Monday, April 25, 2011

Train Wreck Ahead

Regular visitors to this site are aware of my concerns about the serious economic problems confronting the U.S. Lately though, it seems we’ve passed a tipping point of sorts, with potential implications more ominous than the 2008 crisis that almost brought the country (and the world) to its knees. Forgive me for sounding alarmist, but you really need to know what’s going on and what, if anything, you can do about it.

Should you care about my opinion? Well, before becoming an economics teacher, I spent 15 years in the investments business in the 1970s and ‘80s: as a market analyst, a commodities trader, and ultimately a V.P. with a major brokerage firm. There were also 15 years teaching finance and investments courses at colleges in the 80’s and 90’s. And studying and teaching economics for the last 20 years. Plus, I’m not selling anything: not writing a book, running for office, or pushing an investment. So yes, you might want to listen.

Contrary to my normally wordy nature, I’m going to cut to the chase here. The U.S. dollar faces a huge loss of confidence worldwide. Exacerbating the trend in that direction were several remarkable and very disturbing things that happened in the last few weeks. Congress fought like cats and dogs until the very last minute to come up with a budget that cut the deficit by a measly $38 billion. They almost shut the federal government down because they couldn’t agree on whether to cut spending by $30 billion or $40 billion – this with a total budget deficit of $1,655 billion. Right then and there, it became obvious to me and anybody else watching that there is no way that Congress is going to get our ruinous debt under control. Will not happen. This is a big problem, but one that most Americans don’t really understand or care much about.

The key to taming this runaway debt train is to make major changes (cuts, basically) to the “entitlement” programs, e.g. Social Security, Medicare, and Medicaid. But nobody wants to do it. A recent ABC poll shows that 78% of all Americans are opposed to such changes. So that’s just not going to happen, at least not any time soon. Spending on health care, welfare, and pensions – a similar category to the entitlements we’re talking about – accounted for just over 40% of all federal spending in the 1970s and 80s. It’s risen sharply in the last 20 years, however, and now eats up over 60% of all federal dollars. The trend is higher still and nobody has the cajones to stop it.

None of this has been lost on the financial markets, as the dollar has swooned and gold and silver have soared. These trends accelerated last week after Standard and Poor’s signaled that for the first time ever, the United States credit rating was in danger of being downgraded. In other words, investors may soon be less willing to loan Uncle Sam more money, which would present a huge problem to a country addicted to borrowing and unable to cut more than $38 billion out of its deficit. Meanwhile, the other day for the first time I heard relatively intelligent people talking about the outside possibility of the U.S. defaulting on its debt. That possibility, which I previously would have estimated at 1 in 100, may now be as high as 1 in 4. Still unlikely, but not such a long-shot anymore.

All of this is incredibly disturbing, as the U.S. dollar is the lynchpin of the world’s economy and U.S. debt is the world’s “gold standard”. Let me put a finer point on it: if the world loses confidence in the U.S. dollar and our debt, it’s game over, the house of cards tumbles – pick your metaphor. I’m not even going to get into all the ramifications, but they are ugly and, again – ominous - and could have us looking back rather fondly at the gentler times of 2008’s Great Recession. At the very least, these developments imply that the U.S.’s standing in the world, and our own standard of living, are certain to continue sliding for many years to come. It’s very sad, actually, having front row seats for this train wreck that is slowly but surely developing.

What can you do about it? Well, encouraging our politicians to get real and get over their political selves would be one thing. But on a more personal level of protecting yourself, you should re-evaluate your investments. Don’t have any? Well geez, you may be in for a tough ride, as the general cost of living will probably rise sharply from here, with incomes lagging far behind. But for the rest of you, here’s some ideas:

The biggest thing is to diversify out of dollars. Money in the bank, money in bonds – those are likely to lose value in the future, perhaps dramatically so. That’s why the stock market, oil, precious metals, and certain foreign currencies are going up. Investors are shifting out of dollars and fleeing into anything that has real, intrinsic value. Now if things start getting ugly, the U.S. stock market’s not going to be happy, so you don’t want to be heavily invested there. Foreign markets? Asian and the BRIC markets should fare better, but remember: “when they raid the whorehouse, they take ALL the girls”. Translation: still not a great place to be.

Oil and other natural resources could be a decent play for a small chunk of your money. They’re a bit expensive now, but will likely move higher in the long run, especially if the dollar really tanks. All the recent reporting about how higher oil prices are just a scam by the oil companies and speculators misses the big picture, which is about political risk in oil producing countries and currency risk the world over. I like DBE (on the NYSE), which invests in a variety of energy markets. There are lots of other ETF (Exchange Traded Fund) natural resource plays out there, too.

Gold and silver might be the best way to protect yourself from what’s coming, although quite risky (in the short run) at these high prices – especially silver. There's been a literal panic into silver in the last couple of weeks, all around the world. But in the long-run, they’re still likely to go much higher as people scramble for alternatives to a crumbling dollar. Look for mostly lower prices for a few months, before things heat up again. Buy bullion gold coins and silver rounds, and/or invest via the gold and silver ETFs of GLD and SLV, when prices dip.

The most interesting option at this point may be the Swiss franc. Unlike the U.S. dollar and the equally shaky euro, the franc benefits from the Swiss penchant for living within their means and protecting the value of their currency. And really, where else are people going to put their money? In the BRIC’s rupees, rubles, reals, or yuan? Maybe. In the Japanese yen? Perhaps, but the franc is the world’s premiere stable currency, and its outlook is bright. The Australian dollar is another possibility; you can buy FXA to participate in that currency, or FXF to be in the Franc. Unlike gold and silver, they’re more reasonably priced now and not as volatile (don’t move up and down so wildly).

The Chinese have a saying: “May you live in interesting times.” So perhaps we should consider ourselves blessed. I may be wrong; the politicians and the public may have a change of heart before it’s too late and my fears may all be for naught. But the smart money’s not betting on that horse, and if they’re right, we’re in for something much more than just a little hiccup. Make sure your financial house is in order, since the country’s isn’t. Limit your exposure to a discredited U.S. dollar as much and as soon as you comfortably can.

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