The Coming Crashes … Part 2

Dec 17, 2014 No Comments by

As we approach the end of the year, we wanted to get you thinking about your planning for 2015. This, the previous and the next post, feature an article by Austrian economist Robert Murphy, PhD from the October 2014 Lara Murphy Report entitled “The Coming Crash(es), Life Insurance and Gold.” This is Part 2 of a 3-part series giving you time to digest Dr. Murphy’s analysis and recommendations. We’ll also provide key takeaways at the end of each segment to further guide you in your own thinking and planning. As always, we are available to work with you as you plan for 2015, please contact me at Julie Ann Hepburn.

Dr. Robert P. Murphy

Dr. Robert P. Murphy


In this article I’ll outline a framework for estimating the severity and possible timing of the crash.

However, I’ll also explain that there are different types of economic crises—some involving “only” a drop in equities, while more serious ones pull down the currency as well. 

The best mix of assets to hold depends on the type of crisis we endure. The responsible business owner or head of household must be aware of these nuances when preparing for the coming storm—or storms.  — Robert Murphy, PhD

When Will the Crash Happen?

Thus far I’ve explained why I think a hard stock market crash is inevitable. But when will it happen?

Well, as Mises himself explained, there are two ways that an inflationary credit expansion can end.

First, the banks can back off, slowing or even reversing the injection of new money, allowing interest rates to rise toward a more “natural” level. This causes a crash as the era of “easy money” abruptly halts.

However, even if the banks put the pedal to the metal and disregard the warning signs, eventually the currency itself will collapse and the “crack-up boom” occurs. The economy will still experience a crash in “real” terms, but the agonizing switch to a different currency is superimposed on the “normal” readjustment process.

For today’s investor, therefore, the question is one of guessing the Fed’s future moves. Will they keep extending QE, every time the stock market dips? Or will they eventually realize that a crash has to occur, and be the adults in the room to let it happen?

Obviously, nobody can answer this question with certainty; there is nothing in Austrian economics equipping us with psychological crystal balls. However, if I had to guess—and this is only a guess—I would say that the Yellen Fed is indeed going to let the crash happen sooner rather than later. The reason has to do with legacy and politics.

Austrian theory tells us that for every boom, a bust eventually occurs. So on average, Fed chairs will have the same number of booms and busts on their respective watches.

Now, if economic law forces every boom to be followed by a bust, what is the ideal way to distribute Fed chair(wo)manships?

I think it would make sense for each Fed chair to inherit an economy poised on the verge of collapse, then deal with the crash early on—when it can be blamed on the previous chair. Then, the sitting chair blows up a new bubble, giving the appearance of prosperity for most of the term. As things start looking bleak, the chair steps down, handing the keys to the ‘bubblicious’ economy to the next person in line. The economy then crashes early on in the new chair’s term, and the cycle repeats.

Does this story fit the empirical record?

Indeed it does.

Paul Volcker took over as Chair of the Fed in  August 1979. A recession officially began five months later, in January 1980. The second “early 1980s” recession officially began in July 1981, during which the annual unemployment rate hit 9.7% in 1982. This was the worst recession since the Great Depression.

In August 1987 Alan Greenspan took over the Fed. Two months later “Black Monday” occurred on October 19, 1987, when the Dow dropped 22.6%—the worst one-day crash in history. Finally, in February 2006, Ben Bernanke became Fed chair. The worst recession since the Great Depression officially began in December 2007.

Thus we see that there is an alarming tendency for major financial crises to occur relatively soon when a new Fed chief takes over, at least going back to the late 1970s.

If you think back to the actual mechanics of the “taper” of QE3, it was originally supposed to start in the fall of 2013. But then too, the stock market was sliding, so the Fed postponed the start of the taper until December 2013—literally the last month of Ben Bernanke’s tenure. He then handed the keys to Janet Yellen, under whose leadership the taper ran just about its full course until this month, October 2014, when it is supposed to wind up.

To reiterate, nobody can predict the free choices of human beings. It’s entirely possible that the Yellen Fed reverses course and continues to buy net assets, in order to juice the stock market.

However, if I had to guess—and it’s just a guess, folks—I would say that Fed officials will wait until the mid-term elections are over,and then make it more explicit that they really are taking away the punch bowl.

Note that this would be consistent with how the Fed started QE2 (not QE3, mind you): It made the announcement that it would begin its $600 billion bond-buying program on November 3, 2010, 3 literally the day after the mid-term elections.

As we are now in the midst of another mid-term election year, my hunch is that Fed officials will try to keep people in a state of limbo until the votes are cast, then drop the news on everybody.

One of the tricks this time around was that the Fed (the week before the election) announced a relatively “hawkish” move, but then the Bank of Japan followed up with a surprise “dove” announcement of more stimulus, sending the markets rallying. So my guess is that the central bankers don’t want to come off as influencing the U.S. elections, but the bad news will come soon.

A Panic Affects Different Types of Interest Rates

To anticipate what might happen if and when the stock market next crashes, we can look at the last crash, which occurred in the fall of 2008 when the news of Lehman and AIG broke and world financial markets began to panic. Specifically, from September 19, 2008 through October 10, 2008 (less than a month), the S&P500 fell 28%. Going into September, the market had already fallen heavily since its previous high, but the drop we’ve noted here was the fastest collapse.

Looking at that period is thus instructive to get a clue as to what might happen in the future the quick answer—which might sound counterintuitive at first to some readers who are committed to “hard money”—is that Treasury prices rose sharply (yields collapsed) and the U.S. dollar strengthened.

For example, from early August through early October of 2008, the euro fell about 13 percent against the dollar. And Table 1 shows the stunning collapse in Treasury rates across the yield curve, but particularly in the shorter maturities.

LMR_Table1_Oct 2014

As the data in Table 1 shows, yields on T-bills collapsed incredibly quickly in just one weekend in September 2008. (On Monday, September 15, Lehman officially filed Chapter 11, which explains the enormous drop in yields from Friday September 12. Also, on September 16 the Fed authorized up to $85 billion for its takeover of AIG. 4

Over the next several months, the yields on longer-term Treasuries also came down sharply. Yet hold on. We shouldn’t infer from the above that all interest rates dropped sharply once the crisis struck. Consider Figure 3, which compares yields on 10-year Treasuries, Moody’s Aaa-rated corporate bonds, and Baa-rated corporate bonds

FIGURE 3. Yields on Various Bond Classes

LMR_Figure 3_2014

In Figure 3 above, we see that when the crisis first struck in the fall of 2008, the yields on corporate bonds spiked, but the Baa rose much higher than on the Aaa-rated bonds. In contrast, 10-year Treasury yields didn’t move much, as we’ve already seen in Table 1 above.

By the end of 2008, yields across all three bond classes had come down dramatically, but notice: The yields on 10-year Treasuries and Aaa-rated corporate bonds had fallen below their pre-crisis levels by the end of 2008, whereas the yields on Baa-rated corporate bonds did not drop below their previous levels until the recession was officially over in the summer of 2009.

How do we make sense out of all these trends?

The answer is pretty straightforward: When the crisis struck in September 2008, investors around the world rushed to (relative) safety, regardless of return. Like it or not, investors in recent years have perceived the U.S. Treasury as the safest asset on planet earth. During a financial panic, therefore, investors rush into U.S. Treasuries. That pushes up their market price, which is the same thing as pushing down their yield (interest rate), because on a bond, price and yield move in opposite directions. Naturally investors dumped their equities during the crisis, which is why the stock market collapsed. But they also tried to get out of risky corporate bonds, and even reduced their appetite for holding the safest corporate bonds.

This is why the yield on Baa-rated bonds shot up so much, while even the yield on Aaa-rated bonds increased during the first month of the crisis (though the yields on Aaa bonds then dropped quickly as the panic subsided). To put it succinctly, in the first few months of the crisis the highest-quality borrowers (such as the U.S. government and solid corporations) found it easier to obtain funds, while the lower-quality borrowers saw their credit access tighten up. Finally, the U.S. dollar strengthened on the world currency markets, because if foreigners want to buy U.S. financial assets, they need to obtain U.S. dollars to do so.

The Impending Crash and Its Impact on Life InsuranceCompanies

Long-time readers of the Lara-Murphy Report know that we are strong advocates of Nelson Nash’s Infinite Banking Concept (IBC), which counsels the use of dividend-paying Whole Life insurance policies as a method of cashflow management. Many readers are initially intrigued by our ideas, but they ask a very sensible question: “If you guys are so pessimistic about the U.S. economy, the government, and the Fed, why in the world would I want to get into a dollar-denominated asset like life insurance?!”

It’s a great question. This article is already quite long, so I won’t give the full answer. (We address the issue in greater depth in Chapter 19 of “How Privatized Banking Really Works.”) But coming on the heels of the discussion above, we can say: The life insurance companies are ideally equipped to handle a crisis if it resembles what happened in 2008.

In particular, life insurance companies hold a large portion of their portfolios in bonds, both Treasuries and high-grade corporate debt. Compared to other asset classes (especially equities and real estate), these will hold up quite well if we have a repeat of 2008 and beyond.

Intuitively, the bonds that the life insurance companies purchased in order to “back up” the existing block of policies will experience a jump in market value—the Treasuries will do so immediately, while the high-grade corporates will do so over a few months (again, if things play out in similar fashion).

However, once the bond market re-equilibrates, the life insurance companies may be reluctant to issue greater amounts of new (whole life and other permanent) insurance policies. Intuitively, as long-term safe bond yields collapse, the life insurance companies don’t have anywhere to put the new premium dollars to work, unless they are willing to take on more risk (which, by their conservative nature, they don’t want to do).

What does all of this mean for the individual considering the pros and cons of implementing IBC, either as head of a household or a business owner?

We think it means time is of the essence. As the considerations above indicate, people who are already “in” will be very glad they did so, if and when the next crisis strikes.

The value of the assets backing up their policies will be relatively stable, while other assets collapse. Furthermore, as credit channels for the average Joe dry up, whole life policyholders will have their contractually-guaranteed access to policy loans.

Finally, people who try to get into IBC at that point, after the crisis has struck, may find that the terms are much less attractive, as the life insurance companies will understandably take steps to limit the influx of new money into such interest rate-sensitive products. In short, for those who have been toying with the idea of IBC but just haven’t pulled the trigger: The door may be closing faster than you realize.

From National Private Client Group
Part 2: Key Takeaways

  • It appears that ‘crashes’ are poised to happen very early within a new Federal Reserve chairperson’s appointment – usually 18-24 months. History bears this out all the way back to 1979’s appointment of Paul Voelker as Fed chair.
  • In a financial panic such as the one in 2008, investors tend to buy U. S. Treasury Bonds, dump equities, which is why the market collapse and eschew corporate bonds, even the safest ones.
  • Why do we advocate buying whole life insurance? Life insurance companies are ideally equipped to handle a crisis if it resembles what happened in 2008. They hold a large portion of their portfolios in bonds, both Treasuries and high-grade corporate debt. Compared to other asset classes (especially equities and real estate), these hold up quite well if we have a repeat of 2008 and beyond.
  • We believe time is of the essence. If you already have an IBC or  Self-Empowered Banking (SEB) system in place, the value of the assets backing up those policies will be relatively stable, while other assets collapse, plus policyholders have the benefit of access to policy loans, as the loan market for the average Joe dries up.
  • After the crisis, the terms will be less attractive as insurance companies will be less likely to allow new money into their interest rate-sensitive products – which for our purposes means dividend-paying whole life insurance, and not any of the alternative insurance products such as universal life or variable universal life. In short, for those who have been toying with the idea of IBC/SEB but just haven’t pulled the trigger: The door may be closing faster than you realize.

NPCG Bottomline: History does repeat itself. What are you waiting for? Get into a IBC/SEB before the next crash and have both financial stability and access to capital through policy loans.

Please mark your calendar for April 17, 2015 when we will once again present Your Financial Destiny 2015. Dr Robert Murphy will be one of our speakers and you can learn from him firsthand how to read the signals which the market is communicating and the types of actions you can take to protect yourself. If you would like to receive Early Bird information and pre-register for the day-long seminar, please email me at YFD2015.


Dr. Robert Murphy Disclaimers

Every individual is unique. No one knows the future with certainty. I am not in this article providing direct financial advice. Before taking any action, each reader should consult with qualified and properly licensed professionals, especially to consider the tax ramifications of any decisions.

Let me remind the financial professionals who read the LMR: If you do not have a securities license, then FINRA will not take kindly to you urging clients to sell equity holdings (perhaps to fund the acquisition of a new life insurance policy). It is important that your clients come to you, already knowing what they want to do, without you “finding the money” for them.

The Coming Crash(es), Life Insurance, and Gold

References, Part 2

3. For coverage of the announcement of QE2, see:

4. For a timeline of the 2008 financial crisis see:

Building Wealth, Knowledge is Power

About the author

Julie Ann Hepburn, is a Private Banking Expert and Financial Coach. She is the founder and principal of National Private Client Group, LLC , a Chicago based financial consulting group. Ms. Hepburn is a licensed finance professional, and serves as an agent and consultant for several major mutual insurance carriers. For full bio, please see:
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