Our Economic Future From March of 1978

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The economic future is in turmoil for the United States with the economy taking a nosedive.

“I’ve been a subscriber to your magazine for several years now,” said the letter that accompanied the following article, “and I’ve watched ECONOMIC OUTLOOK with special interest since it first appeared in 1975.

“I believe we’re thinking in a similar vein … and, through cycle research, I’ve drawn a bead on where the economy is headed and when it will arrive there. It’s all explained in the enclosed article, ‘Our Economic Walls of Jericho’, which is excerpted from my book, How to Survive a Spastic Economy.

“Perhaps you’d be interested in including this piece in one of your issues. If so, you might want to hurry a bit since the next recession is just around the corner.”

After reading over the author’s (Mr. David E. Rhoads, of San Diego, Calif.) attached material, we tended to agree with him: No one knows exactly what lies ahead in our economic future, nor precisely when the next major turn will take place. The U.S. economic outlook printed here, however, is about as levelheaded and dispassionate as any we’ve seen recently … contains specific recommendations that can help you protect yourself and your belongings no matter what happens … and makes far more sense than any of the proclamations coming out of Washington these days.

And that’s about all the introduction you need to the following article, other than a little background information on the author. David E. Rhoads has an MBA in finance from Indiana University and — among other positions — has worked as a financial planner and a conductor of cost/profit studies.

Perhaps Mr. Rhoads’s most noteworthy “hands on” economic experience was gained when he was the Business Economics Manager for the Solar Division of the International Harvester Corporation. He monitored domestic and international economic developments and reported them to the firm’s executive staff while in that position and projected the impact of those developments on the company’s plans and outlined the resulting financial contingencies that IH would have to deal with.

David resigned from International Harvester in the spring of 1976 to devote more time to his investments, a private consulting service (Mr. Rhoads is a registered investment advisor), his writing (David authors an economic and financial newsletter, The Rhoads Conclusion), and his public speaking (Mr. Rhoads stands ready at all times to present his talk, There’s No “Long Term” Any More, to any political, economic, or other group that wants to hear it).

If you’re interested in purchasing a copy of How to Survive a Spastic Economy, it is available online.

Our Economic Walls of Jericho

Concerned about Southern California’s real estate speculation? Evidence of dollar difficulties tugging at the back of your mind? Anxious for the farmers caught between recent capital expansions and a collapse of farm prices? Worried over the ability of lesser developed countries to repay loans from American and European banks?

If you’re beginning to worry that economic conditions might be worse than anybody is admitting … well, you should. The things that are taking place now have always spelled trouble before. It’s just that it’s been nearly 50 years since they all converged on us at one time. That fact alone signals the gravity of our situation.

Perhaps even more foreboding is the fact that the visible signs of our current economic difficulties are merely symptoms of the real problem. You see, our world is bankrupt. America and most of the people in it are bankrupt … or about to become so. And that condition is pregnant with fundamental meaning for every one of us.

America has accumulated debts and obligations — business and personal loans, social security and government pension promises, and the like — of over seven trillion dollars. This is equivalent to five years of U.S. Gross National Product. In other words, it would take five years’ worth of everything this country produces just to pay off our debts … just to wipe the slate clean.

This means that every man, woman, and child (you, for instance!) owes an average of $30,000 apiece. A family of four must work against a debt load of $120,000. And the situation is getting worse. If nothing happens to stop it, debt will grow until our children will have to surrender 80 percent of the wealth they create just to pay what they owe.

That kind of debt service is out of the question. No nation can physically carry it. The load must be reduced. And it will be … one way or another.

There are three ways to reduce this debt load: [1] inflate the money supply so that the effect of debt is reduced in terms of real wealth, [2] pay off the debts, or [3] repudiate them (i.e., refuse to repay them).

Reducing the Debt Load Via Inflation

Inflating the money supply to reduce debt load is an extremely dangerous procedure. Even our politicians are finally beginning to understand that. The social disruptions that inflation brings are ultimately terminal for a society’s institutions. The Roman Empire, to cite just one example, dissolved during an extended inflation. So, we’ll probably lay off that lever … for the time being at least. Instead, we’ll try the payoff routine.

Reducing the Debt Load by Paying It Off

Arthur Burns, Chairman of the Federal Reserve System (the Fed), is already herding the payoff process along in the U.S. That’s what he’s talking about when he forecasts a long period of reduced economic activity for our country. It will be reduced because people will be working down a mountain of debt instead of borrowing more and buying more.

But reducing economic activity is inherently a destabilizing process too. Many companies simply won’t be able to survive a slowdown in today’s infiation-hyped, frantic pace of business. When the economy slows to work down its debts, the weaker firms will “fall off the ladder.”

The problem is already quite evident: Liabilities of companies that failed in 1975 reached $4.5 billion … the highest dollar level in our history. Adjusted for inflation and growth in our economy, it was second only to the Great Depression. And this $4.5 billion figure (even when adjusted) still doesn’t include bankrupt government units such as New York City … nor does it include reorganized companies such as Lockheed, the U.S. National Bank of San Diego, and the like. Thus, it’s obvious that a certain level of repudiation must accompany even the mildest payoff procedure.

“Paying off” today’s mountain of debt, then, is effectively nothing but putting the economy through a slow-motion crash. And the Fed must catch the bodies of the falling companies to keep the crash from speeding up. Otherwise, one failure’s unpaid bills will cause other companies and banks to fail … which will cause still more firms to go under … and our inflation-weakened, debt-ridden, unstable economy will soon spiral down into an uncontrollable domino wave of economic collapse.

Reducing the Debt Load by Repudiation

Integral to the payoff method, then, is a strong natural tendency to slip into the third method of working off debt: repudiation. All it takes is one mistake, one “missed body” to start the conversion. One slip and the present slow-motion crash is accelerated into a general failure and debt-repudiation procedure.

Debt repudiation usually appears in the trappings of a depression. That’s what most of us think of when someone mentions a crash. And, indeed, that’s how the process of massive debt destruction works: Banks collapse, the money supply implodes, companies and individuals fail … in short, a mass of debtors suddenly admit that they can’t carry their loads and they refuse legally to do so any longer.

This is not inherently a bad process, although it is painful. Many economists think it’s a healthy — even vital — readjustment for an economy to make after the kind of inflation we’ve just lived through. Our predicament is much like having a hangover: Sobering up may hurt, but we don’t dare stay drunk.

And a depression does hurt. Debt repudiation is especially painful to creditors . . . in this case lenders, retirees, investors, and the like. But the process does free up the economy.

Debt repudiation forces us to make decisions and take actions that we’ve been putting off … such as cutting prices to get rid of unnecessary inventory. It makes us close unneeded plants and stores. It makes us stop some of the silly things we’re involved in … things like rampant commodity speculation. In short, a repudiation puts an end to a number of bad economic practices, and it opens the way to a resumption of a sane economic life.

Most important of all, a debt repudiation forces the world to fire its economic “swingers” and “gunslingers” . . . the people who have been playing fast and loose with our capital and resources. The repudiation process expunges from positions of control those who cause a depression in the first place: greedy business managers, overbearing and over-demanding labor leaders, loose-money economists, over-promising and overspending politicians, and those shortsighted bankers who made so many of the loans that, suddenly, have to be written off.

After a debt repudiation, other people take control. The economy rests in firmer, more honorable hands. It seems to sober up, to get on with its business in a more rational way: Something we would all like to see instead of the mad activity we’ve increasingly been sustaining by pumping worthless paper dollars into our economy.

You can imagine, though, that the process of debt destruction and the reordering of the economy is a wrenching, desperate process for those who lose because of it or who are buffeted about by it. That’s why the world tries so hard to avoid depressions.

Still, the process of debt destruction is inevitable in one form or another. Besides, when compared with continued inflation or an extended payoff, repudiation doesn’t look all that bad. At least, it’s over quickly. (That’s probably why so many economic adjustments throughout history have been of the repudiation variety.)

Remember, too, that the severity of a depression depends on the number and size of the mistakes that it must adjust for … the amount of debt and obligations that must be destroyed. That’s why some depressions are bigger than others. And that’s why holding off an economic adjustment of this sort can only make its ultimate resolution more alarming. Holding off a repudiation allows more mistakes — more massive, unpayable debts — to accumulate. Which is just that much more debt load that, ultimately, will have to be worked off.

All Repudation Needs Is a Trigger

As unmade adjustments accumulate, they become subject to release by an economic trigger event. The greater the pressure, the smaller the trigger event required to release the repudiation. And that’s what makes the job of forecasting a depression so difficult.

All great events need smaller ones to trigger them. It’s like using a conventional bomb to set off an atomic bomb. But, many social and economic trigger events are too small — they develop and do their thing too quickly — to be seen early and accurately.

Prior to a trigger event, then, pressures for change can build to explosive proportions, but they will only continue to build until something happens to set them off.

This whole process operates much like an avalanche. Everything gets more and more set to go tumbling down the mountain, but nothing will start until the one right stone is dislodged. Until then, the avalanche just sits there waiting to happen. Conversely, when the right stone is dislodged, everybody is surprised by the results. As when Joshua’s horn brought down the walls of Jericho, the right trigger event can start an unbelievable economic slide.

The Great Depression was like that. The infamous year of 1929 was destined to go down in history because a stock market crash triggered a blowoff of pressures that had been gathering for more than fifty years. A number of commentators had in fact foreseen the massive unwinding that occurred. But practically no one recognized the trigger event even after it had gone off. And, for a while, authorities even argued about whether a recession had actually begun … much the way they greet a recession today.

When Will the Next Critical Trigger Event Take Place?

The problem with predicting “when,” then, rests in foreseeing a trigger event that hasn’t yet started to form, and mistaken identification of that trigger can throw a forecast off by several years. So, even though a prediction may be qualitatively correct, its timing can still be off by months, years, even decades. And that mistake in timing can be fatal to the best laid plans of an investor or businessperson.

Still, predictions remain terribly important. If you and I know “when,” perhaps we can make ourselves exceptions to the unpleasant events that are approaching. That, of course, is very desirable.

The Signs Point to 1981

In an effort to pinpoint this “when,” I’ve looked to business cycle forecasts. They can’t predict the specific events that will occur, but they do tend to identify when something will happen.

So far, the best time for the unwinding, which — sooner or later — must take place, looks like the fall or winter of 1981. That’s when the down legs of four identifiable business cycles will coincide. Four triggers, each one successively larger than the one before, will come together to unleash the boulders that even now are waiting to come crashing down on the world economy.

This will be the first such avalanche for most of us. Still, history gives us a glimpse of what it will be like. Indeed, many of the boulders now waiting to plunge downhill have made the trip before.

[1] For example, the U.S. dollar is now in trouble. It got that way because it was a reserve currency and we abused its status. The last time we saw a boulder like that, it was the British pound in the 1920s. As with the pound, we can expect continued trouble with the dollar. Ultimately, the dollar too will be kicked out as a reserve currency. It will cease to be accepted on the international market, and America will be put on a pay-as-you-go basis.

[2] We also have a massive real-estate-speculation boulder that needs adjusting. We had one of those in the ’20s too. Home prices are rising now much as they did 50 years ago. Then the speculation was most fevered in Florida. That peaked and collapsed in 1927. The rest of the country saw real estate prices break in 1928 just before the stock market got into trouble.

Today our real-estate-speculation boulder centers in Southern California. Many experts feel that that speculation will break in a year or so … if it hasn’t started already. The rest of the country will probably peak a year or two later, say 1979-1980. The whole boulder can be expected to break again with a spectacular fall in prices … just as it did in the ’20s.

[3] Potential debt repudiation by N/O-LDC’s (non-oil-producing lesser developed countries) is a real problem boulder for the world economy today. Prices for N/O-LDC commodities have fallen, which is making it impossible for those countries to meet their existing debt payments.

We saw a boulder like this in the ’20s. Ultimately all the LDC’s of that era repudiated their foreign debts. That’s why the U.S. and western Europe had to initiate aid missions and the World Bank after World War II. No one would lend directly to the tainted LDC’s at a reasonable interest rate.

But here we are with another LDC-debt boulder. True, this one is shored up by government guarantees. But it will go nevertheless. The guarantees only mean that U.S. taxpayers (you and me) will take the loss instead of those who loaned money or sold things to the LDC’s.

[4] Then there are the farmers right here in North America. They’re faced with falling prices for their products just after they’ve invested in a lot of new equipment and opened up new land. That’s a huge boulder added to our pile in the last couple of years. Have we seen one like It before? Certainly.

Farm prices broke in the 1920-21 depression … right after an extended inflation much like the one we’ve just seen. Farmers were in trouble long before anyone else. They never did participate in the general prosperity of the Roaring ’20s. And it looks as if that’s about to happen again. So, when the avalanche lets go, the farm-debt boulder will be one of the biggest to fall.

There Are Many More Boulders in the Pile

These are just a few of the gigantic rocks and stones now waiting to come crashing down the mountain. You may recognize them as the ones that accompanied the 1929 avalanche (depression). They are, in fact, the same.

And we haven’t yet mentioned the government debt, social security, government pensions, private debt, and commercial debt boulders … some of which are new, all of which are alarmingly huge and threatening. These boulders are on our pile today. It looks as if the 1981 avalanche truly will be historic.

Don’t expect government intervention to help. It’s part of what caused the problem. All government can do is “plan and control.” Since It already “controls” 40 percent of what our country earns, and since it already sucks up 80 percent of the savings offered for new loans each year, our government effectively controls the economy already. If we’re in trouble, we must be facing a crisis in government control. It can’t be a free-market problem since the free market is now a minority sector of our economy.

More government intervention can’t fix what government intervention has caused. It will merely shift the boulders around or obscure their fall. It can’t stop anything from happening. So, hang onto your hat. The avalanche is coming. It’s imminent, it’s necessary, and it’s inevitable.

You Can Take Evasive Action

Don’t despair, though. One interesting feature of economic avalanches is that, while nations can’t avoid them, individuals and companies can. Just follow these rules:

[1] Draw the cash out of your illiquid assets (art works, company machinery, real estate, collectables such as rare automobiles, etc.).

In a credit collapse, your equity in illiquid assets can be wiped out before you can unload them. So, minimize your equity exposure. Borrow against the asset, sell it and lease it back, or lease it with an option to buy. That way you will have all the advantages of ownership without the disadvantages of illiquidity.

ONE CAUTION: Be sure to restrict your lender’s default remedies to — and only to — ­the asset he’s lending against. That way if you miss your payments or abandon the asset altogether, the lender won’t be able to get to your bank account or other assets with a deficiency judgment.

Likewise, if land prices fall you can “quit” your present property, buy another place down the road for a fraction of what you now owe, and your lender won’t be able to chase you. (Be sure to consult your attorney on how to set this up. Laws concerning loan agreements vary considerably from state to state, and you don’t dare make a mistake at this.)

[2] Diversify your investments. Don’t put all your eggs in one basket. Buy some gold and silver coins or invest in a commodity mutual fund, but also keep some cash handy. Buy some common stocks or mutual funds, but also buy some bonds or a bond fund. Put some money in a savings account, but also keep some in treasury bills or a money market mutual fund.

Don’t forget that interest rates on short-term instruments such as treasury bills (also available through money market mutual funds) will offset inflation almost as well as a commodity, and they are certainly easier to deal with.

[3] When you see boulders beginning to fall (e.g., when LDC’s default on their loans, when property prices start to collapse, etc.), or if you see prices begin to gallop as if countermeasures are underway (15 percent or more annual rate of increase in the Consumer Price Index), find out what the Federal Reserve (Fed) is doing with the money supply and bet with the trend.

Subscribe to U.S. Financial Data and Monetary Trends, both free from the Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, Mo. 63166. Monitor the “Monetary Base” graph for changes in its growth trend. An upturn signals an inflationary Federal Reserve policy, and a leveling or a downturn signals a deflationary policy. Watch the graph of “M1 Money Supply” to see if the economy is responding to Fed policy (i.e., see if the trend in M1 is in harmony with the trend in the monetary base).

[4] Use liquid vehicles (stocks, bonds, commodities) to protect your purchasing power. If monetary trends are constant — if Fed policy is steady — stocks or intermediate-term bonds are probably a good investment. If Fed policy turns inflationary, begin moving into commodities (coins, bullion, a commodity mutual fund, commodity futures, etc.). If Fed policy is deflationary, convert your assets into cash, treasury bills, a money market fund, a savings account, or the like.

(If M1 and the monetary base are moving counter to each other, the economy is not responding to Fed policy and we might be in real trouble. Either follow the M1 trend and recognize that it’s probably temporary, or take shelter in cash, treasury bills, etc., and wait for the trends to come back into alignment again.)

[5] Stay on the good side of your boss … now is not the time to have to go looking for a new job. Most people still don’t realize that our world has changed. They still expect routine, periodic pay raises and promotions. Their frustrations with slow-moving or non-existent improvements in job or pay will cause them no end of difficulties. Don’t let that happen to you.

If you can recognize the kind of era we’ve entered, if you can keep yourself in perspective, and if you’re mature enough to be happy with what you’ve got … you stand a good chance of keeping what you have. More than likely there will always be a place for you somewhere, even in the midst of an avalanche.

So get your assets in order, learn to recognize the boulders by the paths they leave in the money supply and the monetary base … then just sit back, relax, and watch the show.

Note: “No-load” common stock, commodity, bond, and money-market mutual funds will be advertised in The Wall Street Journalwhen you need them. (“No-load” means that you pay no salesman’s commission when you buy into the fund.)