How to Survive – Even Profit From – the Declining Economy

I was in Baltimore recently for meetings with some of my biggest clients. My job was to review their progress in 2007 and give them ideas about how to grow their already profitable businesses in 2008.

During that time, I taped an interview with J. Christoph Amberger for Today’s Financial News, his multi-media e-letter. In the interview, Christoph and I discussed the coming economic recession, as well as the special opportunities a declining economy provides for entrepreneurs. I thought you’d be interested in reading this rough transcript of our conversation…

JCA: The American economy may or may not enter a recession in 2008. But even if the economy doesn’t fulfill the technical criteria of a recession (two consecutive quarters of negative growth), anyone doing business or working for a business these days is experiencing or expecting a severe downturn.

Michael, we both have been through a couple of recessions and bear markets. What are the secrets to surviving a recession – and maybe even prospering in an adverse environment as an entrepreneur?

Me: That partly depends on the kind of recession. This one is different from recent downturns and stock market declines in three important ways.

First, there is the fact of inflation. Oil has already hit record highs this year. Gold is on its way to $1,000 an ounce. And a gallon of gas is costing $4 in some states. Agricultural prices are going up too. One figure I saw had inflation pegged at 6.8 percent on an annual basis over the last three months. But it is actually worse than that. Because that figure was based on government-supplied data. Our government has made an art of obfuscation – of hiding certain economic realities. Inflation is already eating away at our buying power. It is bad and it is getting worse.

Next, there is the falling dollar. The dollar is weaker now than it has ever been in history. That makes foreign goods more expensive. Which increases inflation. On the bright side, it makes U.S. manufactured goods more attractive as exports. But in most areas, we still can’t compete, price-wise, with China, India, and the Third World.

The third way this downturn is different is the level of debt. For the first time in modern history, American consumers owe more than they have. Credit card debt has skyrocketed. Mortgage debt, which increased enormously during the past 10 years as a result of irresponsible loans, is now at a crisis point because real estate values have fallen, making tens of thousands of loans untenable. It makes more sense to walk away from these loans than to renegotiate them. And behind all this is the federal debt – which has skyrocketed because of runaway spending by an earmark-addicted Congress and Bush’s $3 trillion war.

These are our economic weaknesses – and they are big weaknesses. But there are strengths too. Unemployment numbers are relatively low. Earnings are relatively good. And new business start-ups – which to me is always the most important indicator – are still strong.

Unemployment will certainly increase in some sectors. It is already a fact in the real estate market and will become a factor in banking and the financial industries that support real estate. But other sectors of the economy are okay for the moment. They may absorb some of these people. And new businesses will continue to create jobs, as they always have, because of the amazing growth of the Internet.

What all that amounts to, in my book, is a period stagflation that may be followed by a recession but may simply continue to exist until our debts have been paid by the working man, as they always are.

JCA: Not everyone is familiar with the term “stagflation.”

Me: “Stagflation” was coined ages ago when I was still in college. It describes an economic period of both inflation and flat growth. The best description I’ve heard was provided by Rich Karlgaard, publisher of Forbes. He said:

“Stagflation is present when gas and grocery prices are rising faster than your paycheck is – and in an economy that is strong enough to employ you but not strong enough that you feel emboldened to ask for a raise.”

There are three ways to defeat stagflation: (1) Tighten the money supply. (2) Restrict credit. (3) Lower taxes.

When too much money/too-easy credit is driving up prices – that’s classic monetary inflation. This should tell the Fed to restrict the printing of money and tighten credit. But so far they’ve been doing the opposite because they are afraid that if they tighten credit, the economy, which is already weak, will collapse.

Lowering taxes, particularly taxes on individual and corporate income, capital gains, and dividends would grow the economy by encouraging investment and stimulating production. This is classic supply-side economics. But it’s very unpopular today. The common view is that tax cuts reduce the effectiveness of government and increase government debt. But the evidence contradicts this. Government receipts usually go up after tax cuts because the economy grows and there is more income and profits to tax. When you reduce the cost of doing something, you tend to get more of that thing. Reduce the tax costs of production in America and you will get more production. More production means more goods and services competing for your dollars. “That’s how prices go down, not up,” says Rich Karlgaard.

It’s simple. Supply and demand. If you want prices to go down, increase the supply. Incentivize the suppliers.

But that’s probably not going to happen because it’s not politically expedient for politicians to do it. Chances are our problems will be cured by a period of negative or flat growth along with inflation. This is the solution preferred by politicians because it is a way for average consumers to pay for government debt and bad loans without understanding they are paying for it. It’s another form of taxation.

Assuming we are entering a period of stagflation, certain investing principles apply:

  1. Cash is king.
  2. Buy value.
  3. Buy into the recovery.
  4. Invest in what you know.
  5. Limit expenses.
  6. Be ready to seize opportunity when it arises. Because it will arise.

JCA: Unemployment may kick-start some would-be entrepreneurs’ plans to start their own businesses. Are there any particular sectors that you think will do well, especially for new businesses?

Me: As I said, I don’t think unemployment is likely to be a huge problem – at least in the short run. But it will be a factor. More important will be the squeeze people will feel from stagflation. Prices are going up but not their salaries. This will trigger some start-ups. And there will also be lots of job displacements as some sectors of the economy – real estate-related – go down for a while and others – natural resources and even agriculture – go up. At some point in time – probably in the next year or two – real estate prices will bottom out. Then the vulture funds will come in and begin to buy up excess inventory. When that inventory is absorbed, the construction and building sectors will revive.

In the meantime, I favor:

  • Certain investments – like gold, oil and gas, natural resources
  • Certain services – such as for legal settlements, divorce settlements, business litigation settlements, home remodeling and repair
  • Information and advice on investing, retirement, estate planning, entrepreneurship, tax avoidance
  • Natural supplements and pharmaceuticals
  • Rejuvenation products and services
  • Retirement homes and other retirement businesses
  • Soft exercises and sports – such as yoga, Pilates, tai chi
  • Spiritual wealth information and products
  • Self-improvement information and products
  • Real estate (longer term)

JCA: Judging by the promises of our presidential candidates, U.S. businesses will almost certainly be hit with higher taxes, compulsory health care contributions, higher labor costs. Is it still worthwhile setting up shop in America ? Or should entrepreneurs relocate to a more business-friendly climate… like Eastern Europe… or China… or the Caymans?

Me: There is a big misconception here. One I had until I began doing business overseas. Location of the business matters only in certain industries that depend on cheap, unskilled labor. If you are producing clothing or furniture, it makes sense to have a factory in the Third World. But if you are producing sophisticated products for which labor is a small part of the cost – or selling information or advice – you can do it from the U.S.

Information and advice is especially good because the brute labor cost is almost non-existent. Thanks to the Internet, the cost of storage and shipping is minimal, so you can easily produce your product here and sell it anywhere… anywhere in the world.

In the coming recession, I would want to be in a business that has the following characteristics: (1) positive cash flow, (2) no debt, (3) no accounts receivable, and (4) no merchandise to store. That amounts to a service business or information publishing. Of the two, information publishing is better. In fact, it is the best business to be in for the foreseeable future.

There are some advantages in setting up overseas, but there are also many disadvantages. I would not pick up shop and open up overseas unless I had a proven formula that was working in the U.S.

JCA: The title of your latest best-selling book is Ready, Fire, Aim. What do you think, Michael? Will the coming recession require entrepreneurs and business owners to aim BEFORE they fire?

Me: Entrepreneurs must seize the day. You have to be READY to do that.

When real estate prices bottom out, there will be a rush to buy from the vulture funds. Private investors must be ready with protocols, plans, and money.

The same holds true for any business you plan to launch. Don’t waste valuable time and money trying to perfect it. Figure out a marketing proposition and test it as soon as you can. If it works, then refine it. If it doesn’t work, move on to the next thing. Ready, Fire, Aim!

JCA: What are the biggest mistakes an entrepreneur or business owner can make right now?

Me: There are three:

  • Starting a new business without knowing anything about it. I call this the Principle of One Step Removed.
  • Wasting time and money on activities that are not directly related to sales.
  • Not having a Disaster Recovery/Opportunity Plan.

JCA: That leads to my final question for you: Given today’s economic climate, what does a new business have to have to give it the best chance of success?

Me: It’s no different now than it’s ever been.

  • First is a management team with character, experience, and ingenuity.
  • Second is a plan that clearly identifies the way they will efficiently bring in customers from day one.
  • Third is their use of resources. Will 80 percent of them be devoted to making a profitable sale?
  • Fourth is capital. Do they have enough of it?
  • Fifth is product. Does their lead product have a raison d’etre in the marketplace?

JCA: Thanks for joining us today, Michael.

[Ed. Note: Michael Masterson’s latest book, Ready, Fire, Aim: Zero to $100 Million in No Time Flat, has hit the New York Times, the Wall Street Journal, and now the Business Week lists of business best-sellers. Inside, Michael shows how veteran and rookie entrepreneurs alike can take their businesses to the next level. You’ll learn how to identify and solve the problems that crop up during each stage of a company’s growth… and how to take advantage of profit opportunities along the way. Order your copy of Ready, Fire, Aim now.] [Ed. Note: Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]

Mark Morgan Ford

Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Wealth Builders Club. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.