Monsters from the Id Threaten the System

To understand why the coming bear market will be far more destructive than any before it, ponder the cataclysm that befell the fictional planet Altair-4.

It was there, as depicted in the 1956 film "Forbidden Planet," that Krell civilization reached the pinnacle of technology, having built an inexhaustibly powerful reactor that could serve up anything the mind might care to visualize.

This was great for Krell homemakers because they could rustle up a sumptuous dinner in a seconds, complete with a magnum of cosmically sublime 1949 Chateau Margaux. But the Krell had neglected to consider that the reactor would also materialize the fears, jealousy and savagery of their own primitive subconscious. It did, and they were ultimately destroyed by Monsters from the Id.

Here on Earth we have succeeded in creating a crude version of the Krell reactor that is about to unleash it own monsters from the id on the stock market and the economy. And while it cannot serve up a magnum of 1949 Chateau Margaux on demand, it can surely churn out many hundreds of billions of dollars of credit with little exertion, just as it has been doing for years.

The result has been the creation of a global credit bubble that is about to collapse and take the stock market with it. The size of the bubble is the reason why the market will not return to health with the 10 to 20 percent correction that nearly everyone on Wall Street seems to be hoping for.

For when the bear market finally begins, it will not be correcting excesses in the stock market so much as it will be inflicting punishment on a vastly larger global credit market that has run amok. I have remained quite bullish as stocks have soared to new record highs since the first of the year. But their upward slope has become almost vertical, and this cannot continue for long.

Accordingly, I have begun to advise profit-taking and even the short sale of some stocks and indexes that could get hit particularly hard when the rally begins to sputter out.

Somewhere down the road, when share prices have been cut in half, the excess of the credit system will be cited as the cause of the collapse. It will seem obvious by then that it had become too easy for too many to borrow too much.

All it takes is the mere stroke of a pen. Sign your name to the bottom of a check furnished by one of the money-center banking behemoths, deposit the check in your own account, then spend away. And don't worry about the 19.5 percent interest charges that you will be servicing down the road, since, until May, those charges will be capped at an irresistible 5.9 percent.

I estimate that if Americans woke up one morning in a real borrowing mood, they could cause about $1.5 trillion worth of fresh credit to materialize literally out of nowhere. For perspective, that's a brand new sport utility vehicle in every driveway. Or a 45-inch color TV, digital video player and theater-quality sound system in every living room.

I cannot substantiate that $1.5 trillion figure scientifically, but it may be low. Just ask around the office. If a third of your co-workers have been offered revolving-charge credit totaling $40,000 or more in the last 12 months -- as they probably have, at a minimum -- just multiply that times 36 million potential borrowers, or a third of the American workforce.

So if you thought the Fed was controlling the money supply by deftly manipulating M1, M2 and M3, now you know the scary truth. In reality, money -- or more properly, the supply of credit -- has evolved beyond the control of the central bank. It has become fundamentally a creature of the mind, subject to no limitation other than the vestigial caution and conscience of borrowers.

The phenomenon is global. The world's central banks long ago severed the link between cash money and any tangible store of value, creating in its stead a New Age money system that could only be described as metaphysical in nature. The gnomes have succeeded in institutionalizing the concept of a free lunch, thereby energizing as dangerous a monster as ever stalked this planet.

Consumers are not the only ones who have been empowered to create virtual mountains of extraterrestrial currency, as the Japanese example will serve to illustrate. In trying -- so far, in vain -- to prop up real estate price, and pump up their export-driven economy and keep deflation at bay, Japan's central bank has practically been giving away yen. Institutional borrowers from around the world can tap Japan's money tree for loans at less than 2 percent. And they have done so with unbridled enthusiasm, to the point where this ""hot'' money has become a major factor in driving the world's stock markets to dizzying heights.

It's not hard to understand why the siphon action is so powerful, with U.S. stocks promising steady gains of 15 to 25 percent per year and many other equity markets doing as well or even better. Moreover, as the value of the yen has fallen, the incentives have become even greater to put it to work in stocks and bonds whose returns are denominated in other, stronger currencies.

Those who are betting that Japan will get its act together had better take another look. In fact, they have tried everything imaginable, with no success. This failure has implications which our stock-market bulls evidently have failed to grasp. The most obvious is that the second largest economy in the world cannot sink into oblivion without taking the largest economy with it.

Some who mistakenly regard themselves as prudent bears say we should be studying the lessons of Japan because we will eventually face our own bear market. But this would be like studying fog to get an inkling of what a hurricane might be like.

When our own economy starts to collapse, it will make Japan's problems seem trivial in comparison. The reason is that the Japanese have enjoyed a huge advantage during their ongoing liquidation -- namely, having prosperous Americans around as buyers. But there will be nobody around when our fire sale starts.

There are other warning signs of the swiftness and totality of the disaster to come. A few trading-room cowboys have been flushed out and ceremoniously flogged for losing billions of dollars on highly leveraged, esoteric financial instruments. But these same speculative vehicles still flourish on a global scale and must still be unwound.

There is also the unfathomable prospect of 7,500 mutual funds all trying to sell at the same time. For the record, they won't have to sell if there are no buyers. They will give the shares back to you, then pound the heck out of what few stocks there may be buyers for, namely the bluest of the blue chips. So if you think there will be safety in the so-called ""quality'' issues, you would do well to change the mix of your portfolio, because the "good" stocks are going to get shellacked.

Most likely, gold stocks, bullion and long-term Treasuries will be the best place to be, along with some foreign debt instruments. But don't count on being able to shift your money when the trumpets sound, for there will be no time then.

The probable cause of the crash will be a crisis in the currency markets -- probably a run on the Japanese yen. Because most investors have been thoroughly conditioned over the course of this decades-long bull market to buy every dip, swoon and seizure, look for two huge waves down before anyone seems to realize that The Big One has finally begun. That's when fear will turn to panic. It is as good a reason as I can think of to exit at least some shares now, rather than attempt to squeeze the last dime from this bull market.

About the Author -

Rick Ackerman writes and speaks about the economy and the stock market as well as other business topics. He contributes a regular column, "Market Directions," to The Sunday San Francisco Examiner and has also written numerous times for Barron's. His professional background includes seven years as a newspaper reporter and editor, twelve in the trading pits of the Pacific Stock Exchange and two with Hal Lipset, the celebrated private eye who helped solve a notorious pill-tampering case.

Concurrently, Mr. Ackerman also publishes a daily investment advisory newsletter called Black Box Forecasts.