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March 21, 2010

How to Prepare for a Financial Meltdown

People want to know what to do to prepare for a double dip recession, or even worse, a repeat of 1929-40, or even worse than that, a complete loss of confidence in the US dollar.  The following is not meant to be an alarmist view of our situation, but, rather, my view of what people who wish to protect themselves should consider doing.

While many take comfort in thinking that only radicals think along these lines, it is also important to understand that many of the steps people should take to protect themselves are steps they should be taking anyway to gain greater security.  They are not necessarily mutually exclusive ideals.

1) Security of house and home.

During the roaring 90s people were taught to borrow as much as possible and invest it in the stock market.  With interest rates so low and the stock market recovering so quickly, there is a temptation to do this now.  This temptation should be avoided.  The number one priority, if you can accomplish it, is to pay off your debts so that you own all your tangible assets free and clear of debt.  Absent that ability, you should fix your interest rates so you know exactly what you will be paying to borrow.  Inflation only works to your advantage if you can't possibly lose your assets to creditors. Recommended Timing: Do now. 

2) Security of basic needs.

If we have inflation, the prices of basic goods will go up.  For this reason, it is not a waste to stockpile basic goods such as paper products and cleaning supplies.  Some food supplies also last a good, long time and can be rotated out so you are using older goods as you replace them with newer goods.  Keeping an inventory also allows you to stockpile on sale rather than having to replenish goods at higher prices.  Don't simply think coupons and Walmart.  Some things can be bought in bulk from Amazon or Ebay for a fraction of what they cost in a store.  Note also, that the week between Christmas and New Year's is the very best time of year to stockpile.  Companies are trying to clear out in advance of taking inventory and they are also trying to make their numbers for the year.  If you are really concerned, the most important thing you can stockpile is bottled water.  (Wine is also good cuz at least you'll go out happy!)  Recommended Timing: Do between now and 1/1/2011.  

3) If you want to invest in precious metals you must buy the physical metal, not an ETF or the stock of a metals producer.  Gold is only useful as a hedge against the complete debasement of the US dollar, aka Armageddon.  In an Armageddon situation, I can assure you that you will not be able to convert a gold stock to the real thing.  So if you must hold gold, hold physical gold.  Interestingly, with all the tracking of assets in this country under the Patriot Act, precious metals is the one asset class that is being freely traded and not tracked.  When you buy and sell gold, nobody tracks the transaction and nobody withholds taxes (as long as each cash transaction is less than $10,000).  This is a huge oversight when it comes to tracking wealth flows, but there you have it.  (I don't know anybody who has ever paid taxes on the increased value of their gold when they sell it.)  People may not accept gold in exchange for food, but at least you will be able to pay your real estate taxes when taxes are re-established (historical reminder: taxes were suspended during the Civil War but reinstated afterward and many Southerners lost their plantations to Northern carpetbaggers due to failure to pay their taxes).  Recommended timing:  If 10 year treasury yield hits 6% or better. 

4) If you want to invest in currencies, invest in physical currencies.  There are plenty of Thomas Cook and American Express offices where you can trade US dollars for foreign currencies.  (historical note: privately held gold was confiscated in 1933 so it's good not to have all your eggs in one basket)  Do your homework.  No Euros or British Pounds.  Stable countries with little national debt are best.  (Think Aussie dollars, New Zealand dollars not just for their stability but also for their physical isolation from countries with currency problems; Canadian dollar due to stability and proximity to US)  Recommended timing:  If 10 year treasury yield hits 7% or better.

5) Stocks actually appreciate when the dollar devalues, so, if you can stomach the volatility, stay invested.  If you are squeamish about holding stocks (with put protection, of course), concentrate on large cap companies that pick up market share from smaller players who don't have sufficient purchasing and borrowing power to survive a Darwinian flush.  If you are aggressive and like banks, think about owning the perpetual preferred. 

6) If you are going to own Treasuries, own inflation adjusting TIPS.  These are actually preferential to US dollars held in an FDIC-insured bank since the govt can't inflate its way out of TIPS. 

7) Avoid buying new bonds with long-dated maturities until inflation peaks, unless you are a major player and what you are really after is the underlying assets of the company (ie. its real estate).  Avoid general obligation municipal bonds (bad, but less bad, are munis that have a dedicated revenue stream such as tollway bonds).   

8) Get your foreign exposure through American companies with foreign exposure, rather than through direct investment in foreign companies or foreign assets.  (Don't be shocked if a foreign government (think China) seizes US-owned foreign assets in lieu of debt repayment.)  We are heading for protectionism whether we like it or not.

9) If you are really, really, really concerned and want to buy a gun, for heaven sake, don't forget the ammunition.  (Note that there is currently an ammo shortage in the US with a three-six month wait for quantity discount purchases.  See the letter from Winchester to its customers, it's hilarious.)





House of Cards

I cannot begin to tell you how concerned I am about the true state of our nation's finances.  I am also deeply concerned about the portable nature of the wealth of the top 5%, which makes taxing the rich to make up the difference a very bad idea, indeed.

Here are the scary facts:

1) Although the current national debt is "only" $12.5 trillion (http://www.usdebtclock.org/index.html), we are currently running a budget deficit of $1.5 trillion. "Growing our way out" would require a sudden 50% increase in private sector GDP at an average tax rate of 25%.

2) The FDIC is broke (http://www.fdic.gov/about/strategic/report/index.html), but has access to loans from the Treasury to help defray the cost of bank defaults.  37 banks have failed in 2010 vs 20 in the same period in 2009.  (http://www.fdic.gov/bank/individual/failed/banklist.html).  Total Assets of FDIC insured banks is 13 trillion, but tangible equity capital is only 10%, leaving the US Treasury at risk for up to $12 trillion of potential FDIC liquidity needs.  Nonperforming loans on the books of FDIC insured banks reached an all-time high of 5.4% of total assets at 12/31/09 and total loans decreased 7.5% in 2009.  (http://www.fdic.gov/news/news/speeches/chairman/spmar1910.html).  Bankruptcies in 2009 were 33% higher than in 2008 at almost 1.5 million nationally, putting additional stress on banks.  

3) 2010 marks the first year that the social security administration will be net sellers ($29 billion) of US Treasuries.  In the past, the payouts have been less than the taxes collected, and the difference went to purchase treasuries.  No right-minded retirement planner would ever recommend that someone have all their retirement eggs in one basket, but if you were to look in the coffers of the Social Security administration, all you would find is $2.5 trillion in US Treasuries.  Once the baby boomers start retiring in 2012, the fund quickly runs out of money.  In 2017, the SSA will start spending more than it takes in.  (unless, of course, taxes go up and/or retirement age gets pushed back) The net present value of the baby boomer generation's retirement claim on our society is approximately $7 trillion.  And since Social Security benefits are inflation adjusted, we cannot inflate our way out of the cost of our aging population.

4)  Like the FDIC, Fannie Mae and Freddie Mac are broke, and yet they continue to guarantee 95% of all mortgages currently being originated in the US.  Although their balance sheets look somewhat benign at about $900 billion each, the real problem is with their guarantees, which are referred to simply as "off balance sheet items" and total more than $5 trillion.

5) A 1% increase in the average interest rate on our national debt would equate to $125 billion annually.  That's more than the entire net worth of Bill Gates and Warren Buffett combined.

6) 48 out of 50 states are insolvent and continuing to look to the federal government for financial help to the tune of $100 billion annually.

7) Short of printing money the Fed is broke, having total liabilities of 2.25 trillion against capital of just $53 billion. http://www.federalreserve.gov/releases/h41/current/  


Complicate all the above with the shortening maturities of treasuries, looming commercial real estate default, the refusal of the average American to move to fixed rate mortgages from adjustable rate mortgages, and the shark-mentality of Wall Streeters who see all this and are shorting Treasuries and you have a disaster in the making.

In short, there is no "there, there".  All it would take is a minor jolt, a crisis of confidence in our society, to bring the whole house down.    

March 18, 2010

Consumer Credit? Are You Serious?

Yesterday, Sean got a letter from Banana Republic notifying him that the limit on his store credit card had been reduced to $100. 

$100?  Seriously?  What kind of unanticipated shopping spree can you have for $100?

And trust me, stores like Banana Republic, the Gap, and other youth-oriented retailers need all the spur-of-the-moment buyers they can lay their hands on to drive revenues in this economy.

Was Sean risky credit?  Far from it.  At present, he actually has a $175 debit balance on his Banana Republic card due to the fact that he and I had accidentally both paid his most recent bill!  

Seems to me like this notice is a clue that retailers are having a hard time collecting their debts (or perhaps getting loans against their receivables).  Either way, such a move is bound to have a negative impact on revenue in 2010.