I keep hearing how cheap things such as stocks and real estate have become. "Buy now while prices are cheap," is a common refrain now in most of the mainstream media.

But what is cheap?

It appears that when the prices of assets have fallen by 10 or 20 percent, people think assets must be "cheap"!

Of course, such prices are indeed relatively cheap. But are they really or absolutely cheap, when there is a risk that they may fall further in price?

No! I believe things are only cheap when, on an absolute and realistic basis, they can be expected to rise in price. Then prices are truly cheap, sometimes even after a rapid rise in price.

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Recently we have seen a lot of bad news. Our GDP growth rate (Q4 of 2007) sank to just 0.6 percent. Unemployment rose to 4.9 percent, and retail sales tanked.

Our economy has expanded for a record 74 consecutive months, versus a post-war average of 51 months. Great news, you might say, and most people would agree.

But the average recent growth rate has been only some 2.8 percent, versus an average of 4.3 in previous growth phases. Yet, our apparent wealth has grown to unbelievable levels — and based upon what?

Right, you guessed it: Debt on an unprecedented scale, with debt piled upon debt and then some!

[Editor's Note: Why the Fed Interest Rate Cuts Won`t Work]

Our former Fed Chairman Alan "It wasn't me" Greenspan pumped staggering amounts of sometimes below-inflation-cost liquidity into the economy. Money supply was expanded in some periods at an almost reckless 35 percent.

On the back of this, banks lent on a leveraged and increasingly less prudent basis.

In addition, we entered a new world of hedge funds and leveraged derivatives. As The Economist stated last year, a hedge fund was able, by using bank loans and leveraged derivatives, to leverage its capital by a mind-boggling 52 times!

All this was great in the "good" times when asset values were rising.

However, with a fall in asset value of just two percent, the entire equity capital base would be wiped out. That is reverse leverage, with a vengeance!

As Stephen Roach, then-chief economist of Morgan Stanley noted last year, the world was awash with liquidity. Asset prices boomed.

Additionally, during our recent growth cycle, it is important to note that, despite the fact that our official, "cooked" inflation rate hovered around two percent, for real people who actually eat food, use crude oil and need health care, actual inflation they experienced was far higher.

Furthermore, during the recent growth cycle (since 2000), median household income has actually fallen. It fell by 2 percent for whites and a massive 8 percent for blacks.

Meanwhile, corporate profits rose rapidly, leading to nominal record stock-market prices. But now, even sanguine stock markets appear to be breaking out below both 50- and 200-day moving averages, with advance-decline lines also falling.

With rampant Main Street inflation, falling incomes, rising job insecurity, and now falling stock and house prices, is it any wonder that the great American consumer has become increasingly embroiled in debt and falling confidence?

It appears that our record period of growth was financed increasingly by debt — ever-rising levels of imprudent debt.

It was like piling dry timbers. All that was necessary to set them ablaze was a spark. That spark came in the form of a downturn in house prices. Foreclosures began to mount in the wake of underestimated ARM resets that took place on a morass of imprudent mortgages.

With the tinder alight, the main timbers – the massive debts upon which our economic expansion had been built – are now under threat.

Facing this looming crisis, out government appears merely to be dithering in a state of shock, instead of leading.

For instance; the $107 billon consumer-stimulus package (discarding the $50 billion going to the cash-rich corporate sector) amounts to less then one percentage point of our $14 trillion economy!

In addition, the approval rates under the mortgage-rescue plan are proving to be laughably low, in practice.

Finally, the recent Fed rate cuts have been too little and too late.

So, a recession now looks increasingly imminent.

Just as in a growth period debt acts as an "inflator," so in a recessionary period debt acts as a deflator!

With luminaries like Robert Schiller of Yale and Larry Summers, formerly of Harvard, predicting the sustained and serious recession that we have long forecast, major investment banks, including Morgan Stanley, Goldman Sachs and Merrill Lynch, are now all warning their clients of a serious, even extended recession.

In such an environment debt becomes a major deflator!

In my opinion, most asset prices will now be reduced in price to a level that reflects the squeezing out of almost all the debt component of the price. In some cases that is a very large proportion of the present price!

I find myself a little shocked when considering the impact of such a conclusion — it means the prices of most assets will have to fall much, much further!

Indeed, in my opinion, we are now witnessing only the beginning of a massive fall in asset prices as the world returns to reality, a world where the price of some stocks and other assets, even houses, will truly be cheap.

Of course there will be exceptions.

For instance, I feel that new, improved eating habits (rice, chicken and water being replaced by wheat, beef and milk), particularly in the Far East, will result in consistent and increasing new demand for soft (food) commodities.

As our readers will know, I have always argued that the recession I predicted for America will cause a significant economic slowdown, in the very least, for the world economy.

However, the demand for better food represents a very powerful, grassroots political demand. The governments of most of these countries are rich — very rich — and thus will have to ensure that their impatient, newly freed people continue to get the meals they now expect!

But, for the rest, I see serious declines in price before there is enough "blood in the street," so to speak, to make most assets truly cheap.

I foresee so serious a decline that any investor should, when urged by increasingly hungry salespeople to "buy," ask themselves repeatedly: "Exactly when is ‘cheap' actually cheap?"

The answer is, only when it becomes reasonable to expect the asset to rise in price!

An important point to remember here is that the prices of assets do not all move in unison as an economy transitions from growth to recession and vice-versa. Readers should be careful to judge each economic sector and asset class on its own merits.

For example, Warren Buffett rightly sees blood gushing in the street of the bond insurance world. He possibly judges it too early to buy a mature, downgraded bond insurance company (loaded with a book of business that looks more like a can of worms).

Better to leave that to the major banks and financial institutions, themselves embroiled in collateralized debt obligations (CDOs), to cobble together their own, self-interested rescue package!

However, it may be a great time to form a new company, staffed by skilled employees (laid off by competitors), one able to charge new, realistic rates that reflect a depressed insurance market.

Furthermore, it is a largely a matter of luck to hit tops and bottoms in price cycles, so readers should aim for areas of mood change, not minor price shifts.

Some investors will buy while blood is flowing; others will wait. Both are likely to be near enough to the bottom to make handsome returns.

Editor's note:
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