A Time For Realism

This is a time for realism. While our government and candidates continue to blather on about “solving the problem” by some odd mixture of bailouts, speeches, dollars, firings, and con games, the real crisis is ignored.

This is the crisis we’ve been warning about for many months. It is a crisis of the economy, the dollar, and the value of your assets, all rolled into one, and it is finally upon us. Or, more precisely, the awareness of the crisis is upon us. The initiation of the crisis was many months, even years ago. The fullness of the crisis may still be weeks away. The end of the crisis could be a few short years away, or, if the mismanagement continues, the end of it could be ten or twenty years away. I hope that I don’t need to elaborate on how desperate the situation truly is. Suffice to say that we have entered a period of dire financial crisis. There were many points at which we could have changed paths. Unfortunately, many continued to support this truly terrible government as it squandered those opportunities day by day. We saw Federal Reserve Chairman Ben Bernanke waffle about whether we were in crisis or not, and continue his relatively weak policies for months as the crisis mounted. We saw a series of costly bailouts in recent weeks, which squandered our future tax dollars on meaningless “solutions”.

It is now too late to avoid some level of crisis. My opinion of this latest bailout proposal is that it is the most atrocious piece of legislation that we’ve seen in our lifetimes. At some later date, we can debate what policies might have avoided this debacle, or whether this bailout is warranted. Regardless, it is likely to pass. At this point, we are in the midst of the biggest period of risk in history, and the important thing to our readers is to learn how to protect their assets against this coming disaster.

The first and most important thing to realize is that there is NO EASY WAY to protect yourself. The knee-jerk reaction is to pull everything out of stocks or bonds or whatever you might have invested in, and put it in the bank where it is “safe”. Unfortunately, what we’ve been learning is that banks aren’t innately safe. However, we still can hold on to the idea that the government has guaranteed our money through the FDIC or some similar institutions, and as long as government guarantees remain good, this may be ok. The bigger concern is inflation, even the potential of hyper-inflation. Any form of inflation will destroy the value of money over time, but hyper-inflation will destroy the value of cash overnight.

The key is to realize that there are many possible types of crises. At this point, it is still unclear what this one will develop into. We could see a period of growing inflation, much like the 1970’s. We could see this grow into hyper-inflation as is currently operating in Zimbabwe, or like what Germany saw between the wars, or like the “banana republics” of Latin America were accustomed to in the ‘70’s and ‘80’s. On the other hand, we could find ourselves in a recessionary period like so many we have experienced in the past. Or, more grimly, we could mismanage the economy in such a way to prolong this period of economic weakness into a time reminiscent of the Great Depression.

Of course, none of these things are what we hope to see. But at this stage, some challenges appear likely, and a wise investment strategy must prepare for ALL eventualities. The knee-jerk reaction that might protect you against ONE of these scenarios, might also devastate you in another. We need to be prepared for all possibilities.

In my opinion, our most likely scenario is a return to inflation. We can hope that it will not be worse than the 1970’s version. If this is the case, then the best protection is to hold assets such as gold and silver that are likely to hold their value in times when money is losing. In fact, in inflationary times, bonds and cash are relatively poor “investments”, and if inflation turns into hyper-inflation, both cash and bonds become worthless. Other investments that tend to do well in inflationary times are oil and oil equipment, real estate, and commodities. Even stocks can survive fairly well in inflationary times, and high-growth stocks are particularly good. Yet, if inflation reaches higher levels, over 20%, let’s say, stocks and real estate become poor holdings. Commodities, and even oil itself, tend to be very volatile, and should never compose a large portion of one’s portfolio. Real estate, in today’s environment, is still deflating from a bubble, and is probably due for more price dislocation before it settles back down. Therefore, we’ve preferred gold and silver, mining companies, as well as oil equipment companies, as some of our means to defend against inflation. We’ve also found TIPS, which are inflation-adjusted treasury bonds, as a safe means to protect against this kind of trouble.

A recession also seems to be a reasonable possibility. While a recession is certainly a negative outcome for stocks, it is not a devastating condition, and one that will be relatively short-lived. In the past, I’ve always advocated staying invested during recessions, with perhaps a preference for stocks that are somewhat recession-proof, what we call “defensive stocks” such as food and beverage, healthcare, and utilities – essentially the things that people will still buy when they don’t have money for everything. In that scenario, we avoid things like clothing, cars, etc., that are discretionary purchases. But, essentially, a recession is something we can make it through without serious re-adjustment.

The greatest concern would be the prospect of a serious depression. Until recently, I felt fully comfortable overlooking this possibility, and focusing on protection from inflation and recession. However, recent events have forced me to consider this possibility as well, because if our government is sufficiently foolish, they have the power to prolong a downturn and prevent the kind of re-adjustments that need to take place. If this happens, depressions can result.

Since I’ve recently given little thought to depression-era planning, I had to pluck a book off my shelf that I haven’t looked at since the 1970’s. The late Harry Browne’s 1970 investment classic “How You Can Profit from the Coming Devaluation” is one of the best books written on the subject of investing in financial crisis. This very old book is surprisingly current, and if you can find it, I highly recommend it to anyone who wants to learn more about the crisis we are facing. Browne suggests cash and bonds as the best places to be in a depression, and stocks and real estate as the worst.

What all of this tells us is that we need to be cautious, studious, alert, and nimble in the coming period. There is no single right answer to all of the possibilities. My personal favorite for today is the inflation-adjusted bonds that I mentioned, because, while they will not be outstanding performers in some cases, they are relatively safe in most, and excellent in some of the worst. On the other hand, if things get truly crazy, do we even know if the government will pay off? They may not renege completely, but I don’t find it beyond comprehension to imagine that they might refuse to pay for the adjustments if it becomes too costly. Nonetheless, these instruments are a good place to put some of your money for the present.

Finally, now, more than ever, it is critical to be diversified in your holdings. In light of the uncertainty, putting all your eggs in one basket, even a seemingly safe asset like cash, can be extremely risky. It is important to be somewhat prepared for any eventuality, and not to be too confident in your estimates of the future. It may be worthwhile to lean toward what you believe is the likeliest case, as I tend to do with my expectation of inflation, but there is little excuse to ignore other possibilities. The risks associated with arrogance in today’s market are too high.

There are other strategies that relate to an individual’s own situation. Personal debt levels, life situations, and range of assets might influence the way a safety plan should be developed. These are things that are better handled on an individual basis. As always, I stand ready to discuss developing such a plan with any of my readers. If you are concerned about how well-protected your assets are in the current conditions, please feel free to contact our office to arrange an appointment at (877) 622-9090 or frontdesk@valueview.net.

Bailouts, Bernanke and Bankers. (Oh, my!)

Until last Friday, I was confident. Confident that, while the economy was going to be dismal, I knew how to protect myself and my clients from the economic turmoil.

As of Friday, all bets are off. That's not saying that I'm confused or uncertain, but that on Friday, the government, under the watch of the president who will be remembered in history books, George W. Bush, decided to cancel free markets and move on to an amended form of socialism.

Not REAL socialism, mind you. At this stage, socialism looks relatively good. No, the Bush-leaguers are offering a form of socialism where big businesses still get to the profits, but the losses are socialized. Lest anyone wonder, this is SO much worse than socialism that I don't even question people who want to move to Cuba and serve under Castro anymore. I find my Marxist friends more reasonable than those who still defend the Bush-league idiocy. And, remember, my leanings are strongly free-market. But this administration has now gone SO FAR from free markets that they make anything look good in comparison.

To put meat into this argument, let's evaluate the most recent bailout plan. I emphasize "most recent" because after the last few weeks, it is not enough to talk about a bailout plan, because we've done so much in the last few weeks, and talked about so many variations of the same seven plans, that it becomes difficult to keep up. And just for perspective, we should recognize that more intervention in the economy took place in the last three weeks than took place during the entire balance of my lifetime. Given another three weeks, I expect these "big business-socialists" to exceed the entire 20th century in interventionism.

To add more perspective, consider Thomas Sowell's insights on the size of the proposed trillion dollar bailout:

"A trillion seconds ago, no one on this planet could read and write. Neither the Roman Empire nor the ancient Chinese dynasties had yet come into existence. None of the founders of the world's great religions today had yet been born. That's what a trillion means. Put a dollar sign in front of it and that's what the current bailout may cost."

So, that's the SIZE of the bailout. But, even if we get past that, the STRUCTURE of the proposed bailout is every bit as bad, if not worse.

The bailout is designed to have the government BUY all the bad, non-performing assets from the bad banks (and the good banks, and virtually anybody else). They will leave the institutions afloat, and take all the mistakes away. They will essentially get to start with a clean slate. While this may sound good to the untrained ear, it is essentially the worst of both worlds. Not only do we end up rewarding those who made bad decisions (at the expense of those who made good ones), but we do so at great cost.

This is precisely where the free market is supposed to improve on socialism. In fact, it is the failure of bankrupt companies that has allowed the U.S. to thrive over time. The "creative destruction" described by Schumpeter is key to growth. If we try to prop up these failed companies, we are not only expending enormous sums in doing so, but encouraging more bad decisions. Moreover, we are diverting money away from good decisions and successful companies. Money is not unlimited, and what is invested into poorly managed firms takes away from well-managed ones. The benefit of truly free markets is that poorly managed firms will eventually fail. It is this process that ensures that more money is invested into productive ventures than would be in a centralized economy, and it is this investment that does so much to grow a nation's economy.

Under the proposed program, we get the worst of both worlds. We get the messy business environment that is endemic in any free market, but we are "protected" from the consequences of free markets. We are "protected" from the failure of failed institutions. Instead, we are allowed to go the next ten to twenty years watching the zombie-like AIG, Fannie Mae, and countless other financial firms walk among the living, even though they are essentially failed businesses. We get to watch these government-subsidized institutions compete unfairly with other free-market institutions, until they too are forced to either accept government bailouts, or simply fail and drift away into history.

While I understand that it is not politically expedient to say no to this bailout, it is imperative that our congressmen do so. Without the bailout, it is very likely that our markets will crash, financial firms will fail, and people will be left poorer. But at least this devastating time will be short-lived. WITH the bailouts, not only am I certain we will still see market crashes, business failures and an increase in poverty, but the bailout will extend the period of the downturn for many, many years. I strongly prefer a 3-year recession to a 20-year depression. Anyone with me on that?