Fighting the Next War

The unemployment rate remains stubbornly high.  But other than that, the economy seems to be pleasantly improving.  Sure the dark clouds on the horizon from Cyprus could take some of the wind out of the stock market’s sails.  Nonetheless, the stock market’s needed an excuse to pause all year.

More will be revealed this week.  Later today, for instance, durable-goods orders, consumer confidence, and new home sales will be reported.  Then, on Thursday, 4th quarter GDP revision and weekly jobless claims will be announced.  Come Friday, consumer spending and consumer sentiment will be released.

Naturally, we’ll be monitoring the situation for you…looking for inklings and indicators for what’s next.  Have the negative moods fabricated by the 2008 financial crisis and Great Recession finally swung to the positive?  Are happy days here again?

Looking around, it sure feels like it.  Consumers are consuming.  Producers are producing.  Moreover, for the first time in years, confidence and assurance are returning to the economy like migratory birds to Southern California during springtime nesting season.

There’s new life abounding.  How should investors prepare?  What follows is an attempt at an explanation…

Fighting the Last War

When André Maginot, a World War I veteran and French Minister of War, convinced the French government, in 1930, to invest in and build a line of concrete fortifications, tank obstacles, artillery casemates, and machine gun posts, along its border with Germany, he was looking back at the recent past…not forward to the near future.

World War I had provided a key insight.  That is, mass cavalry and bayonet charges were no longer an effective military tactic in the machine gun era.  Advanced firearms could mow down attacking forces long before they reached the defensive line.  The successful military tactic in World War I was static, defensive combat.

French leaders, with a destructive lack of imagination, took the lesson to heart.  They primarily focused their energy and resources to construct the Maginot Line…the most advanced defensive line the world had ever seen.  Military experts called it a work of genius.  France believed there’d never be another invasion from the east.

But this belief quickly disappeared.  On May 10, 1940, the same year construction was finalized, Germany attacked.  But it wasn’t a direct attack.  Germany flanked the Maginot Line through Belgium’s Ardennes forest.  France was conquered in about six weeks and the Maginot Line, a work of military genius, was exposed as strategically ineffective.

“Generals always fight the last war,” goes the adage.  For interwar French Military leaders, the insights from World War I were not an asset; they were a liability.  They diverted France’s attention and resources and distorted its thinking so that it couldn’t properly defend itself.

Fighting the Next War

Lessons of past financial crises, like lessons of past military misadventures, can be misapplied to future financial conditions.  The lessons of 2008 leave many smart and intelligent people’s finances as unsuspectingly vulnerable as Paris in the spring of 1940.  They’ve placed their life savings in Treasury bills because that’s what kept it safe when the sky – and stock market – was falling in late 2008 and early 2009.

The lesson of the Great Depression in the United States was that cash is king.  The instruction from the mass bank failures and bank runs of the 1930s was that cash should be hoarded, even stuffed in the mattress, where it’s safe.  Regrettably, this lesson cost the depression era generation dearly during the inflationary 1970s.  In just a 10-year period, their savings was more than cut in half.

Similarly, the retirement investor may be unduly worried of another stock market crash.  They are distracted and unable to recognize the future consequences of all the Federal Reserve and Treasury hocus pocus that’s taken place over the last five years.  In additional, they’re dangerously unaware these consequences will be disastrous to investments in Treasuries.

They’re fighting the last war…where the Federal Reserve was able to artificially suppress yields with no readily apparent penalties.

Ironically, the downfall of the Federal Reserve’s apparent success will be an improving economy.  That’s what’ll let the inflation genie out of the bottle.  All the new money the Federal Reserve’s created over the last several years will finally begin flowing into the real economy.

Before long it will be flowing through the economy at ever an increasing velocity.  Treasury holders will be flanked by an advancing money supply.  Cash will be mowed down by inflation.

Our gut tells us stocks could free fall 30 to 40 percent within the next 2-years.  Despite this conviction stocks are the place to be over the next decade.  They’ll provide wealth preservation in the face of the next war of burgeoning price inflation.

Allocate your assets accordingly.

Sincerely,

MN Gordon
for Economic Prism

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