A view on the Greater Depression – part 1

By Doug Casey

In the markets, timing is everything. My last book, “Crisis Investing For The Rest Of The ’90s,” came out in 1993, and posited that the recession we were experiencing at the time would snowball into a depression. Well, I was wrong.

Bob Prechter came out with his “At The Crest Of The Tidal Wave” not long afterward, saying about the same thing – he was wrong too. But it must be said that Bob turned bullish on stocks before I did – and stayed bullish right up to 1993 – and at times well beyond that year.

Now comes Prechter with his latest, “Conquer the Crash,” ($27.95, Wiley). I’m going to use the book as something of a framework to discuss what’s likely to occur in the next few years, because I agree, strongly, with almost everything Prechter says. If you want the bottom line now, it’s that you should buy and read the book.

Bob, incidentally, happens to be an old friend of mine. When it comes to politics, philosophy and economics, I literally can’t think of anything we disagree on. In this book, however, he pretty much stays away from the politics and philosophy (he’s much better disciplined than I), and sticks to economics, in general, but the markets, in particular.

I’m not going to cover the book chapter by chapter – I urge you to read it. It’s not a long book (275 pages), and it reads easily. Instead, let me zero in on a few points in particular – including the one area where we have a difference of opinion.

The Elliott Wave

Prechter, as you almost certainly know, is the leading exponent of the Elliott Wave Theory, and is the editor of an eponymous newsletter – which, incidentally, I very much enjoy. The Elliott Wave Theory was developed by Ralph Nelson Elliott in the 1930s and ’40s, and describes the action of the stock market, the economy and, indeed, human society itself, as fractal in nature – a fractal is an object that’s similarly shaped at different scales.

A nautilus shell, nested squares (one square surrounded by eight others, surrounded in turn by others, ad infinitum), the branches of a tree, and the body’s circulatory system are all examples of fractal patterns. I won’t go into the math of it here. Nor does Prechter really detail it in this book – for that, refer to some of his past works.

In essence, EWT posits five up waves from a bottom to a peak, then three down waves to the next bottom. At which point the cycle repeats again. But since the movements are fractal in nature, the pattern holds (theoretically) during rallies, bull markets and super bull markets. It – theoretically – is just as valid for day trading as for long-term investing.

The way EWT sees it – or at least the way Prechter interprets it – we’re now at the end of the fifth up wave from a “cyclical” bottom that was reached in 1974 (the beginning of the current bull market). We’re also at the end of the fifth up wave from a “supercyclical” bottom that was hit in 1932 (the bottom of the last depression). Most seriously, we appear to also be at the end of the fifth up wave of a “grand supercyclical” bottom, starting in the early 1700s.

Prechter doesn’t really come out and say it in the book (which is intended for the masses, and they scare easily), but readers of his letter know he’s looking for something much worse than what happened in the ’30s. If he’s reading the EWT right, what happened in the ’30s was only a supercyclical bottom – what we’re now looking at is much, much worse. This resonates with me – I believe what’s coming up is going to be so bad, it’s going to be worse than even I think it will be.

Is he right? Bob bases his projections mainly on the EWT, and the problem here, the way I see it (and, of course, assuming the theory is accurate), is in being sure which portion of the cycle you’re really in. My projection of The Greater Depression is based on other factors – but nobody has a crystal ball.

But we have – entirely independently – come to the same conclusion: There’s a catastrophe of historic proportions in store.

One possible difference we have is that Prechter is quite confident it will be deflationary in nature. It’s an old argument. The deflationists hold that the destruction of values through a collapse in share and property prices, plus defaults on bonds and bank loans, will wipe out trillions of dollars of purchasing media. The result, vastly less dollars, will make each remaining one worth more – even though the government will be creating them by the bushel basket in a futile attempt to prop up the collapsing house of cards.

The inflationists – who’ve been right at least since the argument really began in the late ’60s – basically believe that the government will simply do whatever it needs to do to keep things from coming unglued: reducing interest rates, lowering bank reserve requirements, monetizing all kinds of debt, passing a myriad of new laws. Prechter’s discussion of deflation, pages 88-112, is excellent, and deserves close reading.

In fact, at this point, I basically come down on Prechter’s, and the deflationists, side of the argument. But one big X factor scares me: the trillions of U.S. dollars – including a lot of cash currency (75 percent of all $100 bills) – floating around outside U.S. borders.

If the dollar continues weakening relative to other currencies (and I expect it will) that money could get very scared, very fast – they could dump it in a panic and the U.S. dollar could fall very quickly to half of its current value.

Meanwhile, the balance of payment deficit, now running close to $50 billion a month, would go into reverse, as trillions flow into the U.S. in exchange for cheap wheat and computers, and Americans are no longer in a position to export paper dollars for valuable Mercedes and Sonys.

Measures of inflation in the U.S. would explode – and quickly – exacerbating the panic. It’s tough to have simultaneous monetary inflation and price deflation, although, as I explained last month, the Argentines have shown it’s possible.