A few weeks ago, a friend of mine who is a player in the global financial markets returned from London. By his own admission, he’s been a great beneficiary of the unprecedented economic expansion that has proceeded almost uninterrupted since the end of the 1990-1991 recession. (The three quarters of economic contraction in 2001 barely qualify as a recession.) Given his four homes on three continents, he has an unusually global perspective on things.

He’s also of a generally optimistic temperament, so it was with some surprise that I heard his pronouncement that “America is [verb indicating violent intercourse, past tense]!” I have, of course, been of that opinion for quite some time, as long-time readers know, but it was nevertheless alarming to hear confirmation from a party that had been hitherto staunchly contrarian. The fall of Bear Stearns and IndyMac, the recent declines in the equity markets and the ongoing collapse of Fannie Mae and Freddie Mac not only come as no surprise, they were entirely predictable warning signs of the recession that is already well under way. Ominously, the same sort of thing is happening in other countries, especially Britain, where similar bank failures have been grabbing the headlines.

It’s important to understand that expecting the financial news to accurately relay economic information, particularly negative information, is irrational for three reasons. First, the economic data that is presented is a snapshot of the past, usually at least three months in the past. Second, much of that data is fraudulent; for example, the reported inflation rate is so massively twisted and contorted that it may underestimate actual inflation of the money supply by as much as 300 percent. If the Consumer Price Index was still being calculated today as it was in 1980, inflation would have averaged around 8 percent per year since 1990, four times more than the officially reported 2 percent.

Third, remember that the financial media has a direct interest in economic good news. During times of expansion, everyone gets excited about investing and pays a great deal of attention to buying and selling stocks, houses or whatever the commodity of the moment happens to be. For example, the reason there are far more real estate shows on television in place of the financial shows that launched entire networks is that the real estate bubble popped a few years later than the equity bubble. As housing prices continue to fall, housing inventories grow and more mortgage banks go bankrupt, those television shows will go off the air.

So, if the economic news is much worse than is commonly reported or understood, what can you do to prepare yourself for the negative climate? Unfortunately, it’s difficult to give precise recommendations at the moment, mostly because the primary question of hyperinflation or deflation remains unsettled. The Federal Reserve’s natural tendency is to pursue inflation, and certainly Bernanke’s refusal to follow Paul Volcker’s lead and aggressively raise interest rates tends to indicate higher inflation is in order. However, inflation rates have been very high for more than a decade and have only made matters worse, and there is also a school of thought which insists that deflation is inevitable even if the Fed unleashes the full power of the printing press and sends out the hyperinflating helicopters.

It’s worth noting, however, that the existing credit crunch was predicted by the deflationists, not the hyperinflationists, even though the sky high prices of oil, gold and other commodities tends to support the latter. But regardless of which way things play out, there are a few basic principles that almost anyone, regardless of their financial situation, can apply to their lives now.

    1. Cut your costs. Don’t waste money buying things you don’t need. Spend your dollars on things that are reusable rather than one-shot deals, such as video games rather than movies, a nice flatscreen rather than game tickets and cookware rather than restaurants.

    2. Diversify your income. Take a second job, preferably in a field unrelated to your main occupation. This has the benefit of both increasing your income and reducing the financial blow should you find yourself laid off.

    3. Be proactive. You should know if your employer is in good shape or not. If they’re not, it’s time to start looking elsewhere.

    4. Start a garden. As food prices continue to get higher, why not raise a bit of your own?

    5. Exit equities. Big daily rallies are signs of a bear market, not a bull. Use those big 400-point up days to exit your positions; that’s what the big boys are doing.

    6. Buy a rifle for each adult in the household. They tend to be surprisingly good investments, and the worse things get, the more potentially useful they are. It’s your constitutional right, so don’t hesitate to use it.

Above all, learn to watch the signs and read between the lines. Neither John McCain nor Barack Obama can hold back the contraction any more than King Canute could hold back the waves, so put not your trust in politicians.


Note: Read our discussion guidelines before commenting.