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Connecting the Dots on Our Fragile Economy, by Craig R. Smith
Recent events in the financial markets have renewed concerns that should be
considered by any American who has worked, paid taxes, invested and saved for
the future.
It is no secret that America is swimming in debt. Currently the U.S national
debt is $9.6 trillion. That is $47,000 for every adult or $94,000 for couples.
One can only imagine the future burden that will put on taxpayers as the politicians
continue to print money to pay off everything from health care to foreclosed
mortgages. No level of taxation will support this kind of unbridled spending.
We are now spending money at a rate that is ridiculous and there is no end
in sight. Predictions are that by the end of 2008 America will be running a
$500 billion deficit and soon the national debt will exceed $10 trillion. And
while this level of debt should have every American demanding the immediate
halt to most spending, it has not. In fact, more and more Americans are looking
for the government to spend more money fixing their personal problems.
In an unprecedented move, the Federal Reserve, in cooperation with the Treasury
Department, bailed out the investment bank Bear Stearns in March. For the
first time ever, the Fed opened the discount window to an investment bank
issuing
$35 billion of financing for the beleaguered institution. Then in the dark
of Sunday night, the Fed, with the complete cooperation of the Treasury,
set up a sale of Bear Stearns to a commercial bank, JP Morgan, with all
assets
being applied to JP Morgan's balance sheet while only increasing liabilities
for the first billion in potential losses.
But it gets worse.
Within weeks, the confidence in the financial system and American banks in
particular had so dramatically deteriorated, the head of the Securities and
Exchange Commission adopted a rule that forbade naked short-selling of financial
stocks such as JP Morgan, Wachovia, Bank of America, Citibank, HSBC and Well
Fargo, just to name a few. This meant an investor who had no confidence in
a financial stock could no longer sell the stock in a short sale expecting
its value to drop – at which time they would buy it at a lower price
and fill the sale.
Keep in mind, this was still a perfectly acceptable practice with other stocks – just
not the "financials." If that single move did not send shivers up
every American investor's spine, then it's hard to say what would.
The market was so vulnerable to a massive sell-off and further deterioration
of bank-stock values that the free market was abandoned for a government-controlled
market and the folks were almost grateful that a crisis had been averted.
Grateful? We should have been outraged. But then again, many in America don't
really want free markets. They want the government to protect their assets.
Do we believe the government has been so successful in managing the finances
of government that we now want them to manage the financial markets?
Weeks later, Congress passed H.R. 3221, "The Housing and Economic Recovery
Act of 2008." This allowed Congress to bail out the 400,000 homeowners
who are facing foreclosure, while saving Freddie Mac and Fannie Mae, the government-sponsored
enterprises, or GSEs – the same companies that arguably caused most of
this mess to begin with.
The president, who vowed to veto the bill, caved and signed it. It allows,
by statutory limit, the spending of as much as $800 billion, which will bring
the national debt to potentially $10.6 trillion.
Again, more government spending to save whom? Homeowners who fell on tough
times? Or speculators who were trying to play the game and the banks that financed
them? You got it. The banks and the speculators.
This bill will do nothing more than bail out the very people who created the
mess – at taxpayer expense. What homeowner in their right mind, if given
the choice to walk away from a home that has dropped by 40 percent in value
or refinance it at the original value, will opt to refinance? This bill will
directly place billions of dollars into banks in order to clean up and rehab
foreclosed properties which will be put right back on the market at reduced
prices. Once again, all at the taxpayers' expense.
It will be a virtual repeat of the Resolution Trust Corporation bailout in
the late '80s – with one difference. There was a standard held for credit
in the '80s. This last loose-money binge was created by lending anyone who
could breathe and sign the paperwork cheap money to buy a home – regardless
of the reason why.
The bottom line: To "save" the system that was clearly melting down
as a result of plummeting real estate values and frozen credit markets, the
Fed and the Treasury Department will allow the creation of billions and billions,
if not trillions, of dollars which will be added to the national debt. This
will further deteriorate the long-term value of the U.S. dollar and ultimately
threaten Americans' quality of life through increases in the cost of living.
Once again, the American taxpayer and saver will foot the bill – all
the while watching the price of everything from food to college tuition increase
at an alarming pace.
The markets are well aware of the effect these moves will have on the dollar
and have prepared accordingly. The international markets have long ago lost
their appetite for American debt. The days of foreign countries and businesses
lending us the money necessary to survive have ceased. Now they look to buy
our businesses, our real estate and other assets. They are not willing to take
a promise to be paid in the future with dollars that are constantly diminishing
in value.
With the stock market having experienced six minus-300-point rallies, it is
clear we are in a bear market for stocks. Bull markets never experience such
rallies according to the chief economist at Merrill Lynch. Such rallies are
inherent in bear markets and this market is clearly in a bear mood. Earnings
are shrinking, unemployment is increasing and raw material costs are through
the roof. Not to mention skyrocketing energy and healthcare costs.
The once-free American markets that were the envy of the world have become
government-controlled markets, out of necessity for the time being. The powers
that be at the Fed and Treasury can ill-afford a breakdown of the system. News
reports of runs on the Indy Mac bank were reminiscent of the 1929 crash and
were quickly bandaged to stop the bleeding of public confidence. And while
the immediate symptom received treatment, the underlying disease was ignored.
All shareholder equity, for those who invested in Fannie and Freddie, should
have been wiped out. The market should have been left to heal on its own. But
instead, the Fed placed the government version of a Band-Aid on a hemorrhaging
wound. Real treatment of the problem would have been more than the market could
bear.
In the last week or so, we have seen the U.S. dollar strengthen against most
world currencies. Oil prices have subsided back to the $116/barrel level, but
make no mistake about it: It will not last. The long-term prospect for the
dollar remains tenuous at best and the moment the factories go back to work
in China after the Olympics, oil consumption will return and the lower dollar
and higher oil scenario will be back in full swing. Any relief in either of
these areas is an opportunity to get out.
So don't go out and pop the corks on the champagne bottle just yet. Remain
vigilant. In the 1990s, one could place profit ahead of liquidity and safety.
Today, that would be financial suicide. Liquidity should be the No. 1 priority:
Can I get my money if I want or need it? Second is safety: Are my investments
in a relatively safe area of the market? Are they insured if they are in the
bank? Third, look to see a profit. Low interest rates are a sure loss, but
then, you are paying for safety and liquidity.
The best advice I can offer right now is to stay very well diversified. The
long-term portion of one's money can be in stocks. A portion in real estate.
A portion in mutual funds. A portion in bonds and cash. However, a key investment
component would be holdings in gold, knowing this is an investment in your
control, not a bank's, one that's private, portable and potentially very profitable,
and one that has long been a reliable anchor in a financial storm and insurance
against an uncertain future.
As Will Rogers once said, "I am not as concerned about the returns on
my investment as I am the return of my investment."
Future writings in this space will discuss the geopolitical events that may
change things at a moment's notice. For instance, the threat of Iran taking
control of the Strait of Hormuz – and 30 percent of the world's oil supply – is
real. Russia, China, India and Brazil (the so-called "BRIC" economies)
and their growing economies are fully ready to compete and win in the battle
against America for world customers.
Are we prepared for all this, and more?
These are very uncertain times, most of it out of your control. That is why
the only investment strategy that will provide a good night's sleep is one
strictly based on a well-diversified financial portfolio. (Please feel free
to speak to one of the representatives at Swiss America, who can help inform
you on all the latest trends and options,
so your hard-earned dollars are protected against all possible scenarios.)
