‘Before anything else, preparation is the key to success.’
Alexander Graham Bell
The time to make rational decisions is BEFORE the proverbial hits the fan.
Having a clear, well-thought through plan is absolutely critical to surviving (and eventually thriving from) a market intent in correcting the greatest period of excess in history.
When previous bubbles have busted, years of gains were wiped out.
Does anyone really believe this time is going to be any different?
And, if they do, have they thought through the consequences of their history-defying decision?
Sadly, the Fed has set us up for a monumental failure.
The interest rate and stimulus props placed under the market’s exponential structure misled investors into thinking ‘the Fed has our back’ and shares were magically transformed into a ‘risk-free’ investment class. Nothing could go wrong.
But reckless behaviour always comes with consequences…sometimes sooner and other times later.
As John Hussman wrote in his latest Monthly Comment, ‘…the deferral of consequences is very different from the absence of consequences’.
The Fed’s actions and those of investors who believed this flawed institution was omnipotent (more superior, stronger, and smarter than market forces) have consequences.
The period of deferral is over.
In the coming months, the reaction to a decade of reckless action will be evident for all to see.
Those who developed a plan based on the boom-time mindset of ‘shares for the long term’, will, in a state of panic, abandon their plan.
Happens every cycle. Which is why shares prices rotate from over- to undervalued.
Nothing startling about this fact…yet it still amazes me that people do not believe it will happen.
All sorts of myths and half-truths will spook the unprepared into acting against their own best interest.
Cash to be coronated king
What happens on Wall Street will most definitely NOT stay on Wall Street.
Every asset category in every major economy will be impacted…negatively or positively.
Cash will once more be crowned king. Just a thought here…could the universe be so devilish as to time the coronation of cash with King Charles’s in early May?
But there are those who harbour doubts about the regal status of cash. In the minds of some, cash is not the safe haven it once was. The prospect of bail-ins has people spooked.
Personally, I think these fears are unfounded. Those drumming up public suspicion tend to have vested political or commercial interests (gold bullion dealers).
If you know how the Financial Claims Scheme operates and apply a little logic to how the political process works — politicians will do whatever it takes to restore public calm — then you can make a rational decision on how best to allocate your cash holdings for maximum security and peace of mind.
Prepare for the worst, hope for the best
My approach to long-term capital preservation and appreciation is to prepare for the worst but hope for the best.
Having been through three major market crashes — 1987, 2000/02, and 2008/09 — the instinctive reactions range from concern to panic.
All it takes is a few to create enough momentum for the many to escalate their concern into fear.
Rumours abound. Rational thinking is abandoned. Indiscriminate selling takes hold. Queues form outside banks.
And that’s just what I’ve witnessed from what have been ‘average’ market downturns.
While society is plagued with anxiety, economic activity tends to contract. People act with restraint on both discretionary and major spending.
However, as mentioned in last week’s Daily Reckoning Australia, the economy does NOT come to a grinding halt. The wheels of commerce still turn…albeit at a slower rate.
Should we suffer a significant fall in global asset markets, then knowing this fact in advance should stop you from falling for the panicked response of ‘the economy is going to come to a complete standstill’.
As we’ve seen in the case of Greece (often referred to as ‘an economic basket case’) this simply isn’t true.
But what about the Great Depression?
According to History.com:
‘The Great Depression was the worst economic downturn in the history of the industrialized world, lasting from 1929 to 1939. It began after the stock market crash of October 1929, which sent Wall Street into a panic and wiped out millions of investors. Over the next several years, consumer spending and investment dropped, causing steep declines in industrial output and employment as failing companies laid off workers. By 1933, when the Great Depression reached its lowest point, some 15 million Americans were unemployed and nearly half the country’s banks had failed.’
How bad did it get?
‘The Great Depression affected all aspects of society. By its height in 1933, unemployment had risen from 3 percent to 25 percent of the nation’s workforce. Wages for those who still had jobs fell. U.S. gross domestic product was cut in half, from $103 billion to $55 billion, due partly to deflation. The Consumer Price Index fell 27 percent between November 1929 to March 1933, according to the Bureau of Labor Statistics.’
They’re pretty devastating statistics…the likes of which we cannot comprehend.
On the flip side, a 25% unemployment rate meant there were still 75% employed.
While GDP fell in half, there was still US$55 billion circulating in the economy.
Deflation lowered CPI by 27%…meaning, on average, it was only costing 73 US cents to buy something that was previously valued at US$1. That’s good news for those with cash.
If or when the US share market suffers a fall far more than the two previous market collapses, then we should be prepared for statistics that will take us well outside our comfort zone.
Unemployment will rise. Wages will stagnate or could even fall. GDP and CPI will both go into negative territory.
This is deferral of consequences…the contractionary ‘yin’ to the expansionary ‘yang’.
Given that the banking system is at the heart of our economy — as the economic news worsens — we can expect anxiety (along with blood pressure) levels to go through the roof.
This is what happened during the Great Depression:
‘In the fall of 1930, the first of four waves of banking panics began, as large numbers of investors lost confidence in the solvency of their banks and demanded deposits in cash, forcing banks to liquidate loans in order to supplement their insufficient cash reserves on hand.
‘Bank runs swept the United States again in the spring and fall of 1931 and the fall of 1932, and by early 1933 thousands of banks had closed their doors.
‘By [Presidential] Inauguration Day (March 4, 1933), every U.S. state had ordered all remaining banks to close at the end of the fourth wave of banking panics, and the U.S. Treasury didn’t have enough cash to pay all government workers.’
Newly-elected President Franklin D Roosevelt (FDR) moved to reassure the American people of the safety of the banking system.
Part of the FDR Administration’s reform was the introduction of the Federal Deposit Insurance Corporation (FDIC).
The FDIC still exists today…providing a US Government insurance limit of US$250k per account held by FDIC-approved institutions.
The FDIC was a game changer for social mood.
We saw the same psychological effect here in Australia — in late 2008.
Prompting the federal government to introduce the Deposit Guarantee Scheme.
Cash is the lifeblood of an economy
Whether we like it or not, the system is (literally) geared to operate on a cash basis. Money needs to flow through the system to keep the wheels of commerce turning. Community confidence and calm needs to be maintained…as we saw during the pandemic.
Therefore, governments will prioritise the security and safety of the banking system. Unlike Cyprus and Greece, Australia can print its own currency to maintain solvency in the banking system.
What could happen if things get far tougher than we might realise?
Here are some guesses:
- A bank freeze — so keep a stash of cash (3–6 months living expenses) on hand.
- Deposits of less than $250k to be guaranteed by the government. BUT you will not be able to physically access this cash. Which means the government really doesn’t have to come good with the money. However, when you look at your bank statement, it’ll show that you have 100 cents in the dollar if your deposit is under $250k.
- Capital controls will be introduced — restricting access to physical cash of $100 or so a day.
- Still being able to buy and sell assets with the electronic transfer of cash. That suits me fine. If shares are trading at 50–70% below current values, I’m happy to swap my cash (via an online broker) for a share certificate and have the dividends paid electronically into my account. Property purchases will also be transacted via the electronic transfer of funds.
- Eventually, the freeze will thaw. This could take months or years. But so be it.
These are just ‘worst-case scenario’ guesses.
Being mentally prepared for such outcomes — even though you hope it won’t get that dire — is why holding cash doesn’t bother me.
Until someone can come up with a viable alternative — and by that I mean not putting all my money in gold or Bitcoin [BTC] or putting cash under the mattress — then I’m sticking with spreading our money around several Authorised Deposit-taking Institutions (ADIs).
Next week, in Part Three, we’ll take a look at how the Financial Claims Scheme operates.
Editor, The Daily Reckoning Australia