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Over 95% of investors claim not to have seen the current downturn coming nor do they accept the probability of a coming depression (at least they did not by the end of 2007). There continues to be conversation whether we are near a bottom. Much money on the sidelines is eagerly waiting to go back into the market or more likely, existing investments with big book losses waiting for the market to recover. Yet when our probable course is viewed in historical terms, there is a very clear and likely path, much further reduction in the value of everything particularly including real estate, equities, bonds and most commodities (gold is shaping up as a hedge against the problems). What does history tell us?

Most views of history do not go back further than 5 years. In late 2007, I went to numerous prominent investment advisors to look for suggestions. Not one of them gave me recommendations where they would provide investment records that went back more than 5 years, the bottom of the 2002 downturn (Very convenient! I would call this deceptive advertising). The truth is that you need to look at investment histories over three hundred years for many realities to simply jump out at you. You see clearly that history repeats. You see clearly during three hundred years that there are major repeating cycles. You see clearly that ideas like buy and hold make no sense when you look at things over several decades. You see clearly that diversification does not really work when measured in terms of decades. (Commodities almost always bottom within three months of major bottoms of stock indexes.)

History needs to be looked at in two terms. Numerical terms of what has happened to the markets and descriptive terms of what has happened to the market.

Let's look first at a numerical description of the market. I am using a chart courtesy of James Flanagan of Gann Global Financial. This shows commodity prices from 1730 to present. You can clearly see the repetition of cycles in the prices of commodities.

Another excellent source of similar material is from Bob Prechter of Elliot Wave Theory. Both of these men provide excellent historical data on stock indexes, bonds, commodities and many other asset classes. As you look at their charts, you simply cannot avoid the conclusion that there are up and down cycles that have repeated many times over the last several hundred years. We are now in a major down cycle when the above chart is updated through February 2009.

Now let's look at descriptions of previous historical financial bubbles and crashes. While there are numerous excellent books, I particularly like "Devil Take the Hindmost, A History of Financial Speculation" by Edward Chancellor. His book starts will the tulip bubble in Holland in 1630. The book ends with a description of the Japanese Bubble of the 1980s (highly relevant since this is the strategy our government has chosen to peruse as a solution to our problems and this book gives some clear historical description of how it is likely to end). He also finishes with some description of the early problems with derivatives from the 1990s which are highly relevant as we can see how our earlier problems with derivatives ended and therefore where our current problem with derivatives will likely end.

Nearly all the bubbles in history seem to have three aspects in common,

1) A dramatic increase in the money supply (including money created via derivatives, private equity and hedge funds),

2) Usually a wonderful new financial instrument to facilitate this increase in the money supply (this time it is derivatives, where the Mortgage Backed Securities have already exploded. One particular aspect of derivatives is the Credit Default Swaps which is an economic nuclear bomb with the potential to explode through counter party failures) and

3) An easing of credit standards which ultimately leads to much bad credit (we seem to have already lost something like a trillion dollars with several more trillions to be written off as we go through the process with fatal consequences for many banks and financial institutions).

While they may seem like three different issues (increased money supply, new financial instruments and credit quality), in practice they are intimately related to one another in creating their nefarious effects on the world economy.

This is not a happy scenario. But we do no one a favor to pretend the cycle does not exist and that we are not in a major down cycle. If I am correct in the assertions made in this article, it raises serious doubts about the effectiveness of the Obama plan to fix the economic problems of the country.

Disclosure: No positions