The economy is ripe for a disinflationary crash



     People inquire about investments for devaluation, financial planning for a dollar crash, they ask how does devaluation affect the housing market, is a dollar collapse unlikely, how will a dollar crash affect mining stocks?

    My answer is that it finally appears that a new consensus is beginning to develop that the economy has topped out and will head in a growth recession, with commodities and stock due for a crash. Prominent experts Jeremy Grantham and John Hussman have indicated that the SP is worth about 920 points, not the current 1300 range. Nobel winning economist Robert Mundell was quoted in the WSJ today as expecting the economy to cool off and the dollar to go up against the currencies of the other developed countries.

   During a world-wide recession people flee risk assets and seek the safe haven status of the dollar.

    Commodities have usually only gone up during wars or the great inflation of the 1970’s and rarely have they gone up for more than a decade, even though the commodity cycle lasts about 17 years from bottom to peak. Commodities performance in the past decade has been the best in 100 years, even though the past decade had many disinflationary crashes from burst bubbles. Since the private sector credit creation (ex-student loans) has been declining in the U.S. and is unlikely to grow that adds to the probability of Japan style deflation in the U.S. The U.S. government may have budget cuts, which are already being done by some states. So the implication is that commodities went up too much, can’t be supported by the fragile economy and were partly propelled upwards by a speculative bubble rather than intrinsic demand.

   As I have written before, when a crash comes then over-leveraged hedge funds can’t buy put options that their banks require the hedge funds to buy. This is because during a crash the cost of put options increases to prohibitively expensive levels. So the bank increases the margin requirement, the hedge fund will try to sell assets to meet margin calls and can only sell high quality liquid assets because illiquid ones can’t be sold. Thus high quality assets could go down without justification due to panic selling by over-levered hedge funds. The market is very ripe for a flash crash.

risk of stock crashPandora’s box opening may lead to crash


Seven strategies to protect yourself

  • If you insist on owning stocks then hold only quality investments (quality is defined as low debts, high corporate moat, consistent earnings growth, good dividends, low P.E. ratios, etc.)
  • Don’t use leverage
  • Have plenty of cash or mutual funds that hold short term high quality bonds
  • Short selling is dangerous because the bubble could get bigger
  • Avoid the Euro or Yen currencies
  • Avoid European bonds
  • Don’t chase after investments with allegedly high rates of return, instead pursue investments that have the lowest risk, which may mean accepting a lower rate of return

    I have written about these topics in “Copper bubble explained” and “U.S. equities are 70% overpriced“.



     Important: Get more information in my free Special Report about emerging market currency investing.

      Investors should seek independent financial advice.