Here come the skeptics....

It's inevitable when someone comes out with such crazy notions as DOW 3000 that the critics would come out of the wood works.  My recent video comparing Dow 1929 to Dow 2009 is of course no exception.  Alas - a prophet is never welcomed in his own land.  The theory of contrary opinion is a tough position to back.  It's not popular.  That's why it's contrary.  Yet in the stock market it has been proven to very often be correct.  Even if the position is wrong but it provides a position of caution, it is still worthwhile.  

Yesterday I received a very thoughtful email from a student who was simply passing on some points of discussion from a friend.  With our student's permission I am posting excerpts from our exchange.  I figure it's easier to answer the critics as a whole rather than one by one.  So please enjoy the discussion.  

Jeremy/Josh, I have been constantly bragging about the stuff you teach in class with my friends and family. In one of these scenarios one of my friends pulled about your blog recently and has the following views about your blog write up.  I would appreciate your responses on his comments He (Jeremy) is an extreme bear, if he really believes in everything what he says.

Yes - right now it is true.  For the first time in my life I have been converted into a bear.  I have been bullish on the market for the last 15 years.  Even through the 2000-2002 downturn I was a believer in a strong recovery following the correction.  I was also strong on the economy and the market through the fall of 2008, and into 2009.  Strong in the sense I was a believer in the recovery.  I still traded the downside and in fact we made more money last sept/october than I've ever made in my life as a trader.  But I was bullish in the over all strength of the progression of the economy.  However I have come to understand some things about market swings, corrections, and macro level cause and effect that has caused me to turn bearish. I will likely remain bearish for the next several months.  At least until we see Dow 3000.  

He looks at US economy in isolation, and predicts equity markets crash (like Dow crashing to 3000) and hyper-inflation, with dollar plummeting. This scenario is worse than ‘stagflation’, which some economists believe will happen. Stagflation is ‘stagnation – no growth in economy’ plus inflation (moderate to high). The problem with his worst scenario is, when the market crashes to 3000 or a very low number, people stop spending, because their wealth has come down, and many would have lost their jobs, and the inflation cannot go too much up. These two opposites cannot merge.

Yes I'm specifically looking at/discussing the US economy.  First of all it's the economy I'm trading.  Secondly it is the largest economy in the world and all other economies ultimately in some way are affected by the US economy.  So I don't quite understand the isolation issue - but with regards to hyper-inflation and dollar plummeting....

Yes I'm concerned about hyper-inflation, but before I'm concerned about hyper-inflation I'm concerned about DEFLATION.  The biggest fallacy most economists (including Ben Bernanke) have about Inflation vs. deflation is that they confuse the cause with the effect.  Inflation is caused by too much money supply.  Deflation is caused by too little money supply.  The effect of each is that inflation causes prices to go higher, and deflation causes prices to go lower.  The reason is this... if people have a lot of money (via extra supply) they are willing to pay more for goods.  So the price of goods goes up because people can justify it, with the assumption the money flow will not stop.  When the money supply slows down people are not willing to pay as much, consequently businesses drop their prices to meet demand.  This creates the effect of falling prices.  But the cause is a smaller amount of money available to be spent. 

The last several years has been a period of economic growth based on an increase in CREDIT.  Credit is FAKE money supply.  It's money that is available to be spent, but is backed by nothing.  As the credit crisis has blown up, it has exposed the realities of the monetary market.  The effect of people who can not service (pay) their debt is one of a few things:

1) They stop spending and start paying down debt.  This causes less contribution to the consumption of goods as a whole, thus creating deflation

2) They restructure their debt - this is an okay scenario but generally the debt holder does lose some value.  The effect is still the same in that the debtor still slows spending. 

3) They default.  This is the worst case scenario as money simply disappears from the system. 

All of these scenarios create a deflationary environment.  

To counter this - the Federal Reserve (Ben Bernanke) is printing money, and creating IOUs and other forms of money to help INFLATE the market.  They are trying to counter deflation. The deflation alone is bad enough, but when they start debasing our currency through printing money the later effect is even worse - hyper inflation.  Since Dollars become easy to get people are willing to spend more of them for goods.  Hyper inflation is a worst case scenario and yet at the current rate it is a given that it will occur.  We are already experiencing deflation.  And deflation will continue until the goods fall to a fair market REAL value.  But by that time the damage will have been done and the extra printing of currency will already be setting up the scenario of Hyper Inflation.  

Before Bernanke was ever Fed chair he described how he would counter act deflation (in 2002 - speech).  Everyone made fun of him at the time because people said his actions were illegal and America would never go for it.  Here we are 7 years later and not only is he executing his plan as laid out, but America is standing by wondering what is happening.  Bernanke's speech about how he would counter Deflation, mixed with his actions which reflect his worst case scenario, is evidence alone that we are already well into a deflationary period.  I'd encourage you to read the speech but in short I'll sum up his points that the first course of action is to lower the fed rates to virtually zero - done.  The second line is to print money, buy up private assets, and bail out the banking systems - in action.  Bernanke says Deflation CAN'T happen in america because, in his own words. "The United states has a marvelous little invention called the printing press".  He really thinks he can print his way out of deflation.  And that's what he's trying to do.  The problem is Deflation is already happening.  His printing of currency is simply setting the stage for Hyper Inflation. 

They are comparing this recession with Great Depression, ignoring the many differences that exist between the two. It is possible for this recession to become another 1930s depression, but there are a whole bunch of differences. One important difference is, most of the traders at that time were like Bernie Madoff, and any regulation on trading was not even 1% strict as today’s SEC regulations. In other words, the stock market index was a number in 1920s, without any consideration to the fundamentals.

Oh but this argument assumes that regulation (or lack there of) is the problem.  It wasn't, and it isn't.  1920-1929, just like 1995-2007, was characterized by an inflation of credit, and subsequently an inflation of money supply.  The great depression was a prolonged recession for 2 reasons:

1) The recession was accompanied by deflation (as credit, and consequently money supply was contracting)

2) The government tried to regulate and spend it's way out, creating stagnation, and ultimately a prolonged recession leading to depression.  

THE WORST course of action during economic peril is regulation.  It is a fallacy to think that wall street was responsible for the great depression.  It was a symptom of the overall problem.  It's a fallacy to think "greedy wall street bankers" are the cause of our current crisis.  It is a symptom of the overall problem.   Beyond wall street and the presumed greed that drives it, is the congress passing laws that require risky lending.  THIS above all has created the credit crisis.  And now the banks are screwed from every angle.  They can't get their money, the government is telling them how to lend, and at the end of the day it is regulation that is preventing the free market from working. 

(please note I'm not defending some greedy practices and I'm certainly more ticked than anyone that AIG execs and lousy executives who screwed up and are getting bonuses with our tax dollars.  Yet my point is the same - if congress hadn't given them the bailout, they probably wouldn't have given their executives bonuses) 

As far as consideration of the stock market being a number in 1920s.... And how is that different than now?  How is that ANY different than the tech bubble of 2000?  Reality is the market IS a number.  Fundamentals are way more speculative than technicals because they "estimate" the value of a company, and never factor the emotion of the speculators who drive the market on a daily basis.  

Thanks, (name withheld for privacy)

Ultimately I hope I'm wrong.  I actually pray to God I'm wrong because I really don't believe the current work ethic in America is strong enough to survive a 1920's style depression.  America has become incredibly lazy, preferring government intervention and protection to the individual tenacity that the country was founded on.  I'm afraid for our country.  And yet I know if we could stop the government's current actions, get Bernanke out of the Fed and either abolish the Fed completely or at least appoint a true Free Market economists to the post, AND if the people would rise up and say "we're not going to let this happen" and start working their tales off.. we could stave off this crisis from being a total worst case scenario.  Unfortunately the Fed, Congress, and the President are doing everything they can to bring the worst case scenario to fruition, and the people are sitting on the sidelines assuming these political people have a clue about economics.  

As a contrarian in this situation, it is prudent to understand that my warnings may be useless.  But at least they were there.  It's better to sit in cash and wait than to be caught with your pants down as so many economists would suggest at the moment.  If  the country blindly ignores the larger problems, they will be caught with their pants down.  At least by following my logic one can be prepared for the worst, and also be educated to trade if the best case scenario comes to fruition.  The benefit of being neutral is the effect of flexibility.  

I hope this helps to answer some of your questions.  If you want to learn more I'd point you to three locations:

www.Elliottwave.com  - Prechter's book "Conquer The Crash" is an excellent discourse on deflation as well as some additional factors that are affecting the market. 

http://www.thomasewoods.com  - His book Meltdown is an excellent look at how the Fed has affected the current crisis. 

http://mises.org/  - This site as a plethora of information from the Austrian School of Economics point of view.  Austrian economics is the only primary school of thought which predicted the current crisis as it deals with cycles, not the assumption of progression.  

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I hope this discussion gives all of you some better insight into my positions and at the very least I hope it opens up dialog for meaningful discussions.   Until next time Happy Trading.

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