February 1, 2003     Home  l  Broadcast  l  Expert Archive  l  About Us  l  Contact Us

Robert R. Prechter, Jr.
CEO of Elliott Wave International & Author
"Conquer the Crash: You Can Survive and Prosper in a Deflationary Depression"

TODAY'S TOPIC: Update 2003 on Conquer the Crash

Editor's Note:  We have edited the interview in this transcription for clarity and readability.
The original real audio interview may be heard on Mr. Prechter's Ask The Expert page.

JIM PUPLAVA:   Joining me on the program this week is Robert Prechter, Jr. He is CEO of Elliott Wave International and author of the New York Times best-selling book, Conquer The Crash. During the 1980s, Prechter won numerous awards for market timing as well as the United States Trading Championship, culminating in Financial News Network naming him as “Guru of the Decade.” Prechter is a member of Mensa, Intertel, the Shakespeare Fellowship and the Shakespeare Oxford Society. First of all Bob, I want to congratulate you for your book, Conquer The Crash, making it to the New York Times Best-Seller List.

ROBERT PRECHTER:   Thanks a lot. We worked hard to get it there, and I hope it helps some people.

JIM:   We hear much in the press today from Main Street to Wall Street with a cry for help for the government to fix the economy. I want you to take some time to explain why it can’t be fixed. I thought it best that we start out with part one of your book, Conquer The Crash. Why we are headed for a crash and a depression?

BOB:   Well, one of the reasons that the difficulty we face cannot be fixed is that the mistakes are not being made in the present. The mistakes were made throughout the 1980s and the 1990s, when the Fed helped the banking system create credit at an unprecedented rate. The last time we had anything close to that size of a credit buildup was in the 1920s, which eventually led to the crash of 1929-1932. I think the main underlying problem is one that is already there: the overbuilding and extension of credit and the flip side, which is debt. We are more in debt now than in any time in the history of the country. That is setting the stage for the problems we face.

JIM:   Throughout the 1990s, there was this myth of a new era. Corporate productivity was supposedly to have increased. The economy was creating more jobs. American companies were more profitable. I think that a lot of that myth is still with us, because there is this belief that the American economy is going to get stronger. However, there never was really a new era. As you point out in your book, a lot of that is fiction, as we found out with earnings. The debt at all levels of society has risen, just as you have mentioned. Your book talks about similar situations in the US in the 1920s and in Japan in the 1980s. Why don’t you describe, for example, some of the economic performance during this bull market, because a lot of the economic accomplishments were below normal.

BOB:   Absolutely right. Gross Domestic Product, for example, averaged 4½% per year from 1942 through 1966. That was the last time stocks had a really big move. In the 1980s and 1990s, it was only 3.2%, which is far less than 4.5. Industrial production in the 1980s and 1990s averaged 3.4% and back in the 1950s and 1960s, it was 5.3%, a very big difference again. This kind of thing is evident in all of the measures you might want to look at, including capacity utilization, which believe it or not, peaked at 91½% in 1966. In this big bull market, it peaked at 84.4%, and it is down in the 70s now. We have more capacity than we can use, obviously.

This has not been, nor was it, a new era. It is exactly the same kind of experience that we went through in the 1920s. The 1920s was an expansive period, but not nearly as expansive as previous decades. For example in the 1920s, we had a GNP increase of 48% over the eight years of bull market. In previous similar periods, it was 56% and 69%. Japan went through the same thing in the 1950s and 1960s, when it managed an amazing growth rate of 9½%. But from 1975 through 1989, when its big bull market was going on, it grew at only 4%, less than half the rate. What does this mean? It means that we have found a historical time when you can always bet on a crash and depression occurring. That happens when the stock market goes crazy on the upside and simultaneously the economy is weaker than at a recent previous time. That is exactly what we had in the 1980s and 1990s, yet not one conventional economist has commented on this. They don’t even look at numbers that are this long term. They look at month-to-month and quarterly, and that’s all they can see. But the most important message is what has been going on for the last 50 years.

JIM:  In effect, haven’t we transformed our economy? We have gone from an economy that saved to one that borrowed, and an economy that invests to one that consumes.

BOB:    And from one that produces goods to one that produces so-called services, which is really a joke. As a friend of my father’s used to say, “At the end of this, we will all make money by doing each other’s laundry.” It is a sad thing to see some of the greatest manufacturing companies of all time, that got their start in the United States, turn into lending and borrowing companies and other service companies. It is a sad thing, because it takes production of goods to make the entire economy work. You can’t have services without the goods that the services depend on. So the very thing that economists tell us is saving our economy is really another big negative.

JIM:   I think a lot of people would be surprised that a lot of our big industrial concerns, such as General Motors, Ford or General Electric have really morphed, where a lot of the profit derived from the 1990s came from finance.

BOB:   Yes, and it was the accountants who took over these companies, who figured out that they could make the books look really good this way. They were correct, but they were not correct if you take a multi-decade view. Financial booms and bubbles are rare things. You can look very good and be very profitable while the bubble is in force, if you are part of that game. But as soon as it ends, which it did in the first quarter of 2000, suddenly your profit margin shrinks, and your liabilities begin to grow and become more important than the cash flow that you are generating. I think that some of our major corporations are finding themselves in exactly that position today. That is one of the reasons why you have seen a dramatic drop in the amount of commercial paper being issued, because companies are feeling the squeeze.

JIM:   In your book, you are talking about a depression and a crash. Experts tell us we will not have a depression again. The last time we had one was in the 1930s. They say it can’t happen again. Explain why depressions occur in the first place.

BOB:   Well, the first thing you have to realize is that anytime you hear the expression, “Experts agree, when it comes to the markets and economy, you can pretty well bet against it and be safe. I think the reason that crash and depression are inevitable goes back to the very first thing we talked about at the outset of this interview, and that is the buildup of debt and credit in the system. I am certainly not the first one to recognize this as being a problem. Irving Fisher wrote an excellent paper in 1933 after the collapse, describing what the reasons for it were. He said that the build up in credit was the main reason. The Austrian economist, Ludwig Von Mises, talked about this in his seminal work, Human Action. Hamilton Bolton, one of the most celebrated Elliott wave analysts there ever was, wrote a paper on this very thing. He said that the biggest collapses are always preceded by a tremendous expansion of credit in a society. We have not only had a great buildup in credit, we have had a record buildup in credit—the largest ever. I think that fits the Elliott wave conclusion that we are entering, or are already in, the largest bear market in at least two centuries, which in turn will lead to the biggest economic difficulties in at least two centuries as well.

JIM:   In your book you forecast a major crash for the stock market. It was surprising to me in looking at the business publications and investment publications in December. The consensus seems to be that we have had three years of negative returns. We have only had one time in our history when we have had four negative returns and that was in 1929-1932. So therefore, it can’t happen again this year. I take it that you would differ or take a different view on that.

BOB:   This type of analysis is, to be charitable, quite thin to say the least. I think there are three crucial elements to market analysis. One is valuation. Another is psychology. Third is the Wave Principle, which is a price model of how the stock market behaves. Those are the three things that are most important in deciding where the market is going to go next.

In terms of valuation, I would say that there are three main bases on which you can value stocks: the dividend payout, the price/earnings ratio and stock price to book value. All three of those indicators -- we can talk about the specific numbers if you like -- still show the market as historically overvalued. There is still such a long way to go to get those numbers back into a normal range, much less into the area where you would want to buy stocks at a major bear market bottom valuation, that it is ridiculous not to pay attention to them. Three down years means absolutely nothing in the face of historical overvaluation.

Now you have the psychology problem, which you alluded to in your question. If you read the newspapers and magazines throughout late December and into January, you find that the people who are being interviewed are virtually unanimous in calling for an up year. For example, there were two or three magazines that interviewed as many as 15-30 people, major professional money managers, expert stock brokers, firm analysts and so forth, and we found that between 80 to 95% of those interviewed in those magazines were bullish. We just got the latest figures from Investor’s Intelligence, which reports twice as many bullish advisors as bearish. None of these indicators would be in this position had we actually made a major bottom in October. It is literally impossible that we made a major bottom because psychology did not reflect it and still doesn’t.

The third thing is the Elliott wave pattern. To me this is the most interesting, because we are actually approaching the point of recognition, which for Elliott wave enthusiasts means the third wave of the third wave, the center point of the decline. I think we are likely to hit it this quarter, and I think the rally attempt that we had in January was the last gasp for the bulls and we are already heading down into what could turn out the crash part of this bear market.

JIM:   You know we are finding today that despite, once again, three years of losses, stocks still aren’t cheap. Does it surprise you in many ways? And is Wall Street trading the same illusion that they did with the new era by talking about pro-forma earnings? You will see individual stocks and sometimes the markets moving. A good example is the other day Merck beat estimates, but their earnings were up 1.6% and their valuations are still high. I guess my second question is, has the lack of capitulation by individual investors surprised you? I think last year was the first time in 14 years that money went out of the market, but it was under $20 billion. The public is still fully invested.

BOB:   Absolutely. I read a statistic that said no more than 1 to 1½% of investors actually got out. This is utterly typical. The average investor stays in. He believes in the mantra he heard in the late 1990s, “buy and hold.” Well, he bought and now he is holding. It doesn’t take everyone to sell to make the market go down; it only takes people on the margin. As to your earlier question about being surprised: Actually, in one way, we are always amazed at the machinations of the market, how it can go a long way regardless of certain aspects of what we feel is reasonable valuation. But on the other hand, we are not surprised, because we have been forecasting all along that what would happen would be the largest bear market in over 200 years, something we call of “grand super cycle degree.” If we are going to see a bear market that large, it means that stocks are going to fall between 80 and 95%. The only way that the market could fall that far is for people to refrain from turning bearish. Once they are extremely bearish, by definition, you are at a bottom. Sure enough, here the S&P and Wilshire 5000 Index have both fallen 50% from their highs, and most people are still wildly bullish and fully invested. As far as I am concerned, this is rock solid evidence that indeed we are in a bear market of “grand super cycle degree,” with much more to go.

JIM:   The blue chips have held up relatively well in this downturn. If you are looking at the Dow Jones Industrial Average, I think it is down 28-30% as compared to the NASDAQ. It appears to me that what actually happened on Wall Street and maybe with some investors is that when the internet bubble burst and the tech bubble burst, investors just rotated out of tech stocks and went back into blue chips. So the blue chips have held up fairly well. Did they start to break down this year?

BOB:   In my opinion, the answer to that is a definite yes. What you are describing is what happens at every classic top. Let’s take the top of 1968, which was quite speculative. The Value Line index went to a new all time high. A lot of tech stocks were running back then. The first thing the market did was fall hard into 1970, and then, if you recall, it rallied powerfully and made a new high in the Dow Jones Industrial Average in January 1973. In fact, there was even a late rally in 1973 that brought the Dow almost back to 1000 that peaked in late October. So the blue chips were trying their best to hold up throughout that period, and people were rotating to those. There was a group called the “nifty fifty,” which were the top blue chip growth stocks. Meanwhile, the secondary issues were weak and falling. Well, the blue chips finally did succumb. From late October 1973 until October-December 1974, they absolutely fell apart, nearly a 50% loss. So, I think you are seeing the classic distribution pattern again. You are seeing an initial drop in the speculative issues, which are now represented by the NASDAQ. You saw, finally, the secondaries take a big hit last year, in 2002. The blue chips have been eroding, but I think that they are heading into their collapse period as we speak.

JIM:   What you don’t hear throughout all of this, what economists never mention, particularly when they talk about recovery, is the long-term deterioration of economic performance in the second half of the last century, which the first part of your book talks about. For that matter, do you see Wall Street talk about stock market values? It is almost as if either this is self-delusion or deliberate self-serving promotion.

BOB:   You use an interesting word. You said economists “never” mention this. I usually stay away from extreme words like that, but in this case, you are absolutely correct. I don’t know of any economists even now -- much less at the appropriate time, which would be in 1999 or 2000 – who are warning people of what has been going on long term. Recently, in this latest year, there have been one or two economists who got a little bit of press by saying, “Look; things aren’t as good as everyone is saying.” So there are a couple of mavericks who can see what is right in front of their faces at this point.

As to the question of whether it is self delusion or simply profit seeking -- trying to keep people bullish so they will buy more stock -- is probably best answered by saying that there is symbiosis between the two. Wall Street certainly wants people to be bullish. If you are a money manager, you want your customers to stay in, and the only way that they will stay in your fund is if you and they stay bullish. If you are a broker, you want your customers to buy stocks, and the only way they will do that is if you and they are bullish. But at the same time, I think the true engine of the market is general social mood, which is shared by people throughout society. The general bullishness today is shared by individuals at all levels of sophistication. I don’t think it is all a cynical attempt to make money out of the poor suckers, because it is not only the poor suckers who are bullish but almost everyone in the system as well. If you speak to individual brokers and money managers, you will find out that they lost money, too, personally. They were invested in their own accounts and their own funds, and they have been getting killed. I think that the real answer is in what I call “socionomics,” which is a study of the overall psychology that permeates society.

JIM:   That brings me to the next question, because the Wave Principle deals with this public psychology. Explain the significance of optimistic psychology, which even as you and I speak, still exists today.

BOB:   The significance of psychology, in terms of the broad spectrum of society, is that it ultimately is the engine of progress and setback. If we take for example, the recessions of 1974 and again in 1980 and 1982, people were rather pessimistic at that time, which gave them a lot of room to improve their moods. As optimism increased from 1982 until 2000, it caused people to take a lot of social actions. For example, people in business felt more optimistic, expanded their businesses and hired more people. People who were investors began to take risks with their money and buy stocks and put some of their capital to work with start up companies. It showed up in other areas. People who were feeling friskier were creating happy upbeat pop songs, until at the peak there were bubble gum heroes all over the musical landscape. So optimism has all kinds of results. Most people think that events in the outside world are causing people to become more optimistic or more pessimistic. That is actually false if you study the chronology. The optimism comes first. You can see it in the figures. You can see it in the movements in the stock market; the results come later.

An important thing to add for our current time is that pessimism works the same way. Recall that people did not talk about recession until well into 2001, but the stock market topped in the first quarter of 2000. Pessimism increased, which ultimately caused the economy to contract. People were contracting their businesses, hiring fewer people and taking fewer risks. That ended up showing in the economic figures. To answer your question, I think that ultimately, the social psychology is the engine of economic change.

JIM:   The Wave Principle is based on psychological factors, but what about some of the structural malinvestments, and let’s say the distortions, that were created by the credit boom? Don’t they provide, in one sense, the detonator for an economic and financial implosion?

BOB:   Yes, but you also have to realize what the ultimate cause of those very excesses were. It was optimism throughout the society that allowed the people to extend credit to outrageously uncreditworthy borrowers and for those very borrowers to say, “I can borrow this money because some day I will be able to pay it back. No problem.” Both sides had to be optimistic in order for credit to be expanded to the level that it reached. How optimistic do people have to be to bid stock market prices to outrageous, historically unsustainable levels? It had to be extreme. The optimism is the ultimate cause. As you quite correctly point out, that optimism has built structural problems into the economy. So when I hear one of the Fed governors assure us that they won’t make the same mistakes that the Fed made in the early 1930s, I say it is too late. You have already made two decades worth of mistakes, and you can’t escape them.

JIM:   You have made a study of stock market manias. What are your conclusions of our present mania today? It seems that the stock market, even though the technology bubble popped, still has an element of the mania in optimism. We also have, in my opinion, another mania developing in the mortgage market, consumption and real estate. Maybe people lost money in their 401ks, but their houses went up, say, 20% last year.

BOB:   For one thing, we went back and studied the major manias of the past 400 years. Most of the ones we looked at were stock manias. Some were coins, and of course there was the tulip mania of the 1630s. We found that the stock mania of the United States in the 1980s and 1990s was larger than any stock mania in history, including the Japanese stock mania of the 1980s. Every one of those manias concluded in a tremendous collapse in prices. Here is the most amazing thing: In every case, the collapse that followed the mania ultimately brought prices to below where they were when the mania started. So here is yet another piece of evidence that supports the Elliott wave outlook for the largest bear market in 200 years. One thing after another points to the same conclusion.

You mentioned real estate. We found going back that all the major tops in finance usually had a double top with stock market peaking and then real estate topping about two years later. That is exactly what happened here. Stocks topped in 2000, and I think real estate had its manic peak last year. I think it is already over and already contracting. So far, we have the same profile as all the other manias that we have talked about.

JIM:   When you make a forecast as you have done in Conquer The Crash—a forecast by its definition is about things to come—you talk about the inflation. But so far, from a monetary point of view, the money supply has not contracted. We have speeches in November by Alan Greenspan, Bernanke and Ferguson saying that basically they are going to keep the printing presses on. I guess the monetary theory is that the reason we had the Great Depression was because they didn’t print enough money, so they think that if they print more money, they can avoid it.

BOB:   This could be one of the most important questions that we are going to talk about here. Number one, the money supply hasn’t contracted. You are absolutely right. Now in recent weeks, it has contracted, but it has done so a few times, and they haven’t turned into outright deflation yet. As some of my critics have said, they think this is evidence that we will not have deflation. Of course, what we are discussing here is not current reality but the future. I think the slowdown in money supply growth is very ominous for a change to deflation. I think the markets are telling us that we are going to see another big impetus towards deflation, because the stock market is now heading down again. Gold, silver and commodities benefited from the liquidity that the Fed pushed into the system last year when it dropped interest rates a record amount, but I think their rallies in are probably tired.

The final argument I hear from inflationists is that the Fed will print money. We recently had a Fed governor promise that that is exactly what he would do, and the chairman is hinting the same thing. But there are many roadblocks to doing so. First of all, the kind of money printing they are talking about at this point is illegal. They would have to get Congress to let them do it. I think that Congress isn’t going to do that until a crisis is staring them in the face, and I don’t think that will happen until deflation is really raging. More important, I think the people in the Fed who say that all they need to do is turn on the printing press don’t realize that they don’t have a machine in front of them with their hands on the levers. What they have is a sea of people. People act differently from machines. They can get afraid. They can become excited. We have quite a bit of transparency these days, so people will know what the Fed is doing, and whatever the Fed does, I think, in this direction is going to panic the credit markets. We have 30 trillion dollars worth of credit out there. That is if you don’t count things like Social Security and Medicare promises, unfunded pension plans of corporations and a lot of other things that could probably double that figure, but let’s say $30 trillion. If you are a bond holder and you have, say, several million dollars’ worth of government bonds, and suddenly the Fed governor says he is going to turn on the light in the basement of the printing press office and start running the machines, what the heck are you going to do? You are going to sell your debt paper. If that were to happen on a large scale, it would cause a contraction of the overall supply of credit, the value of the credit, which would be deflation. So strictly in my opinion, the size of the outstanding credit we have today is so great that it would dwarf any initial efforts to keep the money supply inflated. Ultimately, once credit collapsed, purely printing paper would certainly have a hyper-inflationary effect. But first, you have to get past the credit markets. I don’t think they will stand idly by while some Fed governor prints cash.

Addendum per Mr. Prechter’s review of this transcription -

[I am, let’s say, 70% confident about deflation. But I am fully confident about crash and depression, because even if the Fed were somehow successful in creating inflation, it would not help the economy. “Printing money” seems to imply value creation, but printing notes just transfers – i.e., steals and distributes -- monetary value from savers to others. You can’t grow an economy by printing notes because it’s just a transfer of monetary value from people who are conscientious to others who are not. You might be able to grow inflation that way but not the economy. Credit is different because the lender thinks he still has the value and often does. Credit inflation is what we have had in recent decades, not money printing. It’s a key difference. So while the government and the Fed might be able to ruin the monetary unit, they can’t prevent the developing depression from taking place.]

JIM:   We also know that there are some limitations in terms of the Fed creating more credit. One thing you have to have with credit is a willing lender and a willing borrower. We are just beginning to see, at least in my opinion, signs of credit problems. We have had credit spreads widening between corporates and Treasuries. I don’t know exactly how much, but close to 11 or 13% of Fannie Mae loans are either in default or delinquent. Do we get to that point here shortly, where lenders start looking at this? I know in the corporate world, they aren’t wanting to make loans. Corporate paper has dried up. Although so far, banks are still willing to open up the spigot in terms of mortgages, refinancing homes and new credit for even bigger homes.

BOB:   You hit the nail on the head. This is not a new trend. It has been going on for two years. In terms of lending, bankers have become radically more conservative towards institutions and individuals that they think are a credit risk, and number one is corporations. For the same reason we talked about a few minutes ago, bankers are completely comfortable in lending money for real estate and houses and re-financing. Why is that? Because they are still caught up in the house mania. They think that that those loans and values are going to be fine. Just as people three years ago thought they should load their 401k’s with mutual funds, which would be fine. The bankers’ psychology is absolutely deadly. They have already become more conservative in terms of lending to businesses that might produce something to stimulate the economy, and yet they are completely sanguine about lending money to support a price boom in property, which ultimately is going to collapse around them. It is really a doubly dangerous stance that they have taken and will ultimately have terrific implications for declining property prices and deflation.

JIM:   In your book, you have a fabulous graph that takes a look at the total amount of credit in relation to the economy in the last century. Why is it you think that economists and analysts on Wall Street never look at debt as a problem? I am really surprised if you follow the circuitous thinking of how this recovery is supposed to take place. Corporations get lean and mean by firing more workers, who are consumers. This greater army of unemployed workers then goes deeper into debt to increase consumption, and this gives us a recovery? Everyone seems to want to avoid the debt issue. That, to me, is staring us right in the face as one big giant storm that we haven’t seen in this country for a long time.

BOB:   This is an amazing phenomenon, and there is only one explanation for it. Economists have become convinced over the decades that credit is some kind of economic gasoline and that contracting credit is therefore a bad thing, going out of debt is a bad thing. One Fed representative a couple of weeks ago issued one of the most amazing statements I have ever read. He was billed as the second most powerful man in the Fed, and he said he believed that as individuals, people should save more, spend less and get out of debt. Then he said that unfortunately, if we all follow this good advice, the economy will collapse! Is that the most ridiculous thing you have ever heard? He is telling you that any sane individual should be out of debt and save money, but the economy is healthy only if you don’t do what is sane and rational. Obviously there is a problem with his philosophy.

The answer is that it is bad for both individuals and the entire society to have a heavy load of debt. Unfortunately, our monopoly fiat money system, which is controlled by a central bank, has only one tool for both making money for its members and helping politicians out at election time, and that is to create credit. It is the only thing that it can do to create credit. Ultimately, it is like taking speed. You may look peppy for a long time, but ultimately you are going to collapse. There are no alternatives. You can’t say, “We won’t make a mistake, because we won’t allow this person to collapse.” He is going to. There is no question about it. The same thing is true for society as a whole as it is for individuals.

JIM:   Is there a potential in your mind for having the broader part of the economy in a mass deflation as a result of the contraction of the money supply, credit and the unwinding of all these malinvestments and poor investments that we have made, but at the same time have certain pockets, let’s say in the area of commodities, where we can see rising prices for example in gold, silver or in energy? The reason I bring this up is Marc Faber, whom we both know, subscribes to the view of deflation but perhaps partial commodity inflation.

BOB:   Well, you cannot be 100% certain about monetary trends; you simply have to study the issue and express what you think the probabilities are. To me, the greatest probabilities are that we will have a deflation, as defined by the dictionary, which is a contraction of the overall supply of money and credit. I have very little doubt in my mind that that is what is developing right now and will ripple through out the entire financial world. Now as to exactly how prices will react, historically, prices have always fallen in that situation—commodity prices, stock prices, most bond prices—right on down the line. Certainly that happened to commodities and even to silver in the early 1930s. It did not happen to gold in the 1930s because the price was fixed by the government. You can’t use that as an example in any shape or form.

The question to me is—and I try to remain open minded about this—we have to realize that money is only as good as its ultimate guarantor. When gold is your money, for example, and there is a lot of it supplying the base of the money supply, you know that gold cannot renege on itself. It is real, it is physical, and it’s providing a base for your money supply. The credit supply can contract, but ultimately, the total money supply has to stop no lower than the value of the entire supply of gold underlying your monetary system.

Today, we have no gold underlying our monetary system at all. All we have is the credit worthiness of the United States government, and that relies on its tax collecting ability. Despite my belief that gold has had a bear market rally, I can imagine a scenario in which the ultimate guarantor of the money comes under suspicion and people begin to fear that the guarantor will not be able to support the amount of money outstanding by collecting taxes, perhaps because the economy has collapsed, tax income has collapsed and government spending hasn’t been reigned in. This would be the primary reason why people might decide to buy real money and perhaps other assets with the paper cash that they have. It is an imaginable scenario.

I think the most useful way to approach this is market analysis. That is why we watch the gold and silver markets extremely carefully. So far, we have watched gold go to a new high over the past several months. Very few people have commented that silver futures actually peaked in the summer of last year. They have not confirmed the new high in gold. Usually when you get a true inflation-generated bull market, gold and silver are moving more or less together on the upside. When we see a divergence like this, we pay attention. If those highs are taken out in the silver market and gold continues past 370, 380, 390 or perhaps to 400, then I would probably concede that the monetary world is extremely worried about the integrity of the US dollar, the monetary unit itself. So far, everything has behaved exactly as it should in the classic deflationary scenario.

We are flexible, and I think as you have read in Conquer The Crash, I told people that by all means, they should have some gold and silver in their portfolio, that this is a good idea even if it might go down in dollar terms, and I can talk about some of the reasons if you would like as well. Every monetary question is open to different scenarios. I am a very stanch deflationist, but I am not dogmatic, and if the market forces me to change my mind, I will take another look.

JIM:   Let’s move on to the second part of your book, where you talk about what steps should be taken. Then I want to bring up the subject of gold again. In the first part of your book you lay out the scenario. You document the sub-par economic growth, the gross malinvestments in the economy, the extreme valuations, public sentiment and psychology. In the second part of the book you say, “This is what I recommend that you do to help prepare yourself for this crash and depression.” Why don’t you briefly mention, Bob, some of the actions that you strongly recommend that people take. Maybe what the Fed governor said.

BOB:   I don’t suppose you could add “Fire the Fed governor” to that list, because most individuals don’t have the power to that. The first big grouping falls into the category of giant errors you can make, things not to do. Number one, don’t invest in most bonds, particularly corporates and municipals. Back in the early 1930s, many bonds that did not have a AAA or AA rating fell substantially in price. And if anyone has been paying attention in the last 15 months, they will notice that Standards and Poor’s and Moody’s have been downgrading bond issues at a record pace. So bonds that used to be AA are now BB or worse. These are the kinds of bonds that will ultimately come under default pressure if we head into a depression. Don’t invest in most bonds that most financial planners will tell you are perfectly fine. I don’t think they are.

As we have already mentioned, real estate has been in a bubble, and I think that bubble has already burst and is deflating. So you should divest yourself of all non-essential real estate. You are welcome to keep your home if you see it as a consumption item, but whatever investment real estate you have you should get out of immediately and get liquid.

Some people recommend collectables. I think now is the absolutely worst time to be in collectables. Premiums have already begun to collapse in some areas that people swore would never come down, such as memorabilia, rock-n-roll records and art works. Coins peaked in 1989 and have been in the doldrums ever since. You can’t get for your stamp collection today what you could get even five years ago, much less 15. So collectables are not the place to be.

What should you do, then? Now we are into the second category, which are the positive actions you could take. The very best thing you can own is safe cash equivalents. It may sound easy, but they are rather hard to find. I think the safest cash equivalents in the world are probably Swiss Government Bonds, preferably local cantonal bonds. You can’t pick up a phone to your US broker and buy them. You have to go through a special outlet such as a Swiss bank to get them. I explain in the book how you can chase down those kinds of investments. Singapore has some bonds that are extremely safe. It has one of the wealthiest governments in the world. It doesn’t have short-term paper because it doesn’t need to borrow short term.

For the average American, I think the answer is Treasury bills or Treasury-only money market funds. I list five of them in the books that have no nuisance charges. You can write wire funds and write checks off of them, as with a bank. It certainly is a better alternative than using a bank. Still, most people have to use banking services, so I have a list of the safest banks in each state as well. There is no downside to any of these suggestions. What is the downside to having your money in a safer bank than the one you have now? It certainly can’t hurt you. Take the half a day off and do it. Look into these options, and move your money into one of these funds or into a safer bank.

Finally, I think it is important to have a modicum of precious metals. If gold and silver break out and prove that they are in a bull market, we will probably move quite a bit of money into the precious metals. Again that opens of a whole new set of questions. What types of metals should you own, and where should you keep them?

JIM:   Let’s move into that. You believe very strongly that cash is king, particularly in a period of deflation, because your buying power increases and you preserve capital. You do recommend gold and precious metals, although in the short term, you think it might be going lower, but you mentioned that you are flexible. Let’s talk about gold investments. What would you recommend in that area?

BOB:  The first thing I would recommend is not to do it through gold mining stocks. I did  a study going back about 85 years for At the Crest of the Tidal Wave, showing that gold stocks generally go down when the overall stock market goes down and up when the overall stock market goes up. The only exceptions are highly inflationary periods such as the ‘teens and the 1970s. We are not in the ‘teens or the ‘70s. We are facing a deflationary period. I think gold stocks are going to be thrown out -- in the old “baby and bathwater” story -- by money managers who have to liquidate their portfolios. I also would not recommend holding paper certificates such as futures contracts, warehouse receipts or anything different from having your hands on actually physical gold. I am not in favor of substitutes. What you want is actual bullion or bullion coins held in a safe depository in a safe jurisdiction. The safest ones in the world at present are in Switzerland and Australia. You can follow some of the recommendations in the book to get access to them. I think that storing some physical metals safely is probably the most important addition that someone could make to his holdings of cash.

JIM:   Let’s suppose that gold changes. Let’s say it hits past $390. Would you change any of your views in terms of equities given those circumstances?

BOB:   No, I certainly wouldn’t, because I think that the stock market would be falling apart, which would still stress money managers into selling their mining stocks. I do think that gold and silver are going to remain under a lot of pressure during this deflationary period. We need to remember that silver had a very strong rally in 1931 but ultimately declined in 1932. I think that is analogous to what is happening to us today. So again, this is nearly riskless advice. If they both go down, gold stocks will go down a lot more. If they both go up, and you don’t have gold stocks but you do have gold, so what? You’re participating.

I mentioned that I gave reasons why you should own gold and silver even if they are likely to go lower. For one thing, it could be different this time. I am not omniscient as to how gold is going to react in a fiat money system. Secondly, the metals have already experienced most of their bear market. Let’s not forget that silver at one time was at $50, so it is down more than 90% currently. That is a heck of a drop, so I think that on a relative basis, metals are going to hold up better than most commodities and relatively better than the prices of most goods and services in the economy. I think there is another thing you have to know: You are allowed to buy precious metals these days. When the last deflationary crisis hit in the United States, Franklin Roosevelt strolled up to the microphone in 1933 and announced that no one would be allowed to own gold any more, that it was illegal. I am not saying that scenario will repeat; perhaps there will be a ban on buying it or trading it, in which case you would be fine if you already have your position.

JIM:   What are the possibilities that somehow they really get this wrong and we have hyperinflation? Do you think it is deflation first, then hyperinflation after that? Is there a possibility that we head straight to hyperinflation? In other words, if we look at Germany in the 1920s, did they experience deflation first, then hyperinflation after that?

BOB:   What the German government was doing was printing bank notes, actual cash. What the Fed typically tries to do is to get people to borrow. I don’t think there is any chance that it is going to get people to borrow enough to overwhelm the inflationary forces. Borrowing is the problem, and credit is what is about to deflate. If they started printing bank notes, I think it would panic the credit markets. So I think we will get a deflation first. I think we will have a hyperinflation after the deflation, but that is not a monetary or market analytical conclusion. It is based on what I think is likely in politics. It is possible that what will come out of this is more conservatism, but I don’t think so. Our last national crisis, unlike Germany’s, was not inflation but deflation. Germany is petrified about inflation, and they will probably not inflate, certainly not hyperinflate. The people who are running the Federal Reserve System are definitely afraid of deflation, because that is what brought on our Depression. It is very likely that they will turn on the monetary spigots and try like crazy to reverse the deflationary forces. Strictly from what I think the political motivations are, I think ultimately our only refuge will be gold and silver. But that’s ultimately. In the meantime, you have to negotiate the waters.

JIM:   Conquer The Crash appeared in 2002. You are now going into another printing. Congratulations again! Is there anything that has changed since you wrote the first copy?

BOB:   Not a thing. In fact, I am quite surprised, because when I finished the book in March, 2002, the Dow was above 10,000. It had been rallying for six months. People were very bullish. I even printed a collage of newspaper and magazine headlines about how bullish the economy looked and how the economists thought we were into recovery and out of recession. Except for stocks being a lot lower, things have hardly changed! I could have published it today, and it would be almost as valuable for people. I think if people read it now, it will still save them a lot of agony and more losses from the stock market. But essentially, all my opinions about deflation, the stock market, the bond market, real estate and precious metals are the same. I guess if I am really trying hard, I would say that commodities rallied farther than I thought they would. But my interpretation of where they are over the long-term trends is still the same, so there has been no big change there, either.

The only thing that we have seen from the standpoint of this book was, ever since October, our sales have gone way down. It’s because people have become convinced that the stock market has hit bottom, the economy is on the road to recovery, and we are going to return to the boom days of the late 1990s any month now. I think that is incredibly misguided, and I think the people who already read the book are in great shape and are out of the way of the next collapse. I think new people will read it in the second round of the bear market. It will be later in the process, but it will help them in the long run.

JIM:   In the meantime, with the one perhaps unknown variable, is it possible, for example, that politicians wanting to be re-elected, looking at the deflationary forces, perhaps take actions, allowing the Fed to take actions or other measures that would completely try to reverse this?

BOB:   Well, they will, but politicians never act in advance of anything. They only react, and they only do so when the pressure becomes intense. Notice that United Airlines got into quite a bit of trouble recently, yet the Bush Administration declined to bail them out. Why didn’t it follow Bernanke’s prescription and buy up all that worthless paper that the airline could sell them? They didn’t want to do it. They are still being conservative. This is deflationary psychology. Even the Democrats are screaming about the rising budget deficit. That is deflationary psychology.

This is a very big barge in a very small river. It is going to take a lot of time to turn it towards the other direction. It will take quite a crisis to convince the powers that be that it is time to open the spigots and just begin to inflate at break-neck speed. I don’t see that psychology in place yet. I think that Bernanke is way ahead of the curve. He may be telegraphing what ultimately will happen, but it is not about to happen next week or next month.

JIM:   As you and I have said, it’s the end of January. If we were to look out to the end of the year, if you were to give any forecast, where do you see the Dow or the major averages by December?

BOB:   We have had three really profitable years on the bearish side of the stock market. I think 2003 is going to be the best year yet in the bear market for anyone who is positioned on the proper side, which is the short side. I don’t want to give a specific number for the Dow for this year. I certainly gave some very specific numbers in Conquer The Crash for the ultimate bottom. These processes take time. When the crisis hits and the crash occurs, it comes when few expect it. I believe very strongly that 2003 will not simply be a year of falling stock prices but collapsing stock prices. Exactly what level that panic takes the Dow, I am not sure. But I am sure it is going to be a lot lower than anyone out there is currently forecasting. Before the process has completely ended, I think we will see the Dow at less than 1000.

JIM:   If our listeners would like to get a copy of Conquer The Crash, it is in most bookstores. But Bob, tell our listeners about your Conquer The Crash website, what they will find if they go there and what you are doing to update your readers.

BOB:   Conquer The Crash came out last year. People who buy it now may say, “I wonder if this is out of date; I wonder if he has updated his ideas.” Well, anybody who buys Conquer The Crash automatically is given access to free updates on our website to all of the strategies we provide in the book. So, if we change our mind on anything or find another really good idea, we post it on the web, so people who bought the book are going to get a whole lot more value than the $19 they spent on the book. You can buy the book through Amazon, but I would highly recommend buying it through elliottwave.com, because you get these extra perks if you do it. The quickest way would be to go to www.elliottwave.com I think there is a picture of it on the front page.

JIM:   It’s on the bottom right. Well, Bob, as always, it is a pleasure to have you on Financial Sense Newshour. Your book is a real credit. I hope those who have not read it and for those who think this is the year that the markets are going to turn around like they did in the 1990s, at least do yourself a favor and pick up a copy of Bob’s book and at least see the other side of things. It is a great book, and I wish you much success with it. Great luck with the second edition.

BOB:   Thanks! I don’t know if you get enough kudos for what you do, but I would like everyone of your listeners and readers to know that Jim Puplava is ahead of the curve on all of these things. As I recall, you were the first person to interview me on Conquer The Crash for the web, and then other media began to pick up on it. I think you are ahead of the curve again, because if the market is heading down in its next big leg—which I am utterly convinced it is from all of the evidence we look at—I think you are ahead of the pack once again. Congratulations Jim, I think you are a real service to your readers.

JIM:   Thank you once again and I hope to talk to you again in the future.

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