Happy New Year's Eve. What a year, eh? Speculation causes a massive market collapse … gold prices soar … leading bankers fail …
But I'm not talking about today's market woes!
I'm talking about the Panic of 1873.
That was a panic that makes our current market downturn look like a tea party. And there's a good lesson for today's investors to learn from those hard times.
It Was Bad in the U.S., But in Europe …
Here in the U.S., the Panic of 1873 (which started in 1869) was a combination of railroad speculation, a run on physical gold, and brand-name bank and brokerage houses failing.
Across the pond, in Europe, it was much, much worse. And it gave one of the world's most legendary capitalists the chance to make a fortune for himself and his friends.
I'm talking about Baron Nathan Rothschild. Rothschild was a respected French investor who became the stuff of legend during the financial crisis.
It was a terrible time. A building boom ended with a mortgage bubble bursting. This was followed by a swoon in the prices of many industrial commodities. There was even an energy crisis of sorts — an outbreak of equine influenza (horse flu) saw many forms of transportation temporarily grind to a halt.
Europe fought the Franco-Prussian War, which ended in defeat for France. Emperor Napoleon III was captured, and the French government collapsed. The economic woes combined with military defeat allowed socialists to seize control of the French capital. Paris was turned upside down, and mobs ruled.
And that's when Rothschild told his clients …
It Was Time To Buy
The story goes that a panic-stricken investor turned up at Rothschild's office and exclaimed, "You advise me to buy securities now? NOW?! The streets of Paris run with blood."
Rothschild, calm as ever, answered, "My dear friend, if the streets of Paris were not running with blood, do you think you would be able to buy at the present prices?"
There is a second part to Rothschild's quote — one that is perhaps even more impressive: Buy when there's blood in the streets, even if the blood is your own.
Rothschild proved to be quite prescient. French bankers were able to fund a counter-revolution. And the investments that Rothschild and his friends made doubled in value … and then went higher!
While many U.S. banks failed in the Panic of 1873, we got off lightly compared to Europe. The global depression lasted until 1879. And the end result was the center of gravity for the world's credit shifted from Europe to the U.S.
Fast-Forward To Today
We've seen a building boom end with a mortgage bubble burst. And we've seen the Reuters-Jefferies CRB Index of Raw Industrials, a gauge of the cost of 22 items including scrap copper, cotton and hogs, and a good indicator of economic health, fall off a cliff.
It's down a staggering 39% from its peaks to its lows, as factory production fell 7.3% through November.
Now, though, the CRB Raw Materials Index looks like it's starting to hammer out a bottom. Once a bottom is in place … the Index could go a LOT higher.
Are Things Bad? Yes!
There are parades of bad news up and down Wall Street and Main Street …
On Wall Street, the easiest way to get your hands on truckloads of government bailout dollars is to own a bank. Heck, you won't even have to tell the Treasury what you do with the money!
And if you don't own a bank, you could go from being chairman of the Nasdaq to setting up a hedge fund so secretive that your closest friends don't know you're ripping them off for tens of billions of dollars.
On Main Street, manufacturing has slumped to its lowest level in 26 years … employment has dropped to a six-year low … retail sales are plummeting. In fact, many experts expect a whopping 25% of U.S. retailers will go bankrupt in 2009.
Problems are rippling around the world, too …
In Japan, industrial production has taken a header — down 8.1% in November from October.
Even China has caught the recession flu. In Dongguan, where many of Santa's gifts are really made, nearly half of the 3,800 toy factories have closed or plan to shut down. China's steel production has dropped by 12%, and electricity demand is down 9.6%.
Yep … things are bad. And things in this downturn seem to be going at lightning speed compared to previous economic hard times …
For example, in the last five months, base metals have fallen in price, on a percentage basis, more than they did during the entirety of the Great Depression!
The question now is: Are we close to blood in the streets … the time when Rothschild would advise buying?
I'll give you my opinion on that in a bit. First, an important difference between now and the panic of 1873 …
The Loosest Money Policy Possible.The Long-Term Effects Are Horrific!
In 1873, the U.S. moved to the gold standard, which meant it stopped minting silver dollars altogether. This reduced the domestic money supply, which hurt farmers and anyone else who carried heavy debt loads.
Today, by contrast, we have the loosest money policy possible …
The U.S. Federal Reserve recently cut its target for overnight interest rates to — zero to 0.25% — its lowest level on record dating to July 1954 — and said it would likely keep it at "exceptionally low levels for some time."
In addition, Treasury Secretary Hank Paulson and Federal Reserve Chairman Ben Bernanke have been handing out cash by the hundreds of billions to every Tom, Dick and Citibank who drives by with a sob story.
The long-term effects of that free and easy money policy are horrific!
Through December, Washington had already spent or pledged $8.7 TRILLION. As a result of all the bailouts for banks, automakers and other new federal outlays, our nation's budget deficit is expected to reach $1 TRILLION in 2009.
And that's just the tip of the iceberg …
The Grandfather Economic Report series calculates that America now owes a total debt (including government, household, business, financial sector, etc.) of $53 trillion. That's $175,154 for every man, woman and child in the country, an increase of $33,781 per family of four over last year.
However, that's longer-term. In the short-term, that easy-money policy could be just what the doctor ordered for an ailing economy.
Sure, it looks like consumers, who power 70% of America's economy, are in a power dive. But we've also been lucky that oil prices have been falling like Wile E. Coyote, and gasoline prices are tumbling, too. That puts more money in consumers' pockets.
While the Grinch may have stolen Christmas, on an inflation-adjusted basis, consumers spent 0.6% more in November than they did the month before. Disposable income also rose on an inflation-adjusted basis, by 1%, compared with an increase of 0.7 percent in October.
Plus homeowners have rushed to refinance their loans to cut costs or switch from adjustable-rate mortgages to fixed-rate loans. Recently, mortgage applications jumped to the highest level in five years.
My point is that things may not be as bad as they seem. Maybe we have much worse to come. Or maybe we are near the point where Baron Rothschild would tell his clients to buy.
So when that time comes, what should you buy?
Here Are Three Ideas …
1) Gold Miners. Gold, with its historic outperformance during times of trouble, is looking better and better. Sure, I've been pounding the table about gold for some time now. And it's been zig-zagging higher. And "buy" signals on select gold stocks are flashing on my board like holiday lights.
2) Oil Companies. Say what? Why buy oil when many analysts are predicting $25 oil in 2009? My reason is simple: Enjoy the cheap oil, because it won't last. We've seen oil prices plunge about 73% in six months. That has never happened in history before — ever.
The current price of crude signals that something is very out of whack in the oil markets. And I can tell you what the effect is: Projects that cost more than the current price of oil are being taken offline — slowly at first. But the process could quickly start to cascade.
That should quickly bring supply and demand in balance. And if prices go higher, we can always bring more production online, right? Maybe.
But the kind of black swan event we've seen in oil markets leaves long and deep scars in the conservative psyches of oilmen. That's why I think it's going to be a while before anyone goes after new deepwater wells that cost $80 a barrel.
So who will profit from this? Major oil companies with lots of cash.
That brings me to my third recommendation …
3) Big Companies With Lots Of Cash. For smaller industrial firms that relied on seasonal demand and outside capital, the Panic Years of the 1870s put them in one heck of a bind.
As capital reserves dried up, so did their industries. Who thrived? The large companies with guaranteed contracts and the ability to force deals on their suppliers and vendors.
Andrew Carnegie and John D. Rockefeller had enough capital reserves to finance their own continuing growth. Both bought out their competitors at fire-sale prices.
And today, large, well-capitalized companies could be the way to go.
Indeed, these are tumultuous times. Yet I'm sure that Baron Rothschild would tell you to make the most of them.
I wish you all the best for 2009.
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