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The Downturnaround Is Here

(Photo: Stephen Frink/Getty Images)

Here’s what Shilling recommended doing with your money:

1. Sell or short homebuilder stocks.

2. If you plan to sell your home, second home, or investment houses anytime soon, do so yesterday.

3. Short subprime mortgages.

4. Sell or short housing-related stocks.

5. Sell or short consumer discretionary-spending companies.

6. Sell low-grade fixed-income securities.

7. Sell or avoid most commercial real estate.

8. Short commodities.

9. Sell or short emerging-market equities.

10. Sell emerging-country bonds.

11. Buy the dollar before long.

12. Sell or short U.S. stocks in general.

13. Buy long Treasury bonds.

If you ever wondered why some people pay $1,000 a year for a monthly newsletter with no pretty pictures, well, now you know. Shilling was an astonishing thirteen for thirteen on his recommendations.

Shilling is 72 years old and works out of a squat office building in Springfield, New Jersey, where he takes his yellow Labrador retriever to work. A beekeeper in his spare time, he’s a small-town Ohio boy who studied physics at Amherst, received a Ph.D. in economics from Stanford, and went to work as an economist on Wall Street in the go-go sixties. He is not a doomsayer, but he does have a pessimistic streak: Donald Regan, who later served as Treasury secretary and White House chief of staff under Ronald Reagan, fired Shilling not once but twice for failing to be sufficiently optimistic about the U.S. economy.

Shilling concedes that it’s quite possible that GDP growth will briefly tick positive, driven by the mere refilling of inventories and modest relief from epic declines in consumer spending. Optimists might hail this moment as the great recovery come at last, but Shilling warns us not to be fooled.

The recovery will hardly feel like one, because the American consumer is changing. “Consumers are going on a savings spree for the first time in 25 years,” he says. “They’ve run out of borrowing power. They relied on their stocks in the eighties and nineties to put their kids through college, early retirement, a few trips around the world. That’s over.”

Housing prices, meanwhile, will continue to drop, says Shilling, dragged down by the massive inventory of unsold homes. And we will endure several more iterations of the government’s bank rescue, as the problems ascend the financial food chain—the trickle-up recession. What started in subprime mortgages is now wreaking havoc on prime borrowers.

The main feature in Shilling’s vision of the future is deflation. Owing to the overwhelming supply of goods, prices must come down, making it difficult for companies to manage their costs. So, for the first time since the Depression, U.S. companies are not only cutting jobs, they’re cutting wages. The average person can’t look five years into the future and realistically project himself as making 25 or 50 percent more. Of course, the upside of that is that prices won’t rise, either, so the cost of living should remain stable or decline. But it won’t inspire much in the way of confidence in the average wage earner. Inflation eases the burden of debt; deflation makes it hell—because while your income goes down and the value of your assets fall, your monthly mortgage payment doesn’t budge.

Deflation is widely considered the major threat to economic prosperity, a primary cause of the Great Depression. And it’s true that acute deflation can be disastrous—when prices fall quickly, consumers put off buying anything significant. If you know that cashmere sweater is eventually going to be 50 percent off, you’ll wait for that to happen. In the meantime, most of the stores that sell cashmere sweaters go broke.

But Shilling has long understood deflation as the basic and mostly benign operating condition of the highly competitive, technologically innovative U.S. economy, alleviated only by “shooting wars,” like Vietnam, when government spending tips the economy into inflation. We shouldn’t be so frightened of deflation, he says; it merely requires us to recalibrate our ideas about certain things, like that real estate automatically appreciates in value. The recent market collapse has certainly helped many of us understand that.

According to Shilling, the transition to this new era of reduced expectation shouldn’t be too awful for most people. “Americans have a lot of frills in their lives they can cut without going hungry,” he says. “The drinking water in this country is clean and safe, so why people pay for bottled water, I have no idea. They’ll take vacations closer to home; what’s the big deal about that? There are things we have gotten used to that won’t be that hard to do without.”

But adapting to a chronically slow-growth economy may be more difficult for New Yorkers because the city has profited from three powerful trends that Shilling sees coming to an abrupt end: a relatively cheap dollar that drew tourists and overseas investment, loosening of trade restrictions that encouraged money to zip freely around the world, and deregulation that allowed financial firms to leverage up and massively compensate their executives. Shiller forecasts a stronger dollar amid global weakness (“the best-looking horse in the glue factory,” as one currency expert puts it), a new era of protectionism as governments respond to internal political discontent, and a federal clampdown on Wall Street.