Investments: Back to the Roaring Twenties?

Are we headed for another 1929-style crash, followed by a devastating depression worse than the 1930s? Many financial gurus, from Doug Casey to Joe Granville, are predicting just that. Will it happen, and if so, how should we prepare ourselves monetarily?

If you want to make money and avoid the pitfalls, know your financial history. As science fiction writer Robert Heinlein says, "He who refuses to study history has no past and no future."

The comparisons between the 1980s and the 1920s are alarming.

First, as in the '20s, Americans have a careless attitude about debt. The government encourages a high-debt exposure by making interest charges tax deductible while taxing investment income (the Keynesian anti-savings mentality). So it's not surprising that consumer, business, and government debt are growing faster than personal income and national output. The results aren't without risk. Despite Reagan's so-called economic recovery, homeowners are defaulting on mortgages in record numbers, and banks and savings institutions are going bankrupt at the highest level since the depression.

Second, a wave of speculative fever is hitting the country. The volume of trading on the futures and options markets is expanding by leaps and bounds, doubling in the past three years. Net purchases of mutual funds have grown from $8 billion to $30 billion in the past four years.

Third, as in the '20s, American agriculture is struggling. It has never recovered from its heyday in the early 1970s. Grain prices may appear to be "screaming bargains" to the commodity speculator, but there is no sign yet of their recovery.

Fourth, despite substantial growth in the money supply, price inflation has not moved up significantly. The same thing happened in the 1920s, giving a false sense of security. Most mainstream economists are now concluding that "money doesn't really matter after all," but in reality the fiat money expansion continues to distort the economy and could cause an unexpected economic or banking crisis at any time.

Fifth, the protectionist movement is growing in the United States, which could easily lead to another depression. The infamous Smoot-Hawley Act sharply raised tariffs in the United States in the 1930s, exacerbating the Great Depression. It could happen again in the 1980s.

These are just a few of the comparisons between the 1980s and the 1920s. Joe Granville has been so impressed with the similarities that he's compiled a thick book with small print on the subject, called The Warning. Is he right? Not entirely.

The biggest difference between the 1920s and the 1980s is that the federal government is much more powerful today and is truly a "lender of last resort" for both the banks and major corporations. That's why I believe that the inflationary fiat monetary system could last much longer than Granville, Casey, and the other doomsayers predict. The reason the United States continues to suffer from strong recessionary pressure is that the Federal Reserve has attempted to slow down consumer price inflation. It has been an extremely difficult task, considering the expansionary fiscal policy by Congress and the malinvestments of the past. I believe we will live in a "high interest, low inflation" economy for the remainder of the 1980s (as opposed to the "high inflation, low interest rate" economy of the 1970s). Crises will appear periodically but will be resolved, at least temporarily, by an omnipresent state.

How to protect yourself?

First, avoid consumer debt like the plague. The stronger your personal financial picture, the better. Build a strong cash position. Easy credit can be extremely destructive as interest charges add up fast. Don't be tempted by favorable tax advantages and easy money. One of my colleagues in the financial advisory business is extremely successful but recently found himself in a bind with $75,000 in consumer debt. Credit cards can be a killer, even for those who we think should be immune. My advice: use cash whenever possible, and control your spending. In this uncertain business world, your income could drop significantly at any time. Be prepared by being in a solid financial position.

Second, stress conservative investments. Avoid speculative fever in futures, options, and unorthodox investments. Watch out for highly promoted "rare coins." Don't get involved in "nothing down" real estate deals and negative cash flow. Avoid "junk" bonds. Instead, invest in quality and diversify your holdings. Invest in mutual funds with a good money manager with an excellent track record. (I can recommend Mutual Shares—26 Broadway, New York, NY 10004; 800/457-0211 or 212/908-4047—which has a $1,000 minimum investment requirement.) Buy a few gold coins as an insurance policy in case a 1929-style panic occurs suddenly.

The people who have been burned in the 1980s have been those who got in over their heads in personal and business debt, failed to save their surplus wealth, and invested in illiquid, unorthodox investments. Don't let it happen to you.

Want to learn more? Read a classic book written in the 1920s but just as relevant today: The Richest Man in Babylon, by George S. Clason (available from Laissez Faire Books, 532 Broadway, 7th Floor, New York, NY 10012, $6 paperback).

Mark Skousen is adjunct professor of business management at Rollins College in Winter Park, Florida, and editor of Forecasts & Strategies, a financial newsletter.