Fast-forward to today, and, just as in Rothschild"s day, we"ve seen a building boom end with a mortgage bubble burst. There are parades of bad news up and down Wall Street and Main Street.
On Wall Street, the easiest way to get your hands on truckloads of government bailout dollars is to own a bank. Heck, you won "t even have to tell the Treasury what you do with the money!
And if you don"t own a bank, you could go from being chairman of the Nasdaq to setting up a hedge fund so secretive that your closest friends don"t know you"re ripping them off for tens of billions of dollars.
On Main Street, manufacturing, employment, and retail sales all got shredded like they went through a wood chipper. Problems are rippling around the world, too. The question now is: Are we close to blood in the streets-the time when Rothschild would advise buying?
I"ll give you my opinion on that in a bit. First, an important difference between now and the panic of 1873 . . .
The Loosest Money Policy Possible. In 1873, the United States moved to the gold standard, which meant it stopped minting silver dollars altogether. This reduced the domestic money supply, which hurt farmers and anyone else who carried heavy debt loads.
In 2008 and 2009, by contrast, we embarked on the loosest money policy possible. In addition, the Treasury and Federal Reserve have been handing out cash by the hundreds of billions to every Tom, d.i.c.k, and Citibank who drives by with a sob story.
Through the first quarter of 2009, Washington had already spent or pledged $12.8 trillion.1As a result of all the bailouts for banks, automakers and other new federal outlays, our nation "s budget deficit is expected to come close to $2 trillion in 2009, and the national debt stood at a staggering $11.5 trillion. The long-term effects of that free and easy money policy are horrific!
And that"s just the tip of the iceberg.
In 2009, the Grandfather Economic Report series calculated that the United States owed a total debt (including government, household, business, financial sector, etc.) of $57 trillion.2 That"s $186,717 for every man, woman, and child in the country, an increase of $32,104 per family of four over the previous year.
However, that"s the longer-term consequences. In the short term, that easy-money policy could be just what the doctor ordered for an ailing economy. I agree with critics of the administration that if you"re going to try to stimulate the economy by building roads, railroads, and bridges, do a lot of it. Unfortunately, the Obama Administration"s wishy-washy, middle-of-the-road approach seems like it will load us up with more debt without being big enough to have the desired stimulative effect.
Also, in the short term, there"s a simple reason why the government has an easy money policy: They"re deathly afraid of deflation. Deflation makes the huge debts of the government insurmountable, while inflation makes those debts smaller over time. If the policy makers in Washington can get the United States back to 2% inflation and hold it there, that would cut the real value of debts in half in a generation. Of course, the money you hold would also lose half its value in the same amount of time.
Why Deflation Is Bad. In 2008, U.S. commodity prices, wholesale prices, and consumer prices plunged; mortgage debts, corporate debts, and other forms of debt were liquidated at the fastest pace since the 1930s; and the U.S. dollar enjoyed the most rapid surge overseas since the mid-1980s.3 That is deflation in a nutsh.e.l.l-the value of a currency strengthens while the value of everything else (relatively speaking) goes down. These trends continued in 2009.
Many people would think that prices going down would be a good thing. But when we"re in deflation, even nominally low interest rates become punishing. That is because the real interest rate is the nominal rate minus inflation, which can be positive or negative. When we experience deflation, the real interest rate is brutally positive-higher than the nominal interest rate. When we are experiencing inflation, the real rate of interest is lower than the nominal rate. We saw a period of negative real interest rates begin just a few years ago when Alan Greenspan slashed interest rates and goosed the rate of inflation to juice up the economy.
This comes with consequences: When real interest rates are negative, consumers take on huge amounts of debt-in the short term, they"d be fools not to, because they "re effectively being paid to borrow money!
The problem with the short term is it"s followed by the long term, and real interest rates usually aren"t negative for long. But they last long enough to sucker people into taking on more debt than they can service if interest rates go up or incomes go down. Many people find themselves in that trap today.
This is why some people believe there is no safe level of debt to hold, including home mortgages. I disagree with that point of view, and I"ll explain why in just a bit.
If you are going to own a home, remember that real estate can become illiquid (you won"t be able to sell it) in a severe financial downturn. So own only what you"re going to live in-speculative real estate is for suckers. By the time you realize that you need to sell a property because you can no longer pay the mortgage, it may be too late.
More importantly for the broad economy, deflation makes it nearly impossible for governments to pay off the kind of huge debts that Uncle Sam is racking up. Right now, international investors are willing to ignore that as they buy into the big lie. But if and when they start demanding the United States act like a fiscally responsible adult and not run up more debts than we can ever hope to pay off, the economic adjustment-and hit to the U.S. dollar-could be huge.
How would they punish us? They"d slow down their purchases of our Treasuries.
In March of 2009, China"s premier, Wen Jiabao, expressed concern about the safety of China"s $1 trillion investment in U.S. government debt, the world"s largest such holding, and urged the Obama administration to provide a.s.surances that its investment would keep its value in the face of a global financial crisis.
"We have lent a huge amount of money to the United States. Of course we are concerned about the safety of our a.s.sets," Wen told reporters. "To be honest, I am definitely a little worried."
Does that sound to you like a guy who might shift some of his country"s foreign reserves out of Treasuries? It sure does to me.
After Deflation, Brace for Surging Inflation. Everything goes in cycles-that"s why it"s dangerous to say "you should always invest in Investment A," as if the markets and the global economy-and their effect on Investment A-will never change.
For decades, the U.S. dollar has been the reserve currency of the world. Many people think this will never change. Roughly 65% of the world"s foreign exchange reserves were in U.S. dollars at the end of 2008.
However, the winds of change are blowing. China and Russia have expressed a desire for a new global reserve currency based on a mix of currencies and gold, and in the form of IMF special drawing rights (SDRs). Zhou Xiaochuan, the governor of China"s central bank, is calling the new currency a "super-sovereign reserve currency."
Russia, India, and Brazil, along with China-the emerging powers of the world-also back the idea of a new reserve super-currency. Such a transition would take time. But once it starts, the U.S. dollar will be on a very slippery slope.
And in 2009, Chinese premier Wen Jiabao threw down the gauntlet, calling for more surveillance of countries that issue major reserve currencies. Without mentioning the United States by name, he ripped us a new one.
"We should advance reform of the international financial system, increase the representation and voice of emerging markets and developing countries, strengthen surveillance of the macro-economic policies of major reserve currency issuing economies, and develop a more diversified international monetary system," Wen said.4
More Problems for the U.S. Dollar
China"s desire for a new international super-currency isn"t the only problem facing the U.S. dollar.
Soaring deficit could get bigger! Because of the economic slow-down, the stimulus package, and the various financial-relief measures, the federal deficit for 2009 could come in close to $2 trillion. If things go wrong-and they haven"t exactly been going right-the deficit could be even larger.
We have to borrow more to fill the gap. Usually, federal tax receipts provide 80% to 90% of the money needed to fund the U.S. budget. In 2009, Uncle Sam will need to borrow 45% of the money the government will spend. Not since World War II has the government borrowed anything close to what it is borrowing now.
In a March 2009 forecast, Goldman Sachs estimated average annual deficits of $940 billion through 2019. If this proves true, deficits would remain above 4% of GDP through the next decade, and the national debt-now at $11.5 trillion-would reach a whopping 83% of GDP, a level not seen since World War II.
Reserve balances ballooning. When we say the Fed is running its printing presses to create money, that"s only partly true. The Fed creates money mostly by crediting banks with deposits at the Fed.
Those deposits are called reserve balances. Reserve balances are the key component-along with currency-of base money or central bank money, which ultimately brings about changes in broader money supply measures.
These deposits or reserves have been exploding as the Fed has made loans and purchased securities. In the third quarter of 2008, reserves were $8 billion. As of March 2009, reserves had soared to $778 billion-an increase of 9,625%!
The reserve balances are soaring as the Fed creates money to finance loans in an attempt to unwind the mess created by AIG and other banks. Just to keep up with what it plans in 2009, the Fed will likely have to increase reserves by another $1.15 trillion to $3.37 trillion!
Here"s my point: In the short term, it is prudent to hold a lot of U.S. dollars and Treasuries, and to have as little debt as possible. In the long term, we are probably going to see inflation return, and it could be particularly vicious this time around. When that happens, the U.S dollar will tank and longer-term Treasuries will come under pressure-hammering two investments that many investors see as safe havens.
In an inflationary period, stocks can be a good investment. Heck, the Zimbabwe Stock Exchange grew by a record 322,111% in 2007,5 mainly because the Zimbabwe currency turned into toilet paper.
When paper currency turns to toilet paper, where do you hide? Gold can also protect you from inflation. Gold provides protection against a currency collapse or government collapse-both of which we could experience in the next decade.
Gold works in a variety of economic circ.u.mstances. It did very well during the inflationary heyday of the 1970s and it held its value very well through the ups and downs of the Great Depression. I"ll talk more about gold in the next chapter.
One last important point . . .
The Economy is NEVER Going Back to the Old Normal
From 1995 through 2009, America"s central bank, the Federal Reserve, flooded the economy with trillions of dollars through increased money supply and easy credit. This triggered a ma.s.sive consumption boom along with several bubbles such as the stock and housing bubbles. All of this created artificial stimulated demand as consumers bought and bought and grew more and more indebted as they spent beyond their means.
* The tumble in interest rates-from 18% to 1%-fueled a shopping boom as consumers spent like there was no tomorrow.
* That sparked a surge in spending on new technology-and when the tech bubble burst, the financial froth flowed into real estate.
* Lending standards declined, allowing people who never should have gotten loans to each borrow hundreds of thousands of dollars.
* Many of those liar loans were spent on homes. The housing boom provided millions of jobs.
* And since so many people were buying homes, everybody"s home values went up-allowing people to borrow more equity against their homes, and start the cycle all over again.
In other words, the lifestyle we enjoyed for 15 years was based on a lie. It was like living a high-falutin" lifestyle paid for with bad checks. Eventually, those bills come due. A sustainable lifestyle-the new normal-is actually at a much lower level.
Another reason why we won"t see the old normal any time soon is because many of the actions taken by both the Bush and Obama administrations in the name of stimulus are not stimulus at all. The bank bailout is a pa.s.s-through of taxpayer dollars to well-heeled con artists on Wall Street. Another name for it would be legalized fraud. It is the ma.s.s looting of national wealth to enrich a well-connected few.
Sure, these ruinous bank bailouts may have helped reinflate the bubble, but they may also worsen the coming crash, as the bill for trillions of dollars in debt and derivatives comes due. As Martin Weiss wrote on MoneyandMarkets.com:The Treasury"s plan primarily shifts the burden of toxic a.s.sets from the private banking sector to the public. This can only (a) bloat an already-ballooning federal deficit, (b) damage the credit of the U.S. government, and (c) raise the risk that borrowing costs will surge for nearly everyone.6 I"m not saying the fault lies entirely with President Obama. Former President George W. Bush presided over a 33% increase in total government spending in his first term alone. Not content with the level of spending in which he already was engaged, he declared a war against a country that hadn "t attacked us-the Iraq War alone will cost us about $3 trillion.7 And that war with its big-ticket price tag was rubber-stamped by both parties in Congress. Heck, that"s just part of the problem. The big spenders in Washington are bipartisan.
Rearranging the Deck Chairs on the Hindenburg
Even though President Obama is doing the bidding of the worst special interests on Wall Street, I sincerely hope he succeeds in pulling our collective fat out of the fire. So far, it seems Obama"s economic team is enacting policies as if they"re h.e.l.l-bent on reinflating a doomed zeppelin, and we all know how the Hindenburg story ended.8 Throwing more money at banksters in the hopes that they"ll loan out some of it is, at best, hoping to artificially boost demand. Keeping every insolvent bank and delinquent mortgage afloat is not a strategy-it"s just putting off necessary pain. Probably one of the better potential outcomes is that we just give up trying to reinflate the Hindenburg, discover and implement a new sustainable lifestyle, and pay down our debts as quickly as possible so we don"t burden our great-grandchildren with them.
Many U.S. families are going to be way ahead of the government on this one. If you haven"t joined this trend already, you really might want to start.
Get Your Financial House in Order
Are you in debt up to your eyeb.a.l.l.s? That"s not a good place to be-it"s stressful, and it may become untenable in a time of rising unemployment and falling incomes. The common-sense thing to do is pay off your highest interest-rate debt first. I don"t advocate cutting up credit cards-you might need them in a real emergency-but I"m all in favor of burying them in a waterproof container in the backyard to keep you from using plastic unnecessarily.
One thing many survivalists recommend is to pay off your mortgage. The best reason to pay off a mortgage is to have emotional peace of mind. But I can also think of a couple of reasons not to pay off your mortgage:1. You might need that money-especially if you"re preparing for the end of the world as we know it. I"m much happier with a fat cash cushion. In fact, if you can pay off your house, one option would be to not pay it off and put the money in an interest-bearing account. As long as mortgages stay tax deductible, you"ll come out ahead of the game.
2. The value of your home may go down. In fact, it may go down a lot. So how will you feel if you"ve sunk all your money into your home and it is worth less every month?
3. It"s much more important to pay off credit card debt and other high-interest debts. As long as you have a low rate of interest on your home loan, that"s the last debt you want to pay off.
4. The next person to get bailed out may be you. Honestly, the way they"re throwing money at problems in Washington, I wish I could walk into the White House, perch on the edge of Barack Obama"s desk, and confess to every bad financial decision made by Wall Street in the previous eight years. I "d probably get off with a stern look and be sent on my way with a billion dollars in my pocket. That seems to be what"s happening to the other financial miscreants and banksters.Seriously, we"ve already seen the Obama administration roll out one mortgage bailout plan that costs hundreds of billions of dollars. Who knows what they"ll do next? What if they devise a mortgage forgiveness plan or something else of which you can take advantage?
So for all these reasons, I don"t think your goal should be to become completely debt-free. However, prudence dictates you . . .1. Pay one extra payment a year on your mortgage. This can save you hundreds of thousands of dollars in interest and years on your mortgage. You can save even more time and money when you make payments to reduce your princ.i.p.al balance earlier in the year-for example, instead of increasing your monthly mortgage payment by one-twelfth, you are better off increasing your monthly mortgage payment by one-sixth for the first six months of every year. By the way, if you"re struggling to pay your mortgage, see if your lender is partic.i.p.ating in the HOPE for Homeowners Act. Pa.s.sed by Congress in July of 2008, this government-run program encourages lenders to refinance mortgages for borrowers who are at risk of losing their homes. The program will refinance mortgages for borrowers who are having difficulty making their payments, but can afford a new loan insured by the Federal Housing Administration. Call (800) 225-5342 for more information.
2. Pay off your credit cards every month. Credit cards are one of the most expensive kinds of debt. Interest rates can run as high as 25% for credit-card holders who are late with a payment or have low credit scores. If you have multiple credit card balances-ouch. Focus on paying off high-interest-rate cards first. But don"t do a balance transfer without reading the fine print. Credit card companies got wise to the fact that consumers were switching debt around, so now they charge to let you do it. As of this writing, the average fee for a balance transfer is 3% or a minimum of $5 to $10 and a maximum of $50 to $75. And these costs are on the rise.Also, try to aim not to have more than two credit cards. The theory goes that two cards with a $10,000 limit each is better than 20 cards with a $1,000 limit each. It"s too easy to use a card without thinking (and forget to pay it-therefore putting yourself in line to get spanked with higher interest rates and late fees), and it"s far too easy to lose a card or have one stolen-and not realize it-when you have a wallet stuffed with them.
3. Get rid of auto loan debt. Next to credit cards, auto loans often carry the highest interest rates that many consumers pay. But you can refinance a car loan as long as you improve your credit score since you bought the car. That way, you can turn a 10% loan into a 6% loan.
4. Double-check the figures on any medical debt. One of the worst disasters any U.S. citizen can face is a serious medical problem-both physically and financially, it can wipe you out. Medical debt is responsible for nearly half of personal bankruptcy filings, according to Health Affairs, a policy journal.But many things can end up on your medical bill that shouldn"t be there. For example, an insurance company will use a code for a procedure and your doctor incorrectly inputs the code-this gets kicked out by the insurers" computer and you get stuck with the bill. The insurer won"t pay unless you bring it to their attention.
If you"re really underwater, speak to the medical provider. Many hospitals have government funds to help patients who can"t afford their medical care, and independent nonprofits also provide financial a.s.sistance. Finally, unlike the soulless junkyard dogs who seem to populate credit card companies, medical providers are often open to working out payment plans with patients.
5. Take a good hard look at your current spending. It"s tough to change spending habits, even wasteful ones. One method that works-but that can blow up in your face if you do it wrong-is for a husband and wife to keep track of all their expenses in a week or a month and then go over each other "s list of personal expenses. Studies have shown that couples have more fights over money than s.e.x, so try to keep the emotion out of it when you question each other"s spending. Cut back all expenses wherever you can. Streamline for more efficiency and stop wasting money on frivolous or impulsive items. Shop like you"re preparing for the end of the world, because you are.
One you have your personal debt and spending in hand, develop a budget for your survival purchases. How much money are you going to spend on stockpiling food every month? How much are you going to spend on new tools? Gardening equipment? Are you buying a bicycle? Remember to purchase things you will absolutely need (a three- month food supply) before things you may or may not use (an expensive gun and 1,000 rounds of ammunition). Make a monthly budget, stick to it, and remember to include something-even a small amount-for building up cash.
Once you"re gotten your personal spending and debt under control, it"s time to look at your investments. If you don"t have any investments outside of Ruger, Smith, and Wesson, then you"re probably feeling pretty smart right now. Don"t get c.o.c.ky, kid! You can skip ahead. But if you have a 401(k), this next part is for you.
Your 401(k) Survival Guide
If you"re like Baron Rothschild, with an eye on the really long term, a strong stomach for losses and the luxury to wait things out, you can try to do just that. But if you"re going to need your money in the next decade, be aware that (1) we probably haven"t seen the real bottom in stocks yet; (2) we don"t how far stocks will go down; and (3) we don"t know how long they"ll stay down. And by the time stocks do come back, resurgent inflation might have destroyed all your gains anyway.
With these things in mind, you might want to consider doing the following:1. Get a list of the investment options available in your 401(k).
2. Look for the safest investments. The safest is a Treasury-only money market fund. The next safest is a government-only money market fund. Third is a standard money market fund. Fourth is a fund that invests mostly in U.S government notes and bonds and as little as possible in corporate bonds.What you"re trying to do is choose government paper over corporate or bank paper and short-term instruments over long-term.
3. Put at least 50% of your money in the safest fund. If you"re doing this after the market has plunged, and you worry you are selling at the wrong time, cut the amount you were going to put in the safe fund in half again. When you get a rally, sell the rest into that.So now half of your total 401(k) money should be in very safe investments.
4. The rest can be invested in a mix of precious metals, bonds, ETFs that track sectors or commodities, and U.S. and foreign stocks. The hard truth is that the market changes constantly-there is no one investment to fit all people all the time. And depending on market conditions and business and market cycles, there may be times when you want to put money to work.
The mix of these other investments will vary depending on your financial situation and market conditions, but one investment I keep coming back to again and again is precious metals. Just to talk about gold (we"ll talk about silver later), it has eternal value, it will never go to zero, it"s a hedge against inflation, and I sleep better having a substantial portion (10% or so) of my wealth in it.
I"ve been at financial conferences where speakers have advised people to put 100% of their money in gold. That"s absolutely insane, and if anyone tries to tell you that, run away! You wouldn"t have wanted to have all your wealth in gold during its 20-year bear market. But it definitely has a place in your portfolio. In the next chapter, I"ll explain some of the reasons why I think it could outperform going forward.
What to Do in a Bank Holiday When a bank fails, the FDIC steps in, finds a merger partner or takes the failing bank over. This usually happens quickly and with a minimum of panicking.