As the credit orgy ends, and the excess leverage of the past years unwinds, few people have experienced any real pain. Big banks such as Citigroup have lost tens of billions, but who cares? There were rich Asian and Middle Eastern investors flush with cash who were happy to infuse it into Citi for a big chunk of equity. The only people hurt by this were existing Citi shareholders.
What happens to all of that “money” we thought we had when houses were priced higher? Individuals felt rich for two reasons: first, their personal balance sheets looked great because their houses were worth a fortune. Second, people extracted all the equity they could from their houses to consume. Ok, that’s all over now, so what happened to all that money people thought they had? Did it just evaporate? The velocity-of-money effects that pushed everything higher should now be working in reverse.
But the good thing about having a central bank and a paper currency is that you can literally create more money out of thin air. By lowering interest rates, issuing repos with junk as collateral, deficit spending, accepting a bunch of Asian money, the broad monetary base is being replenished.
If the Fed can pull us out of this mess without any real pain I will be shocked. It just doesn’t seem possible that you could unwind from a massive debt bubble without a recession. There just has to be some pain.
Middle class people in this country are hurting. They work night and day and yet their incomes, in real terms, are declining. Worse, they are consuming themselves into incredible amounts of debt and saving nothing. If we acknowledge that much of this consumption was financed with debt and was unsustainable, how can we possibly get out of it with a quick fix? It seems obvious to me that people need to stop spending so much — they need to downsize.
If people actually started to do this though, a long recession would be almost unavoidable. There are very powerful interests all over the world that will fight this with all their money-printing might. Because of the demographic issue facing the rich world, everyone is terrified of what happens if the US consumer has a change in outlook and starts to save instead of consume.
Ok…. None of this is news. What do we do with our money now?
Here are two important themes that shape my views. They could be completely wrong, by the way, so feel free to trash them in the comments (or to me in person) if you disagree.
1) As anybody who reads this blog knows, I think we will have lots of inflation in the coming years. Inflation of 3-4% may not seem like a lot, but if it is sustained over a multi-year period the cumulative effects will be huge. My prediction is that gold will resume its standing as a currency and will continue to gain value against paper currencies all over the world. Or, you could look at it this way: paper currencies will lose purchasing power while gold maintains its value.
2) Because of #1, US Treasuries look massively overvalued to me. They are priced as if we are going to experience deflation, something which the Fed will do absolutely anything (including trashing the value of the currency) to prevent.
3) “Emerging” economies all over the world have realized that the way to improve their standards of living is through markets. Capitalism, in one form or another, is on a tear across the world. You can’t have free markets without strong private property rights. These laws are being strengthened all over the world… especially in the BRIC countries (well, maybe not Russia).
What this means is that stocks will be a great way to make money! US Multinationals will probably do well, but we are seeing the emergence of new multinationals coming from what we use to call “the third world.” Personally, I think the Indian stock market will be a fabulous way to make money in the coming decades. As with the United States during its industrialization (18th & 19th Centuries), the path to prosperity was anything if not volatile. Same thing will happen in India and China – there will be huge booms and busts. The key is to be liquid and prepared to buy after the next crash.
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