The Bear’s Lair: Liquidate, liquidate, liquidate

The above was the supposed advice of Treasury Secretary Andrew Mellon to President Herbert Hoover after the Wall Street Crash of 1929. It was good advice, which Hoover did not follow, thus landing the country in a decade of Great Depression. However, if Mellon’s advice was good after the crash, how much more intelligent would it be to follow it before the bubble has burst, as today?

Mellon’s advice was good on an individual level and on an economic level, when he is supposed to have said it, around the end of 1929. On an economic level, there had been a great deal of unjustified over-investment in the 1920s boom, caused by an excessively loose Fed monetary policy (where have I heard that before?) so liquidating it was necessary to get down to a base of sound investment that could be built upon. This had been done in 1920-21, and it produced a sharp but mercifully short recession, followed by a decade of remarkably robust growth. Had this policy been followed in 1929-30, the result would doubtless have been similar – as it was in Britain after 1931, where Neville Chamberlain followed essentially Mellon’s prescription.

On a personal level, when Mellon made that statement, the stock market had roughly halved from its peak, and was to enjoy a modest recovery in the first half of 1930. Anybody who followed Mellon’s prescription and went into cash at that point, would have found that cash worth some 30% more in terms of purchasing power by the bottom of the recession in late 1932 – and worth 500% more in terms of the stocks it could buy. Anyone who followed Mellon’s advice in 1929-30 and went back into the market anywhere near the bottom would have enjoyed a prosperous 1930s. John Paul Getty, in the 1950s the world’s richest man, was asked how to become a billionaire (real money in those days). He responded: “Start as a millionaire and buy in 1932.” It was an opportunity never to be repeated.

Both individually and economically, Mellon’s advice would appear to apply with additional force today, with the important difference that we have not yet had the Wall Street Crash. That means for an individual, there is no psychological problem of regretted millions, which you would suffer from selling after such a crash. If you sell today, you know you are selling near the top. You may miss a last upward burst, a last speculative frenzy, but think about it: how upset do you think were those who sold in say March 1929. For six months, they suffered mockery at fashionable cocktail parties, yes. After that… Avoiding the huge losses of a crash is well worth suffering a little short-term mockery.

The only difficulty is deciding how to invest the liquidated proceeds. Pay off all debt, obviously; even if it appears cheap I can tell you from experience that debt payments can suddenly loom very painful in a downturn, when income sources have unexpectedly disappeared. However, merely stashing everything into cash is not as sensible as it was in 1929. In 1929 the U.S. was on a Gold Standard, so cash was unlikely to lose much purchasing power, and might earn a little interest. (Relying on gold clauses in any bond investments turned out to be foolish, however; President Roosevelt was to repudiate such clauses, for the Federal government and everybody else, in 1933, thus making them forever suspect as an investment protection. It was a disgraceful act of tyranny, but that is what you get when the SOBs vote Democrat and the Supreme Court wimps out, as it did in 1935.)

This time around, loss of purchasing power on cash holdings is more or less inevitable. In that respect, we are in 1973, not 1929. For those too young to remember, there was yet another episode of Fed monetary profligacy to get President Richard Nixon re-elected in 1972 (all wasted, as it turned out, because the Democrats found a way to steal a landslide through a phony impeachment; rest in peace G. Gordon Liddy.) That resulted in a massive surge in commodity prices in 1973, followed by a surge in reported inflation in 1974. Sound familiar? Nixon having been forced out of office, President Gerald Ford responded to the inflation by printing “Whip Inflation Now” buttons.

Those might have worked – you never know – but alas, within six weeks of the unveiling of the “WIN” buttons further economic data revealed that the economy had gone into a major recession, at which point Ford and the Fed together reverted to the usual political solution of throwing money at the problem, and the inflationary fight was abandoned. To be fair, Ford was overall the only President in the last half century under whom Federal spending declined in real terms, but this was not enough to cure inflation, it merely got him defeated for re-election in 1976. President Jimmy Carter went on spending money, until being scared straight by the bond market in the summer of 1979, at which point he fired the Fed Chairman, appointed Paul Volcker, and the rest is history.

We are now in the incipient stage of a return to 1970s stagflation, as I forecast a year ago, at which point I forecast a double-digit rate of inflation by the spring of 2022. March 2021 saw a Producer Price Index rise of 1.0% (12%, annualized) and a Consumer Price Index rise of 0.6% (7.2% annualized) so we are well on the way to that result, which was caused by the 20% plus rise in M2 money supply in the spring of 2020, as well as by the inefficiencies of shutting down the global economy and re-opening it. Further inflation will be caused by the excessive bursts of Federal “stimulus” and spending in general that are being instituted – that should extend the accelerating inflationary trend into 2023.

How far we go beyond low double-digit inflation in the early part of next year depends on the political reaction to inflation’s re-emergence. On current form, the Fed and the Biden administration will ignore inflation for as long as possible, then attempt to re-define it, then claim it is a temporary blip, then finally do something as ineffectual as Ford’s “WIN” button (yes, it might work this time; again, you never know!) What they will not do is raise interest rates, because it would crash the stock market and every known asset market, all of which are grossly over-leveraged. The Biden administration also will not stop spending money; the period of spending restraint is unlikely to last as long as six weeks this time, and Biden is certainly not going to be the second President in 50 years not to increase real Federal spending.

Economically, it is more than clear that a massive de-leveraging is needed – a liquidation well beyond the scale of what Mellon recommended in December 1929. Everywhere you look, debt is increasing with unprecedented speed, in both public and private sectors and is being funded by feckless central banks. The trend is worsened by the approaching bankruptcy of rich countries’ pension and medical systems, most notably in the United States but in many other countries as well. For the global economy, this period of de-leveraging will be excessively painful, which is why policymakers for the last two decades have strained every sinew to prevent it happening on their watch. Given the incentives involved, the only way out appears to be a burst of hyperinflation that wipes out liabilities, at the cost of impoverishing the most provident citizens and institutions and destroying productivity.

Which is why the question of what to hold once you have liquidated is such a difficult one. Money itself has no intrinsic value in the current system, nor does anything else. This makes the search for a reliable store of value almost impossible. Gold will help you against hyperinflation, and you should certainly hold some, but an overall collapse of values and economic activity probably collapses the value of gold as well. It is interesting that Bill Gates has put much of his gigantic wealth into farmland; I can see the appeal, but in a general collapse property rights collapse as well as values, so he is most unlikely to be able to keep it. For those of us less well endowed, a modest, remote rural farm, with a shotgun to deter marauders, a generator, and a supply of fuel for the generator and the combine, may be the only refuge from universal economic disintegration.

As for shares in loss-making tech companies? Don’t make me laugh – in the next recession they will be the worst investments of all.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)