The "Final Four" Lessons of a Financial Crisis

“A forecast is never so useful as when it warns man of a crisis.” ~ Bertrand de Jouvenal, The Art of Conjecture (1977)

Falling real estate prices, an unrelenting decline in the U.S. dollar, gasoline prices approaching $4 a gallon, gold hitting $1,000 an ounce, a grinding bear market on Wall Street….

How does one survive and prosper during a financial crisis that just won’t go away?

The latest crisis occurred this weekend, when the Federal Reserve engineered a bailout of Bear Stearns, a major U.S. bank that was selling for $70 a share just a week ago, and today is selling for under $4.

The Fed also cut a quarter point off the Discount Rate, and opened up the Discount Window to brokerage firms for the first time since the Great Depression. It is expected to cut the Fed Funds Target Rate substantially at its meeting tomorrow.

Not surprisingly, the dollar fell and gold rallied.

Lesson #1: You Can’t Trust Government or Big Business

You can’t count on government officials to warn you of impending disaster, whether it be the next war, depression, or monetary crisis. The great French economist Bertrand de Jouvenel once observed that those in power have “the least foresight” as to where we are headed. Government officials are notorious for withholding the reality of the crisis, whether it be the rate of inflation, the cost of war, or an impending bank failure. Big business isn’t much better. Bear Stearns released a statement saying everything was fine two hours before JP Morgan stepped in to shore up the investment bank.

The best source of information is from private economists and independent analysts.

Lesson #2: Don’t Panic, Especially on Monday

If you have a well-diversified portfolio, as we have encouraged, you will survive and prosper. I have a book on my shelf entitled “Never Sell on Monday!” It’s good advice. Monday is a notoriously volatile day when investors panic and dump stocks at drastic prices, only to regret it later in the week. With the market already in a slump, stocks could rally at any time.

Lesson #3: Don’t Fight the Fed

Since the Great Depression, history is on the side of the Fed in stabilizing the economy during a monetary crisis, whether it be the 1987 stock market crash, the 1997 Asian currency crisis, or the 9/11 terrorist attacks. The Fed learned a hard lesson in December 1930, when it failed to bail out the official-sounding Bank of the United States. By failing to act, the Fed precipitated the Great Depression. Ever since then, the Fed has moved quickly to step in and act as the true lender of last resort.

The 2007-08 real estate credit crunch may take longer to work out, but I’m betting that the Fed will once again stabilize the economy and the financial markets. However, there is no guarantee that history will repeat itself. And given that the Fed is a source of great instability (easy money - tight money cycle), it pays to hedge your bets. And that brings me to the final lesson.

Lesson #4: Invest in Gold

Most importantly, stay invested in “non-correlated” investments, especially gold, oil and commodities. You should always invest in non-traditional “alternative” investments as a hedge. The Fed is making some serious mistakes, especially cutting interest rates too far below the “natural rate” of interest, and thus further weakening the dollar and encouraging gold and oil prices to rise even more. That’s why I’ve been emphasizing a 15% position in natural resources recently – stocks and funds that invest in mining and energy companies, and the outright buying of gold and silver coins.