Investments: Omens from the Crash

The October stock market collapse came suddenly and unexpectedly to the vast majority of financial analysts, mainstream economists, and the establishment press. Completely caught off guard, they were quick to blame the Wall Street debacle on "impersonal" computerized systems and technical trading, not on any fundamental flaw in the economy. President Reagan claimed, "There is nothing wrong with the economy." Prime Minister Margaret Thatcher said that the British economy is "absolutely sound." And Nobel Prize–winning economist George Stigler said that a 1930s-style depression "can't happen anymore because of the Federal Deposit Insurance Corp."

These statements seem like voices from the past—1929 specifically. After the 1929 crash, President Herbert Hoover proclaimed, "The fundamental business of the country…is on a sound and prosperous basis." And Yale economics professor Irving Fisher, the foremost monetary theorist in the 1920s and a big promoter of the stock market, stated that stocks had reached a "permanent plateau" both before and after the crash!

The fact is that, as in 1929, today's orthodox academic and financial community completely miscalculated the greatest financial crisis in modern times. Only a handful of security analysts felt that there was something fundamentally wrong with the economy and the stock market. Dick Russell was one of the bears who wrote before the crash, "August-September 1987 presented the perfect picture of a market top, and I honestly don't see how anyone could have missed it!" But of course most did, including many members of the hard-money movement.

I was one of the lucky few who had the foresight to recommend getting out of the markets before the October Massacre. I sent out a "flash alert" to my subscribers on September 8, when the Dow Jones Industrial Average was at the 2600 level. "The coming credit squeeze could devastate the stock and bond markets; get out now!" I warned.

My analysis was based on the fact that the Fed had stopped expanding the money supply since January and had raised the discount rate in late summer. I knew that the bubble was about to burst. Actually, the events of 1987 were not that different from those of 1929. By late 1928, the Fed had stopped inflating and it raised the discount rate in the summer of 1929. The crash began on Black Thursday, October 24, 1929.

Only a handful of Cassandras predicted the 1929 crash—including such monetary "cranks" and "outsiders" as Roger Babson, E.C. Harwood, and Joe Kennedy. Actually, Joe Kennedy appeared to have the best record. He sold all his RKO stock and options in late 1928, stayed in cash throughout 1929, shorted the market in 1930, and got back in the market in early 1933! (The legendary Bernard Baruch and speculator-king Jesse Livermore actually lost money during the crash, contrary to what you may have heard or read.) While Irving Fisher and John Maynard Keynes failed to anticipate the collapse, "sound money" economists Ludwig von Mises, Friedrich A. Hayek, and Benjamin Anderson fully predicted it.

Most mainstream economists and politicians in Washington are now claiming that the 1987 stock market crash is an "isolated" event and won't have an impact on the economy. But this is nonsense. Every major recession in the 20th century has been anticipated by a stock market decline several months beforehand. According to the National Bureau of Economic Research, the stock market is the leading indicator of future economic events.

What is the October Massacre predicting? Undoubtedly, a major recession in 1988. Not only could this be bad for the Republicans, but it could be devastating to business. Of course, the Federal Reserve and chairman Alan Greenspan are doing everything they can to allay fears and ease credit—but it may be too late.

What to do? My recommendation is to build a strong cash position. Reduce your exposure to easy credit or debt. Stay liquid. Increase your savings and cut out unnecessary consumer expenses. Maintain a conservative position in investments. If you need monthly income, stick with high-quality bonds. Avoid long-term investments in the stock market. Buy some "survival" gold and silver coins, and perhaps some Swiss francs.

We may well be entering the most dangerous period in economic history. The Black October on Wall Street was a vote of "no confidence" in the Reagan bull market and the inflation-built financial system. The Reagan Era is over. Bringing back an age of stable economic growth, low interest rates and low inflation may be as difficult as putting Humpty-Dumpty back together again. Act now to protect yourself. As the Spanish proverb says, "The wise man gets out in the beginning, the fool in the end."

Mark Skousen is editor of Forecasts & Strategies, a monthly investment newsletter, and adjunct professor of economics and finance at Rollins College, Winter Park, Florida.