely to encounter a mob, a criminal or a terrorist than to face state-sponsored controls within your own country or military attack from without, and there may be little that a retreat or karate can do for you in those situations.

You cannot anticipate every possible law, regulation or political event that will be implemented to thwart your attempt at safety, liquidity and solvency. This is why you must plan ahead and pay attention. As you do, think about these issues so that when political forces troll for victims, you are legally outside the scope of the danger.

Far more people in the past century had their lives wrecked or terminated by domestic implosions that by war. Whether you lived in Russia in the 1920s, Germany in the 1930s, Europe in the 1940s, China in the late 1940s, Cuba in 1959 or Cambodia in the 1970s, the smart thing to do early was to get out of Dodge.

People and institutions that best weather the system-wide debt liquidation of a deflationary crash and depression are those that take on no debt and extend no risky credit. This is the ideal situation for most people most of the time, anyway.

If you are entrepreneurial, start thinking of ways to serve people in a depression so that you will prosper in it. For example, I am writing this book. Think about what people will need when times get hard.

Don’t rely on government programs for your old age. Retirement programs such as Social Security in the U.S. are wealth-transfer schemes, not funded insurance, so they rely upon the government’s tax receipts.

Government surpluses generated by something other than a permanent policy of thrift are the product of exceptionally high tax receipts during boom times and therefore signal major tops. They’re not bullish; they’re bearish and ironically portend huge deficits directly around the corner.

Don’t expect government services to remain at their current levels. The ocean of money required to run the union-bloated, administration-stultified public school systems will be unavailable in a depression. School districts will have to adopt cost-cutting measures, and most of them will result in even worse service. Encourage low-cost free-market solutions, which will benefit both children and teachers.

The 500-Year Delta by Jim Taylor, Watts Wacker, and Howard Means.

The 500-Year Delta: What Happens After What Comes Next. Jim Taylor, Watts Wacker, and Howard Means. 1998. ISBN-13: 978-0887309113

Excerpts

“freedom to know” – a world in which for the first time in human history caste or schooling or economic circumstance no longer limits access to knowledge, a world in which knowledge itself is less important than the skill to access it.

“freedom to go” – a world in which for the first time true global citizens will have true global mobility.

“freedom to do” in accord not with professional processes or bureaucratic structures but with one’s own intuition and entrepreneurial zeal.

“freedom to be” whatever one wants to be and the obligation to exercise that freedom.

If you are going to succeed in chaos, you must connect with chaos. You must act in concert with chaos. What does that mean? It means that you must trust in intuition, trust in self.

The media today is not only the message – it is the message discriminator. And increasingly it is around those finely discriminated messages that we organize our social lives.

Jacque’s theory … what really mattered in any organization was not how many people you managed, not how much money you had under your control, but how binding your decision was on the life span of the organization.

Rainmakers – individuals who simply by virtue of their existence, their contacts, and their reputations could cause large pieces of business to move with them.

The island-hopping executive. The professional who is most willing to make life changes not in pursuit of the group mission but in pursuit of his or her own ambition. The employee who recognizes that power in a chaos organization migrates to the greatest variable, that the new success paradigm frees the individual.

Because access creates globalism, and globalism disrupts political systems by making the concept of borders obsolete. As borders disappear, the concept of taxation, which supports governments, becomes increasingly fragile.

Because leverage in a chaos world goes to the critical variables, the person able to cut the best deal in a corporation today is not the most loyal one, but the one willing to leave himself or herself the most outs.

… there is no surer way to lose customers – and lose them for good – than to sell them stone and flint when you are just about to introduce safety matches into the marketplace. That is another corollary of the acceleration of technological change. Quality may still be job one, but mediating a consumer’s risk of feeling like a fool is at least job two.

First, as new products arrive on the marketplace with ever greater rapidity, the products themselves lose value and the ideas that drive them gain value. Second, as consumers increasingly drive the economic relationships of the marketplace, the need to massively accumulate data on individual consumers increases proportionally.

Generation X has powerful subsidiary values. Its very uncertainty about its economic future is helping to turn the fear of downward mobility into the virtue of downward nobility, and the rise of downward nobility – the desire not for many things but a few good things – will drive consumerism in the years immediately ahead.

Flight impulse is building to critical mass. Undermined by the death of loyalty or liberated by the new freedoms to know, to go, to do, to be – it is all a matter of interpretation – forty-five to fifty-year-olds soon will be seeking en masse completely different lifestyles and actively plotting their flights.

As the marketplace drives toward a supersaturation of products, scarcity disappears, and with it status orientation. As mass culture breaks up into, in effect, hundreds of millions of individual realities, there can be no shared assumptions of what is enviable to own.

For most people in most industrialized nations, governments now exist as a mechanism for the transfer of payments and almost nothing more – save for their sheer entertainment value. For a radical theory, that one, in fact, is about as plain as the nose on your face. Why has the Washington intellerati failed to grasp it? Because the centrality of the political process is intimately tied to the intellerati’s own centrality – if government doesn’t matter, it doesn’t matter. Like other communes, the political commune talks mainly to itself, and thus has its worldview both set and confirmed within the confines of its commune.

In the drive toward sameness, cultural discriminators are disappearing. It is in the interest of politicians to foster the impression of international business conflict, because conflict is drama, and politicians get to star in the playlets that ensue.

If nationalism no longer has meaning, if corporate identity can float away in an instant, if you are no longer identified by your race, your gender, your sexual orientation, by where you went to college or what clubs you belong to, you can choose to reinvent your life every single day.

One of the reasons, perhaps the chief reason, the explosion in information has bred such widespread discontent is that too much information is chasing too few decision – and too little interest.

Every human life becomes, in effect, a data bank. And as that happens, everything about you – your habits, your preferences, your buying whims, your opinions – assumes a transaction worth. They become more than the sum total of your wants and needs; they become your intellectual property, to be valuated and protected as strongly as any other property you possess.

As privacy becomes rarer and rarer, it will assume greater and greater worth, and privacy management will become one of the great growth industries of the twenty-first century.

… as people become more and more aware of the economic worth of their own privately held information, they will come more and more to realize what a fortune about themselves they have absolutely pissed away. Therein lies the beginning of anger. And revenge.

Time really is money; so is attention.

For better or worse, study after study has shown that working women still can be broken into two groups: those who think that what they do is a career and those who think it is a job. Otherwise, the lives of women who work outside the house for money are virtually indistinguishable one from the other.

Like the lives they reflect, the new lifestyle discriminators are situational, deal-based. None of them relies on loyalty, because the future itself isn’t about loyalty – it’s about contracts.

“filocity” – the ability to adapt instantaneously to multiple relationships and move easily among multiple cultures.

Mass religion, we contend, is as doomed as mass culture, not because people will believe less, but because group reality is becoming particularlized and because loyalty to a single overriding interpretation of the divine is as dated as loyalty to family or to a corporation.

By definition, freedoms free, but they also sweep away excuses.

To be free to know whatever it is you need to know to pursue your destiny means that there will be little sympathy for those who fail to arm themselves with the essential knowledge to succeed. To be free to go wherever it is you need to do to pursue your destiny means that there will be little sympathy if you elect to go nowhere and suffer as a result. To be free to do whatever it is within you intellectual and physical capacity to do means that if you fail to make an attempt to do it and suffer as a result, there will be little sympathy. To be free to be whatever it is within your intellectual and physical capacity to be means that if you don’t pursue possibility and suffer as a result, there will be little sympathy.

True freedom … entails true responsibility. It is impossible to have one without the other, impossible to demand true individual rights on the one hand and claim group victimization or demand group redress on the other.

Like success, failure is a solo act; individuals alone are responsible for both.

… the only thing you can count on in your personal or professional life is that people and organizations will act irrationally.

The reality is that “families” are largely a status symbol today, a luxury for those who can afford to keep them intact.

The reality in a chaos world is that the greatest power belongs to the person who controls the most unstable variable.

The reality is that there are only two kinds of workers in any business organization: owners and employees. And the further reality is that there are only two kinds of employees: the 5 percent who would stay where they are if they were offered twice their salary to leave and the 95 percent who would be gone in a flash.

The myth of governments. the myth is that they matter. The reality is that they matter mostly to those who have an economic stake in their day-to-day operation – that is, to government employees and those who receive federal transfer payments.

The myth of action. The myth, made famous by the Nike sports-wear slogan, is just do it. The reality is that in a chaos world, you cannot “do” your way to anything. You can achieve an end only by focusing on outcome and letting each individual decision be dictated by your final goal. Don’t do it. Be it.

… the myth that reality is real. The reality is that each individual edits reality for himself. The reality is that the combinations and permutations of media choices allow each person to have an entirely idiosyncratic view of reality. The reality is that today reality is constructed.

In a chaos world … the only way to manage a life is from the edge, and the only thing you can depend on is you.

… when you can’t depend on institutions as you have known them, when you can’t depend on relationships, when converging rivers of change are rushing forward into a new world, and when uneasiness, chaos, and disharmonious conjunctions have become the organizing principles driving those rivers of change, anxiety is simply unavoidable. And we further argue that the largest part of our cultural schizophrenia – of this disconnection between attitudes and behaviors – comes not from the onrush of change, but from the fact that we are being programmed to avoid anxiety as the same time we are coming to intuitively understand that we must embrace anxiety to survive.

What do you find when you embrace anxiety? That it turns to enlightenment.

Enlightened anxiety doesn’t mean that you ignore problems or that you worry over them at random. It means that you allow problems to take their course and do the best that you can within them. It means that you recognize that there are enormous numbers of things in your personal and professional life over which you have not control, no ability to effect an outcome, and that you recognize further that there is great liberation in having no control over them. It means that you stay permanently flexible, because it is only by being so that you can achieve synchronicity with a world that has itself entered into a state of permanent flexibility, a world that is being subtly and meaningfully altered every day. Here’s the real secret of successful people and businesses: They are different every day of their existence.

Fusion creates energy. Energy feeds values. Energy plus values creates wealth.

Corporations frustrate the four freedoms by their very nature. No matter how deftly they are handled, they limit the right to know, to go, to do, and to be.

It is only by giving loyalty to your customers that you can get loyalty back in return, and it is only by recognizing that customers are under no obligation to give their loyalty that you can hold on to it day by day.
How do you prove your loyalty to customers? Not by pursuing customer loyalty, but by being loyal to your customers. In a customer-loyal world, your first concern is someone who purchased your product, not someone who might do so, because that customer with the product is now your best and cheapest billboard. In a customer-loyal world, you thank your customers, not in expectation of what they might do in the future, but for what they have done in the past. And in a customer-loyal world, you make your own value structure isomorphic with the value structure of your customer base.

To structure a business so that it meets its customers’ real lives, make the ownership of a customer relationship a fundamental part of the creation of the business itself.

Best of all, maybe, you build scarcity into products by individualizing them for the individual realities that collectively compose today’s marketplace. By becoming, in effect, a component editor for your customers, you allow them to create their own individual realities instead of imposing a collective reality on them. Nothing, finally, could be more scarce than that.

Instead of the old rules of social behavior that required us to build relationships based on a reciprocal self-disclosure of information, we build them instead on a systematic sharing of information in the service of the deal at hand. And when the deal is done, we all walk away.

… pseudo-intellectuals actively pursue an entry in Who’s Who, while real intellectuals flee from such exposure. Why? Because it is in the culture of the tribe of pseudo-intellectuals to want recognition – recognition is the validation of their pursuit – while it is in the tribal culture of real intellectuals to be eternal outsiders.

The rules of such exceptional intelligence are very simple for children: Never acknowledge it, not even to yourself, and never flaunt it in from of others. Yet very smart children almost inevitably know they are very smart, and from an early age. They understand things before other children even begin to grasp the question, and they are too smart to miss that fact. Other children see it too, and being to organize their own tribes in defense against such intelligence.
Thus is born what is known as the “dilemma of the genuinely talented individual”. And thus, too, arises the fundamental ethic of the tribe of true intellectuals: never pursue celebrity and never care what others think about you.

… “privilege” implies conspicuous consumption when it is inconspicuous consumption, stealth wealth, and downward nobility that are helping to drive the dynamic of the marketplace today.

Avoid the activity trap. Manage choices out of your life, not into it. In the storm of information washing over you, realize that only a tiny fraction of it is germane to your own goals and that it is that tiny fraction on which you absolutely have to concentrate. Take a nap, catch an afternoon matinee. Conserve energy and you’ll have more of it for the things that really matter. You’re the boss; you’ll make sure you get the job done on time. That’s freedom, too.

… the ones most likely to have achieved satisfaction – the ones most likely to have internalized that they don’t have to overspend their capability in order to achieve very high levels of social and self-esteem – are people who are living ordinary lives extraordinarily.

Stop thinking of your customers as a mass market and start thinking of them as a mass of individual collectors.

In an age in which raw intelligence is the most prized commodity, being thought stupid is the greatest fear. Making customers feel stupid is the worst sin a business can commit.

What does risk management mean at a personal level? That the only way to manage risk is to embrace it. That the only way to cope with risk is to swim in it, dance with it, let it happen. A victim says that the world is at fault for exposing me to this risk. A thrivalist – a person who not just survives but thrives – says that every risk is an opportunity.

… even if you are not robbed or shot or bombed or vandalized during your adult life, even if you somehow escape the mortal lock, the only way to survive in a chaos-based world is to be 100 percent prepared for all those things to happen. Ducking for cover and planning for disaster aren’t just exercises for the nuclear generation. Today they are exercises for sustained reality – and for corporations more so than any other single entity.

Take out a sheet of paper. Write down the ten worst things that could happen to your business in the next five hundred days, the next five hundred weeks, and then start acting as if they will happen, because in a chaos world they or something very similar will.

Write down where your own business’s moats are, where and how fortified your castle walls are, where the intellectual property of your company – its secrets, its private systems – is stored, who has the key, and how many keys there are.

The best thing to do when you are lost is wait to be found.

Our advice: Find your own sacred site, not ours, a place where you can sit on the edge and look back to the center. There is no greater clarity to be found anywhere.

Listen, escape your own white noise, and you’ll be astounded by what you will hear.

It is only by concentrating on the inevitability of disaster that you can free yourself to pursue the fruits of possibility.

The critical issue in planning today is not how to get there. The critical issue is where you want to be.

It is not products per se that consumers want. Products are everywhere, generally at deep discounts. In a world starved for scarcity, uniqueness gains value. And it is only by focusing on points of distinction that you can produce uniqueness within your category.

Nothing holds you back but the reluctance to exercise your own Freedom to do, and beyond that, there can be no asking for more.