Robert Prechter is expecting a devastating dose of deflation leading to a depression, and no collective body (read "government") can do anything about it. He is one of the "old-timers" who has survived the market's up and downs for more than 20 years, and his outlook on our situation is not to be taken lightly. Being high profile, his pronouncements make headlines, and it's all too easy to point to a previous mistake and write him off. However, his scholarship is second to none. He's been right in the past; he just may be right again. And if he is, most of us are in real trouble. Thus, his argument is too important to dismiss without a thorough reading.
Prechter starts with a good overview of his pride and joy, and the basis of all his study - The Elliott Wave Theory. His conclusion is that we are at the end of the 5th wave of the Grand Supercycle which reaches all the way back to 1700. We're talking big-time financial implications here.
To quote Prechter on describing the milieu we've just lived through, "Third waves are built upon muscle and brain. Fifth waves are built upon cleverness and dreams. During third waves, people focus on production to get rich. During fifth waves, they focus on finance to get rich." Sounds remotely familiar.
At the bottom of all our troubles is debt. Gobs and gobs of debt, piled as high as the eye can see. Deflation/depression results in a contraction of credit as debt gradually gets wiped out...one way or the other. It produces a line of falling dominos where less credit means less borrowing means less spending means less production means less employment...which means more liquidations which means more defaults as everything feeds on the downward spiral.
Prechter blames some of this on The Depository Institutions Deregulation and Money Control Act of 1980 which gave the Fed authority to monetize any government agency's (any government anywhere) debt. That power was recently noted in a speech on 21 Nov 02 at the National Economist's Club in DC by Fed governor Bernanke who said, "But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost." Clearly, Greenspan & Co. don't plan to sit around while deflation envelopes us. Yet, Prechter contends that the Fed's action to drive rates downward, in addition to continually reliquefying the economy via debt, also participated in the initial phase of the deflationary process.
One of Prechter's most fascinating contributions on which he's written several books ("The Wave Principle of Human Social Behavior and the New Science of Socionomics," "Pioneering Studies in Socionomics," and "Socionomics: The Science of History and Social Prediction"), is that stock market crashes produce depressions and stock market booms produce eras of optimism and economic expansion. Not the other way around. The stock market is a discounting mechanism, leading the economy, not following it. He, correctly, I believe, perceives that stock market values are a function of investor (and public) psychology. When we feel good about ourselves, we bid prices up as is evidenced by expanding PEs. When we are down on ourselves, we sell stocks down to rock bottom prices, again evidenced by low PEs. Therefore, he measures the health of the whole system based on the health of the stock market. And that, he shows us, is in very bad condition - internally weak and grossly overpriced. He even puts a potential number at where the Dow Jones Industrial Average could eventually bottom out...all the way down to 777!
From the stock market, Prechter continues on to the economy, where debt, liquidity, GDP, production, unemployment, trade and budget deficits, etc. are all laid out for investigation, and the picture is one of weakness compared with the economic cycles that have preceded our current era. It is the portrayal of a gradually slowing economy.
All of this foreboding coincides with the Kondratieff Wave (Kondratieff Winter), producing this perfect storm of financial upheaval that's just around the corner.
After laying out why things are going to hell in a hand basket, Prechter proceeds to recommend a way out for the individual investor. He summarizes a list of investment precautions to take to protect yourself from potential calamity by surveying the various asset classes available to us today.
Bonds - Risky. AAA are safest but ultimately depend on ability to service debt.
Real Estate: Lack of liquidity. Prices will collapse with everything else.
Collectibles: Coins, maybe.
Stay away from commodities except gold and silver after they bottom out.
Money market funds are suspect.
Stocks: Only inverse index funds or going short.
Cash: All assets go down in deflation except cash. Short-term Treasuries. Outside US - hold bonds and notes of strong foreign entities. Protect against hyperinflation.
If you listen to Precheter, you will, as he cautions, not be any worse off if it doesn't happen as he predicts. But if he is right, then, at the bottom, you will be in perfect shape to buy stocks, real estate, etc. at bargain basement once-in-a-lifetime prices.
The book tells you why and how disaster could happen, with a lot of evidence on its side. Will it happen? No one knows how it will play out, but Prechter has done his best to ready you for the worst. Perhaps all we're waiting for is the last straw to break the camel's back, Precheter's "The Tipping Point."