How to Prepare for the Next Crises

Last year, I told you about the idea of the coffee can portfolio…

A coffee can portfolio is one you set and leave alone for 10 years. A reader recently wrote to say it seemed to depend on an optimistic view, à la the one Warren Buffett expressed in his latest annual letter.

Today, I want to refute that view. You can have quite a dim view of the world and still I’d recommend you build a coffee can portfolio. Below, I’ll explain why. But first, a bit on that optimistic view of Buffett’s…

I read his annual letter. I also read a lot of commentary on the letter. One of the more interesting criticisms comes from SNL Financial columnist Ada Lee. She wrote:

The greatest flaw in the letter is the same as last year’s greatest flaw; Buffett is given to expressing bullishness on America’s prospects in a way that seems almost designed to instill precisely the sort of complacency that poses the greatest risk to that bullish view.

In the letter, Buffett writes how he “always considered a ‘bet’ on ever-rising U.S. prosperity to be very close to a sure thing. Indeed, who has ever benefitted during the past 238 years by betting against America?”

To that, Lee has a good rejoinder:

Nobody. Unfortunately, that sort of statement is completely true right up to the day it is completely false. One might have said the same thing about Athens right up to the start of the Peloponnesian War, or Rome through the rule of Augustus, or even the Soviet Union up until around 1980, after which a great many people benefitted immeasurably by betting against those states.

So that sets the table for thinking about a future that might not be quite as prosperous. What do past calamities tell us about preserving wealth?

Many have tried to answer it. The first guy I thought of was the late Barton Biggs. He was a mainstream guy, a longtime strategist at Morgan Stanley and then a hedge-fund manager and author. (Hedgehogging is his best book and worth reading.)

But Biggs was something of a catastrophist. History’s periods of great wealth destruction, when the Four Horsemen of the Apocalypse ran wild, transfixed him. He worried about disasters happening again. He asked the timeless question: “How to do you preserve wealth in times when the Four Horsemen are on the loose?”

It was one of the two questions that, in his own words, “long obsessed” him. The other was whether the stock market was wise in its judgments or merely a “foolish consensus of crowds”?

One of his books, Wealth, War & Wisdom, deals explicitly with these questions through the lens of World War II history, a hobby interest of his.

On the wisdom of crowds, Biggs finds that the stock markets of the world showed “surprisingly good intuitions at the epic turning points. As the old saying goes, when coming events cast their shadows, they often fall on the NYSE.”

He writes how:

• “The British stock market bottomed… in 1940 just before the Battle of Britain.”
• “The U.S. market turned forever in late May 1942 around the epic Battle of Midway.”
• The German market “peaked at the high-water mark of the German attack on Russia just before the advance German patrols actually saw the spires of Moscow in early December 1941.”

“Those were the three great momentum changes of World War II,” he writes, “although at the time, no one except the stock markets recognized them as such.”

I must admit those are amazing intuitions. It’s easy to write off the market as nutty when it doesn’t agree with you, but Biggs makes the case that the collective judgment of the market can be wiser than we allow. In any event, this is tangential to what I consider the meaty second question.

The second question deals with how to preserve wealth when the Four Horsemen are on the loose. Biggs goes through a lot of WWII-era carnage to find answers. You’ll find such chapter headings and subheads as “Preserving Wealth in a Time of Cholera,” “The Plunder of Land in Poland,” “The Seizure of Estates in Hungary,” “The Theft of Land and Valuables in Czechoslovakia,” and “Rape and Robbery by the Red Army.”

And yet, after all that, even the catastrophist Biggs recommends putting 75% of your wealth in stocks.

This is partly because his own history of catastrophes validates such a move, stocks were still often the best way to preserve purchasing power over a period of years, even in devastated Germany. But it is also because he understands the best shot you have at growing your wealth is to own stuff. You want to be an owner.

If you own stocks, you are part-owner in a real business – with real people trying to figure things out with real assets and real profits. Ownership of assets is your best long-term protection against calamity.

But what to do with the other 25%?

Biggs recommends a much smaller part of your wealth go toward a ranch or family farm. He advocates a safe haven, well stocked with seed, fertilizer, canned food, wine, medicines, clothes, etc.

You may notice what’s absent from his list is gold.

I always find it amusing to listen to catastrophists say there is a big monetary collapse coming and then they recommend gold, as if gold is not part of the existing monetary order. As if that’s going to protect you.

In a real breakdown, you’ll want: Food. Shelter. Weapons. These are things that have value in a real breakdown, not a pile of shiny gold coins. Have you ever read Cormac McCarthy’s The Road? There is a scene I’ll always remember when the protagonist rummages through a house and finds a stack of Krugerrands. He shoves them aside like worthless poker chips in search of something with real value – like canned food.

I own some gold and silver, but it is a small part of my net worth, almost incidental. The idea behind owning gold is it has held its value for thousands of years. So have land, productive farmland, livestock, etc. This is wealth ancient kings would recognize. But in a crisis, gold is the least useful of these. I’ll take the farmland, livestock, weapons, shelter, etc. You can keep your coins.

You also hear people say you should invest outside the country. Again, that strikes me as ironically optimistic. In a catastrophe, long-range travel is one of the first things to go. A lot of good that gold you put in a vault in Switzerland will do you. Ditto that little oasis you created in South America or Asia. Good luck getting to it.

And besides: Who will be the first people they steal from when times go bad in Argentina, Nicaragua, China, India, South Africa, or wherever? The locals? Or the plump, white foreigners? I think these questions answer themselves.

The greatest optimists are those who invest overseas thinking it will protect them from a catastrophe. Au contraire, you’re probably better off in your own country, where you can easily access that wealth and you know the ins and outs of the system in ways you never really know overseas. That’s realistic.

I think you invest overseas for lots of reasons – in search of a better risk and reward, for example. Or just for variety’s sake. But you don’t invest overseas because you think it will protect you when the system breaks down.

Anyway, this survivalist stuff is not my main idea. I just want to make the point that in a real collapse, your portfolio – whether it has stocks or gold – will probably be among the least of your worries. But at least in a calamity like WWII, stocks were your best bet.

So let’s pull this back to the coffee can idea and think about a coffee can for catastrophists.

First, your coffee can doesn’t have to include stocks. You could, if you are so inclined, stuff your coffee can with gold. I wouldn’t do that, but the point is the coffee can idea is not an expression of Buffett’s optimism on America. You could put whatever you want in your coffee can.

The essence of the coffee can idea is really a way to protect you against yourself… from the emotions and volatility that make you buy/sell at the wrong times. Bullishness or bearishness doesn’t enter into it.

If you are a bear and abstain from making a coffee can, you’re basically saying you’ll make a series of better short-term decisions over the next 10 years than you would if you just sat on your best ideas today. That seems unlikely given all the research that shows how most investors trade too much and how it hurts their returns.

Put another way, the theory behind the coffee can says your series of shorter-term decisions is likely to be worse than one decision today. It might not turn out that way, but it is independent of whether you think the world will be less prosperous in 10 years.

If the world is worse off in 10 years, all strategies will be affected. It’s not like you can say, “Well, I think the U.S. is going to be the next Argentina, and hence I won’t do the coffee can.” The conclusion does not follow from the premise. You still have to decide what to do…

And as I’ve said before, you don’t have to put all of your wealth in a coffee can. I’ve told people that they only need to put a part of their money in a coffee can… it doesn’t have to be the only approach you use, but one of several.

In summary, don’t let the fear of apocalypse keep you from building a coffee can portfolio.