Unintended Consequences

To buy stocks right now is to bet on the willingness of the major central banks (that is, Europe, the Federal Reserve, Japan, and China) to create as much money as possible to prevent a stock market and economic disaster.

Prudent analysts say the ratio of a country’s debt to its GDP is already too high for many countries. Our view is that no one knows what is too high.

Whether debt is 100% or 260% (Japan) of GDP, who says the central banks can’t double it? Who is to say that in a market crisis, the Fed or BOJ in Japan can’t double their monthly infusions? In fact, we consider that ratio somewhat artificial and perhaps meaningless. GDP measures total economic activity. What does it have to do with the government’s debt? The government doesn’t produce the GDP. It’s comparing apples and oranges. It would be more relevant to compare governmental debt to tax receipts.

Before the Greenspan/Bernanke era, the current rate of money creation would have been unthinkable. But anything and everything is possible now. Imagine, the Fed is now buying from 70%-80% of all Treasury securities sold to finance the deficit. There is no reason it can’t go to 100% or higher. We are not saying it is good or prudent, just that there is no limit… until no one wants to accept your currency.

Believing that at some point the central banks will “get religion” and reverse their questionable policies is like believing in Santa Claus. History shows that the worse the conditions become, the greater the policy errors of governments. Just read about the German hyperinflation of the early 1920s, or Zimbabwe, or China, or John Law in France. To have a sense of history now is to be ahead of the pack.

Former Office of Management and Budget Director David Stockman under President Reagan warned in early April that “yet another unsustainable bubble” will burst and “America will descend into an era of zero-sum austerity and virulent political conflict, extinguishing even today’s feeble remnants of economic growth.”

Washington was outraged by these statements. Stockman made news in 1981 when he went against his President and warned that the Reagan deficits would ruin the economy. He was wrong then, and we said so at the time. He has been wrong since and may be wrong again, although now his forecasts have a better chance. His theory is correct. Ultimately, you cannot print your way to prosperity.

No one can forecast the future with infallible accuracy. An eventual change in Washington or at the Fed could reverse the course of the economy. But no one can predict such events. Let’s look at history. In 1978, the Fed began its big money creation period. It took two years before the wheels fell off the cart. Inflation was in the double digits and the prime interest rate soared first to 20% in early 1980, and after a brief plunge, soared to a new high of 21.5% by the end of 1980.

Many of our friends and colleagues recommended stocking up on food and gold and preparing for the “end of western civilization.” That was the term used.

We disagreed. At conferences, after predicting a deep and serious recession, and profiting from selling stocks short, I said that we would come out of it. And we did, with the recovery that started in 1983. It was “Reaganomics”, with the efforts to reduce the role of government, that accomplished the turn. At the same time, Europe was lead out of the morass by Margaret Thatcher. The world is resilient.

Let’s fast forward to now. How long will it take until the real unintended consequences of the massive stimuli in the US and Japan show up? The day of reckoning will come and we using our methods of analysis expect to catch it once again, as we did in 2007 and in early 2000. The massive reflation efforts of the Fed starting in 2003 created the huge housing and derivative bubble which eventually imploded in 2008. Unintended consequences occur when government interferes with market forces, as it is doing now.

Currently a weak economy is still bullish for stocks because it assures a continued accommodative Fed money printing policy. We aim to make some great profits on the way up and again on the way down, as we have done in prior crises of the past 35 years. You must be sure you have the advice of someone who has avoided the big crashes in order to protect yourself. This is no time for a “perma-bull” or a “perma-bear.” You must “go with the flow.”

Bert Dohmen, Founder
Dohmen Capital Research, Inc.

Note: If you want a roadmap for the next crisis, and how to read the signs before the crisis destroys your nest egg, read Bert Dohmen’s book about the 2008 crisis, FINANCIAL APOCALYPSE (www.dohmencapital.com). It shows with charts how that crisis was predictable and how Bert Dohmen’s analysis and advice allowed his clients to make big profits during the meltdown.