Let’s say that the economic crisis really does turn in to a full-blown depression, currency crisis, inflation or deflation spiral and obviously further deterioration in the stock market. What can you do to protect your investments? Not a whole lot, but there are a few alternatives that should be considered. What I’m about to suggest is not an easy thing to do, because it requires knowledge far beyond traditional investing and hedging in The United States.
The premise on which this analysis is based is that the U.S. economy as a whole, including the financial economy, the government, the local governments and U.S. corporations are all in very bad shape, and hence cannot be trusted as investment vehicles. Furthermore, if the U.S. government is in bad economic shape, that fact has word-wide implications on most investments.
The real core of any investment is what’s actually behind it. In the end it comes down to what someone else is willing to pay for that investment, and that in turn has everything to do with the environment in which the investment is situated. If the U.S. economy is sinking, then U.S. corporations will suffer, and U.S. stocks will sink too. (also, in case someone forgot, the U.S. stock market was and is a house of cards…)
If the U.S. government is doing poorly, and is at the same time drastically lowering interest rates, not only does one not get a good return on U.S. Treasuries, the government may actually default on the Treasuries, or inflation will make the principal worth much less. In the end, all this has to do with the way a country is run in the long term. Keeping your money inside a country that is poorly run will deteriorate all your assets domestically and internationally. The key to protecting yourself during a catastrophic crisis could then be to find a different, well-run country, from which to buy Treasuries.
If you can find a “well-run” country, you can then invest in that country’s Treasuries, or government debt. The taxpayers of that country will stand behind the debt and guarantee its value. That, in turn, means that for your investment to be safe, those taxpayers must have jobs and overall security, and the government of the country must have responsible long-term policies. Otherwise you run the same risk that you run in buying U.S. Treasuries. In order to analyze what country might be a good one to invest in, one must know about mainly the political and fiscal situations in that country. A well-run country has:
- a persistent budget surplus
- a diversified economy
- a sufficiently regulated financial sector
- a long-term political commitment to fiscal responsibility regardless of ideology
- an independent national (or supra-national) bank committed only to fighting inflation
Being able to identify countries according to all these conditions is certainly not easy, and one must know a lot about international comparative politics, history, law, government studies, institutional studies, economics and much more. However, I would like to suggest two countries that fit these descriptions: The Netherlands and Sweden.
The Netherlands has for centuries been involved in trade and business in a prudent way. The commitment to sound fiscal policies is very strong, and just like Sweden, this country consistently supports the heavy spending of the EU while getting less money back in return. The country responded well to the economic crisis and took pre-emptive steps to protect its prudent, venerated banking sector.
Sweden has a more inconsistent history of financial prudence, but has more recently gone through crises that has made the commitment to sound economic dealings very strong. Sweden is most of all famous for its efficient government institutions. When the economic crisis started in the U.S., the former Swedish minister of finance, Bo Lundgren, offered to testify before Congress on how to deal with the crisis, which is very, very similar to the Swedish crisis of the early 90s. The Bank of Sweden recently had to suspend its sales of Treasuries because demand from abroad was too high. Obviously there were some investors who were thinking in a similar way to what I am describing in this post.
Addendum - What’s wrong with the traditional hedging strategies?
U.S. stocks: Traditionally, stocks are supposed to at least keep pace with inflation and pay dividends, so that they make for good investments in the long run. We now know that the stock market was a house of cards, and there is no imaginable reason why the stock market should be a good investment anytime soon.
Foreign stocks: Before the crisis, a lot of people were talking about the idea of de-coupling. that meant that it was thought that other economies were operating independently of the U.S. economy. We now know that that idea was completely misguided. Hence, foreign stocks more or less equal U.S. stocks, and as such don’t constitute good investments.
Cash: In 2008, the Federal Reserve increased the money supply enormously. That creates a huge potential for massive inflation in the future.
U.S. treasuries: Danger of default and massive inflation, in addition to non-existent returns.
Treasury Inflation Protected Securities (TIPS): Danger of default and even lower returns. Danger of deflation.
Municipal bonds: Clear danger of default. Local and state governments have not been able to sell bonds lately because confidence has already evaporated to some extent. This is because a lot of construction projects have fallen through because of the credit crisis. Many states are in a state of fiscal emergency. If all this weren’t enough, rampant fraud with respect to these assets are beginning to come to the surface. that is why Bill Richardson had to withdraw from his attempt to join the Obama administration.
Savings account: Danger that the FDIC will run out of money. In a catastrophic crisis, this is not at all a distant possibility.
Gold: Subject to much speculation and danger of loss of value. Still, by owning a commodity, you will probably be better off than with the abovementioned assets.
The premise on which this analysis is based is that the U.S. economy as a whole, including the financial economy, the government, the local governments and U.S. corporations are all in very bad shape, and hence cannot be trusted as investment vehicles. Furthermore, if the U.S. government is in bad economic shape, that fact has word-wide implications on most investments.
The real core of any investment is what’s actually behind it. In the end it comes down to what someone else is willing to pay for that investment, and that in turn has everything to do with the environment in which the investment is situated. If the U.S. economy is sinking, then U.S. corporations will suffer, and U.S. stocks will sink too. (also, in case someone forgot, the U.S. stock market was and is a house of cards…)
If the U.S. government is doing poorly, and is at the same time drastically lowering interest rates, not only does one not get a good return on U.S. Treasuries, the government may actually default on the Treasuries, or inflation will make the principal worth much less. In the end, all this has to do with the way a country is run in the long term. Keeping your money inside a country that is poorly run will deteriorate all your assets domestically and internationally. The key to protecting yourself during a catastrophic crisis could then be to find a different, well-run country, from which to buy Treasuries.
If you can find a “well-run” country, you can then invest in that country’s Treasuries, or government debt. The taxpayers of that country will stand behind the debt and guarantee its value. That, in turn, means that for your investment to be safe, those taxpayers must have jobs and overall security, and the government of the country must have responsible long-term policies. Otherwise you run the same risk that you run in buying U.S. Treasuries. In order to analyze what country might be a good one to invest in, one must know about mainly the political and fiscal situations in that country. A well-run country has:
- a persistent budget surplus
- a diversified economy
- a sufficiently regulated financial sector
- a long-term political commitment to fiscal responsibility regardless of ideology
- an independent national (or supra-national) bank committed only to fighting inflation
Being able to identify countries according to all these conditions is certainly not easy, and one must know a lot about international comparative politics, history, law, government studies, institutional studies, economics and much more. However, I would like to suggest two countries that fit these descriptions: The Netherlands and Sweden.
The Netherlands has for centuries been involved in trade and business in a prudent way. The commitment to sound fiscal policies is very strong, and just like Sweden, this country consistently supports the heavy spending of the EU while getting less money back in return. The country responded well to the economic crisis and took pre-emptive steps to protect its prudent, venerated banking sector.
Sweden has a more inconsistent history of financial prudence, but has more recently gone through crises that has made the commitment to sound economic dealings very strong. Sweden is most of all famous for its efficient government institutions. When the economic crisis started in the U.S., the former Swedish minister of finance, Bo Lundgren, offered to testify before Congress on how to deal with the crisis, which is very, very similar to the Swedish crisis of the early 90s. The Bank of Sweden recently had to suspend its sales of Treasuries because demand from abroad was too high. Obviously there were some investors who were thinking in a similar way to what I am describing in this post.
Addendum - What’s wrong with the traditional hedging strategies?
U.S. stocks: Traditionally, stocks are supposed to at least keep pace with inflation and pay dividends, so that they make for good investments in the long run. We now know that the stock market was a house of cards, and there is no imaginable reason why the stock market should be a good investment anytime soon.
Foreign stocks: Before the crisis, a lot of people were talking about the idea of de-coupling. that meant that it was thought that other economies were operating independently of the U.S. economy. We now know that that idea was completely misguided. Hence, foreign stocks more or less equal U.S. stocks, and as such don’t constitute good investments.
Cash: In 2008, the Federal Reserve increased the money supply enormously. That creates a huge potential for massive inflation in the future.
U.S. treasuries: Danger of default and massive inflation, in addition to non-existent returns.
Treasury Inflation Protected Securities (TIPS): Danger of default and even lower returns. Danger of deflation.
Municipal bonds: Clear danger of default. Local and state governments have not been able to sell bonds lately because confidence has already evaporated to some extent. This is because a lot of construction projects have fallen through because of the credit crisis. Many states are in a state of fiscal emergency. If all this weren’t enough, rampant fraud with respect to these assets are beginning to come to the surface. that is why Bill Richardson had to withdraw from his attempt to join the Obama administration.
Savings account: Danger that the FDIC will run out of money. In a catastrophic crisis, this is not at all a distant possibility.
Gold: Subject to much speculation and danger of loss of value. Still, by owning a commodity, you will probably be better off than with the abovementioned assets.
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6 comments:
What do you think of peter schiff's analysis of the economy?
At this point, most americans can't even invest because their wages have become so stagnant that by the time they are done paying all their essential bills, there is literallly nothing left.
Obama's plan makes no sense to me. where is he going to get the money to rev up the economy?
When will government officials understand that americans are not spending because they literally don't have the money
I believe that Schiff's projections for the future are correct, and that he is right in saying that there is little you can do to fix the problems, but what he fails to realize is that the free market will create assets bubbles with or without government intervention.
Obama's plan is kind of a gamble. I believe it's meant to be, to a significant degree, a psychological intervention, as well as a political opportunity to achieve long-held political goals, such as restoration of infrastructure. The money would have to come from China, Japan or maybe Germany.
Americans certainly are saddled with a lot of bills, and I can see no conceivable reason for them to invest in the stock market. The payment of a few very important expenses in life for Americans depend on accounts in the stock market such as: 1. college savings account 2. retirement accounts, and 3. general savings which must be used for healthcare. As the stock market has gone down by 50%, all these things must still be paid for. How? The Wall Street-based system just doesn't work anymore....
Meanwhile, the citizens of the vast majority of other Western country never have to worry about paying for college, retirement or healthcare, because it's always free and guaranteed.
Jacob, what do you think the chances are of Obama decreeing a devaluation of the dollar in February? That is when many problems are going to converge regarding the sale of gov. bonds.
Say, a devaluation of 40% like his hero FDR did.
Interesting that you mention it. I have not heard of currency devaluation being thrown around as an option for many years, except recently in Russia.
I see the option of currency devaluation as the ultimate detrimental quick fix with inevitable, grave future consequences. Again, there is a parallel to the Swedish crisis. In Sweden, currency devaluation was used as a tool to promote exports. That practice was artificially making Swedish goods cheaper on the world market, but in a sense also creating an export bubble that was nowhere near sustainable. China is experiencing the same thing today because they have kept their currency artificially low, and would be truly devastated economy-wise if the U.S. started devaluing its currency at this point.
It would be very radical of the U.S. to start using this technique, although you would certainly see instant results. That's the allure, but also the danger...
Also, currency devaluation by the U.S. would go against a number of international trade agreements. In the big scheme of things, though, keeping those promises is probably secondary to rescuing the economy, in the eyes of U.S. politicians
Yeah, I'm thinking they probably won't do it because of the psychological impact it would have on the country. And also, it seems to me it would screw our creditors, and make them less inclined to buy our future debt. Unless, perhaps this was all worked out beforehand with them. Anyway, one has to wonder how our gov. is going to deal with this unbelievable mess.
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