Dateline: 10/14/97

In August 1991, James Dale Davidson and Lord William Rees-Mogg's book The Great Reckoning was released. Two years later the revised and updated edition came out. The first edition had successfully predicted the end of the Cold War, the end of the Soviet Union and a host of other events.

Their earlier work, Blood in the Streets, published in May 1987, predicted a 1929 style stock market crash. A few months later the October 1987 crash happened. They predicted the Japanese stock market crash. That happened too.

Clearly Davidson and Rees-Mogg are no pikers in the economic analysis game. And they predict the worst is yet to come. Is it? Where do we stand now, four years after the release of the updated Reckoning and ten years after the 1987 crash?

They base their predictions and analyses on a broad theory of history they call megapolitics. This is a theory based on power and the physical limits placed on the exercise of power. They also make a great deal out of cyclical patterns in history. Thus on the basis of five great credit cycles over the last 300 years, the last ending in 1929, and the circumstances surrounding these booms and busts, they predict an impending collapse greater than the Great Depression. You might say that they are predicting the mother of all depressions.

They are very careful to hedge their bets though. "Our own view is that cycles and patterns from the past are good ways to explore what may happen, but not the basis for forming a view of certainty," they say. "In human affairs there is no certainty about the future."

The broad sweep of the book is too complex to go into in detail here. They deal with the information revolution, the relationships and patterns emerging from the economies of Britain, America, Japan and Germany, the rise of Islamic fundamentalism as a greater threat to Western society than Marxism, increasing crime and violence in urban centers and so on.

The important thing for our consideration here is their arguments for a deflationary depression in the 90's. These include rising debt to GNP, high returns on investments that outstrip growth in profits, debt compounding faster than income, debt growing in proportion to the money supply and so on.

They argue further that deflation is not a conscious policy on the part of authorities, but rather "the culmination of an historic process that takes years to unfold." The reason a deflationary depression will come, they say, is because after years of inflation and deficit financing and the buildup of huge national debts, the time has come to pay the piper. The excess debt must be liquidated. The alternative to deflation, inflation, is worse and politicians know it. Nevertheless, they again hedge their bets by saying a hyper-inflationary depression is a possibility "You should prepare yourself for either outcome, which means remaining alert to the dangers of both."

One of their more interesting analyses is the list of parallels between the 1920's and the 1980's (23 altogether). Everything from the abandonment of the gold standard to lower inflation to Republicans in the White House to Prohibition and today's "War on Drugs". But again, they cite a host of differences as well (20 this time). In fact, these dissimilarities show the U.S. may be in the situation of Britain during the Great Depression. Britain recovered quickly in the 30's in sharp contrast to North America where the depression dragged on for years.

The upshot of the entire book is a list of guidelines to steer yourself safely through this "age of crisis". Many of the suggestions are good common sense and worth following in any kind of economic climate. Advice such as put your business on a sound footing, maintain adequate insurance, connect more closely to family and neighbours and even turn off the television and read or play chess instead (heresy for me to say that as I work for a television station!).

Their more specific economic advice I have problems with though. Such advice as "consider selling your home if you have less than 50% equity or is more than 50% of your assets." This is based on the theory that house values will drop drastically. For many like myself, it is just not a reasonable thing to do. We would pay double what we are paying in mortgage payments if we rented.. That would put a severe crimp in an already strained cash flow. Besides, they say that interest rates fall in a depression. So if their prediction is correct, my costs will decrease accordingly.

They recommend considering short-selling, though they urge extreme caution because of "short squeezes". Sorry guys. That's too risky for my blood. Anyone following their advice and selling short in the last couple of years of this bull market would have lost a fortune unless they really knew what they were doing or shorted Bre-X.

Is the time right to sell short now? Maybe on selected stocks. Again, you really need to know what you're doing to play this game and I confess, I don't know enough to even want to try. (They do tout their newsletter, Strategic Investing, for help in this area and do recommend seeking expert advice.)

They recommend growth stocks. This is one I can buy into. I have lots of money in growth mutual funds. But they disparage a "buy and hold" policy. Sorry. I intend to hang on to my growth mutual funds which have good long term track records and a history of sound management.

They recommend having 5-10% of your assets in gold bullion or gold and silver coins. Been there. Lost money doing that. I do have about 10% of my investment assets (excluding my house) in precious metals mutual funds. They've declined about 30% over the last year. But I continue to hold them as part of my diversification of assets. (I am slowly rethinking the value of gold and precious metals in my portfolio and will write further on that in a future column. It has to do with the political control of the metal and with Julian Simon's theory of constantly decreasing commodity prices.)

I'll leave the discussion here for this week. Next week I'll see where we have gone in the four years since the revised Reckoning came out and discuss the possibility of another market crash and whether we should give a damn anyway.

The Great Reckoning Revisited: Part 2

Note: Warren Buffett has reportedly been buying non-coupon long bonds. The value of such bonds goes up if interest rates go down. Buffett does not generally like bonds, nor does he pay attention to the stock market or politics. He also believes that the long run trend of the economy is inflationary. Does his foray into long bonds have any significance? Does it mean he believes inflation is dead? That a correction and/or a depression is imminent? Or does it simply mean he has a lot of extra cash floating around and is having a hard time finding a business to invest in that meets his exacting value investing criteria? Either view tends to support the idea that a correction is imminent. I haven't seen Buffett selling off Disney, Coke or Gillette, though!

Previous Features