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The Next Crash

Just about everyone expects the economy to crash, in some fashion, in the next few years. The fundamentals are very bad: year after year of virtually no growth; ever-declining labor force participation; grotesquely wasteful government spending; exploding federal debt; cronyism that saps vitality from our economy; and a largely dysfunctional education system. The questions are: 1) when will the crash happen? and 2) what form will it take?

The last two crashes occurred in 2000/2003 and 2008/2009. The first represented the exploding of the tech bubble. The second followed a catastrophic decline in home prices. These two crashes were different in this respect: by 2000, everyone knew that tech stocks, the dotcoms, were overvalued. The only question was how long the party would last, and when, exactly, an investor should cash out. Some got out in time, others didn’t.

In 2008, the situation was quite different. Hardly anyone foresaw what happened. Very few understood how feel-good government policies that forced banks to make bad mortgage loans, the Typhoid Mary role played by Fannie Mae and Freddy Mac, and the little-understood consequences of securitization would come together to create financial disaster. I was probably a typical investor–when the crisis hit, my retirement portfolio was weighted toward bank stocks because they weren’t considered to be very risky.

So what form will the next crash take? The great fear, of course, is inflation. Ben Bernanke has gone on a money-printing spree without precedent in our history, to the point where we are like the cartoon character who walks off a cliff and keeps going for a while before he realizes there is nothing holding him up.

Given the Fed’s money-printing, inflation is inevitable unless everything we think we know is wrong. Lots of people saw inflation coming years ago, and invested in the traditional inflation hedges–precious metals and land, especially farmland. I confess that I was one of those who thought that Bernanke’s money-printing scheme was nothing but trouble, and therefore bought gold, and subsequently silver, some years ago. Those investments did very well. But where do we go from here? Gold and real estate have been bid way up over the last few years, in contemplation of the inevitable Bernanke burnout. So, if you assume that those particular ships have sailed, what do you do now?

Some are fleeing the stock market in anticipation of a crash, but that doesn’t make much sense. If we are about to encounter a burst of inflation, the worst thing you can do is convert your assets to cash. The second worst option is to put all of your money into bonds. By default, I think the stock market will continue to rise for the time being. I am not at all impressed by the stock market peaks that the liberal media have announced nearly every day over the last couple of weeks. Adjusted for inflation, the Dow and the S&P are considerably lower than they were 13 years ago. Many investors believe that this time it is different: this time, market valuations are justified by earnings and aren’t just a bubble. I think that is correct. I also think that for the next few years, as investors seek a haven from value-destroying inflation, equities will continue to rise, like boats driven before a storm.

All of that is rather comforting. Still, I doubt whether I, or anyone else, has foreseen the nature and dimensions of the next crash. We are all passengers on a railroad train, facing backward. We see the past and try to make sense of it. That is a worthy endeavor, but invariably, the future comes out of nowhere and takes us by surprise. Only when it has receded into the past do we claim to understand it and, perhaps, to have seen it coming.

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